How Does a Cap-and-Trade Program Work?

Posted on February 3, 2010. Filed under: Advanced Biofuel, cap-and-trade, Hydrous Ethanol | Tags: , , |

U.S. Energy Information Administration
February 1, 2010

What is a cap-and-trade program and how does it work?
A cap-and-trade program is designed to reduce emissions of a pollutant by placing a limit (or cap) on the total amount of emissions. The cap is implemented through a system of allowances that can be traded to minimize costs to affected sources. Cap-and-trade programs for greenhouse gas emissions would increase the costs of using fossil fuels.

A cap-and-trade program is different from an emissions tax. An emissions tax is a fee on each unit of emissions released. A tax sets a price on emissions, which provides an incentive for emissions reduction, but allows the actual amount of reduction that occurs to vary.

A cap-and-trade program sets the quantity of emissions, letting the price of allowances be set in the marketplace. However, both programs ultimately place a value on emissions and provide incentives for emission reductions.

What Is a Cap-and-Trade Program?
A cap-and-trade program is an environmental policy tool designed to reduce emissions of a pollutant by placing a limit (or cap) on the total amount of emissions that can be released by sources covered by the program during a fixed time period.

The overall cap on emissions is implemented through a system of allowances. Each allowance represents the right to emit a specific amount of emissions, and each emissions source covered by the program must submit enough allowances to cover its actual emissions. These allowances, sometimes called permits, are initially allocated to affected sources or auctioned off by the agency implementing the program.

Allowances can be traded, which creates an incentive for those who can reduce emissions most cheaply to sell their allowances to those who face higher emission reduction costs. The incentive to trade allowances persists as long as one or more sources can reduce emissions by an additional unit at a lower cost than some other source faces to achieve its last unit of emissions reduction. Therefore, allowances will be traded until the marginal cost of emission reduction is equal across all covered sources. At this point, the pollution level required by the cap is achieved – theoretically at the lowest possible cost to society – regardless of how the allowances were initially allocated.

How Does a Cap-and-Trade Program Work?
Not all cap-and-trade programs are identical. Below is a list of four characteristics shared by all cap-and-trade programs, with some possible variations shown. These variations could affect how a particular program works.

1. A limit or cap on emissions of a pollutant is established.

Who is required to limit their emissions. Is it all sources of emissions or just some sources of emissions?
What area the cap covers. Is it a region or State, the whole United States, or a group of nations?
When emission limits take effect. Will the cap be in place in the near term or at a later date?
Whether the cap will become tighter, meaning the total allowable level of emissions drops over time. If so, how quickly will this decrease happen?
When the cap is in place. Will it be in effect for a season – such as just for the summer months – or is it applied for the whole year?

2. An allowance must be surrendered for every unit (often a ton) of emissions generated.

Who must submit allowances. While this depends on the specific cap-and-trade program, some examples include producers of the polluting substance, distributors of a product whose production or consumption generates emissions, States, or even nations.
How allowances are initially distributed. Allowances could be auctioned, distributed for free based on current or historical emissions, or given out using some combination of an auction and a free distribution. In an auction, allowances are sold to the highest bidders. Uses of auction revenue depend on the specific cap-and-trade program, and could include the distribution of a portion of the revenue to consumers.
Whether the program allows for the purchase of offsets in lieu of allowances. Offsets are certified reductions in emissions from sources that are not required by the cap-and-trade program to restrict their emissions.

3. Allowances can be traded.

Here’s an example of how the trade could work. Emitter ABC found it really easy and cheap to reduce its emissions below the level covered by its allowances, while Emitter XYZ had a tougher time. ABC was able to make larger reductions in its emissions and offered to sell its extra allowances to XYZ. This transaction was a good deal for XYZ because the cost of allowances it bought was lower than the cost of equipment needed to reduce its own emissions to a level that matched the number of allowances it held before buying more allowances from ABC.
How much an allowance costs. In general, the allowance price depends on the options available to reduce emissions and the demand for allowances. If there are relatively low-cost options to reduce emissions, the price of allowances would be lower.
Whether emitters are allowed to save – or “bank” – allowances, either for their own future use or to sell to someone else later. Some proposals might also allow the current use of a future period’s allowances.

4. Actual emissions are measured and penalties are assessed if targets are missed.

Depending on the program, these tasks could be the responsibility of one or more governmental agencies.

How Do Cap-and-Trade Programs Affect Our Use of Energy?
The burning of fossil fuels, including coal, oil, and natural gas, is the main source of carbon dioxide – the most important greenhouse gas produced by human activity – and a major source of other emissions. A cap-and-trade program for greenhouse gas emissions would increase the cost of using fossil fuels, making them less competitive with non-fossil energy resources and increasing the overall cost of energy to consumers. The cost of using coal, which has the highest carbon dioxide content and the lowest price per unit of energy among the fossil fuels, would be most affected by a cap-and-trade program for greenhouse gases.

Why Might a Cap-and-Trade Program Be Considered?
A cap-and-trade program allows emitters to have flexibility in their approach to reducing emissions. An alternative environmental policy might require each regulated source to use a specific emission control technology. With a cap-and-trade program, the overall cap on emissions is fixed, but the compliance approach by any individual source need not be specified. This flexibility allows parties to choose the least costly option and should reduce the cost of reaching the overall emissions cap.

The implementation of the U.S. cap-and-trade program for sulfur dioxide beginning in 1995 is an example of the benefits of flexibility in reducing environmental compliance costs in the energy sector. Allowances for sulfur dioxide emissions were actively traded as coal-fired electricity generating units covered by the program chose a variety of compliance strategies. These strategies included installing scrubbers, switching to lower sulfur coal, and buying allowances.

Where Has Cap-and-Trade Been Used?
Cap-and-trade programs have been used to limit several different types of emissions in State, U.S., and international contexts. 

As noted above, a cap-and-trade program limiting sulfur dioxide emissions has been operating in the United States since 1995. The European Union established its Emissions Trading System for greenhouse gas emissions in 2005. In 2009, the Regional Greenhouse Gas Initiative established an interstate cap-and-trade system for greenhouse gas emissions covering electric power plants in 10 northeastern States. Recently, there has been a lot of discussion about the Federal Government establishing a nationwide cap-and-trade program for greenhouse gas emissions.

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President Obama Urges Congress to Pass Energy and Climate Change Legislation that Places a Cost on Greenhouse Gas Emissions

Posted on January 28, 2010. Filed under: cap-and-trade | Tags: , , |

Carbon Traders and Clean-Tech Companies Heartened by State of the Union
By Joel Kirkland
The New York Times
January 28, 2010

It was music to the ears of carbon traders and clean-energy company executives to hear President Obama urge Congress to pass energy and climate change legislation that places a cost on greenhouse gas emissions.

“To create more of these clean-energy jobs, we need more production, more efficiency, more incentives,” Obama proclaimed in his first State of the Union address.

“And yes,” he said, “it means passing a comprehensive energy and climate bill with incentives that will finally make clean energy the profitable kind of energy in America.”

Obama thanked the House for passing a bill in June, sponsored by Reps. Henry Waxman (D-Calif.) and Edward Markey (D-Mass.). At its core, that bill would create an economywide cap-and-trade program that ratchets down industrial carbon dioxide emissions over time by distributing a declining number of pollution permits to electric utilities and factories. Support in the Senate for cap and trade is much more tenuous, because of concern about the economic impact and the creation of an international commodity market for carbon allowances and offset contracts.

“This year, I am eager to help advance the bipartisan effort in the Senate,” Obama said.

Dirk Forrister, director of Natsource, a New York-based asset manager in carbon and renewable energy markets, said extending an olive branch to Republicans is critical to getting that bill passed out of the Senate, and Obama did just that.

‘A deal to be had on climate’
“He acknowledged the differences with the Republicans and said he’d work with them,” Forrister said after the speech. “So I took that as a real encouraging speech for climate and clean energy. There’s a deal to be had on climate if they can get past the partisanship.”

Forrister, former chairman of the White House Climate Change Task Force under President Clinton, and Henry Derwent, CEO of the Geneva-based International Emissions Trading Association (IETA), urged Obama to focus on passing a cap-and-trade scheme this year, rather than jettisoning the House approach for a less comprehensive energy bill. They called on Obama to “establish a clear timeline for passage of an economywide cap-and-trade bill.”

IETA represents some of the world’s largest investment banks and trading houses, most of which have carbon trading divisions poised to inject billions of dollars into a U.S. and European carbon emissions market.

The group asserts that a global financial trade in carbon credits, offset contracts and derivatives would fuel investment in clean-energy projects aimed at slashing global emissions. But it has long said it won’t happen unless Congress creates a U.S. market to buttress any global agreement on emissions reductions and financing programs for developing countries.

Obama placed energy and climate in the context of jobs, perhaps not suprisingly, given rising political pressure to turn his attention to bread-and-butter economic issues.

“I took it as a sign of real seriousness,” Forrister said.

Pitching a race to jobs and green technology
Obama emphasized an emerging race among the United States, China and Europe to capitalize on new clean-energy and battery technology to replace coal and oil, which dominate the world’s energy use.

“There is a race in the global theater,” Forrister said. “Folks in America don’t really like a defeatist attitude. They want a winning attitude.”

Ken Newcombe, CEO of C-Quest Capital, based in Washington, said the mere mention of “green jobs” should be a positive sign to the carbon trading and energy finance community.

“If he mentions green jobs, that’s talking big that he’ll continue on the climate security bill,” he said.

Before the speech, Newcombe warned that mentioning climate directly could complicate the political environment, but he said many investors are already convinced Obama is serious about the issue.

“The president turned up in Copenhagen and was singlehandedly responsible for getting accord out and breaking the deadlock,” he said. “That was a remarkable sign of his commitment.”

For his part, Obama also mentioned some items popular with the GOP: zero-emissions nuclear power plants, oil and gas drilling, biofuels and clean-coal technology.

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Motion in Senate Seeks to Stop EPA from Regulating GHG Emissions

Posted on January 21, 2010. Filed under: cap-and-trade | Tags: , , |

Three Senate Democrats Join Effort to Block EPA Carbon Rules
By Simon Lomax
January 21, 2010

Three Senate Democrats today joined a Republican effort to stop the Environmental Protection Agency from regulating greenhouse gases under existing law.

Democrats Blanche Lincoln of Arkansas, Mary Landrieu of Louisiana and Ben Nelson of Nebraska said they co-sponsored a motion that seeks to overturn the EPA’s finding that greenhouse gases are a threat to public health and should be regulated. The agency has proposed regulations for new cars, power plants, oil refineries and factories that could begin in March.

“This command-and-control approach is our worst option for reducing the emissions blamed for climate change,” said Senator Lisa Murkowski, an Alaska Republican, who wrote the measure. “Congress must be given time to develop an appropriate and more responsible solution.”

Murkowski decided today to seek a disapproval motion of the EPA’s Dec. 7 finding instead of trying to block the agency’s regulations by amending legislation now before the Senate. To pass the Senate, the disapproval motion would require 51 votes, fewer than the 60 required to amend legislation being debated this week to raise the U.S. government’s debt ceiling.

Lincoln said she will support Murkowski’s disapproval motion to block “heavy-handed EPA regulation.”

“I am very concerned about the burden that EPA regulation of carbon emissions could put on our economy,” Lincoln said in an e-mail.

Murkowski didn’t say how soon she would bring the motion to the Senate floor. Her decision will delay a vote on whether the EPA can regulate carbon dioxide from cars, power plants, oil refineries and factories “possibly until March,” Whitney Stanco, an analyst in Washington for Concept Capital, said in a report today.

Murkowski could ask for a vote on the disapproval resolution “at any time,” Robert Dillon, a spokesman for the Alaska Republican, said in a telephone interview.

The EPA’s authority stems from a 2007 Supreme Court ruling on the scope of the Clean Air Act. Legislation to limit that authority and set up a cap-and-trade market for carbon dioxide permits is stalled in the Senate.

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Senate Climate Change Fight Looks as Tough as Healthcare Reform Bill

Posted on December 31, 2009. Filed under: cap-and-trade | Tags: , , |

Senate Climate Change Fight Looks as Tough as Healthcare Reform Bill
By Ben Geman
The Hill
December 29, 2009

Senate Democrats will face a problem when they return in January every bit as tough as crafting the healthcare bill: Assembling a climate and energy package that can be shoehorned into the election-year calendar.

Imposing limits on greenhouse gases is a White House and Democratic priority, but it’s stuck in line behind healthcare, Wall Street reform and jobs legislation.

It’s also become increasingly apparent since the Copenhagen climate summit that the Senate will go forward in a dramatically different direction than the House, which approved its own climate bill last summer.

Environmentalists familiar with Democratic plans say party leaders remain committed to bringing up a bill next year. They are looking to Sen. John Kerry’s (D-Mass.) effort to craft a compromise plan with Sens. Lindsey Graham (R-S.C.) and Joe Lieberman (I-Conn.).

But in a sign of how difficult it will be to cobble together 60 votes, Kerry and Graham have provided few details about what their plan will contain.

They hope to blend emissions limits with wider offshore oil-and-gas drilling, expanded federal financing for nuclear power and a lot of support for low-emissions coal projects, among other measures aimed a navigating a thicket of regional and partisan interests.

Graham noted that different senators are proposing a variety of plans for limiting carbon emissions, and he said he’s open-minded to what is included in a bill, as long as it is a “meaningful control” on pollution.

Some Democratic centrists including Sens. Blanche Lincoln (Ark.) and Byron Dorgan (N.D.), who are both up for reelection next year, want the Senate to take up a broad energy measure that the Senate Energy and Natural Resources Committee approved in June as a standalone bill, rather than grafting it to a cap-and-trade plan.

That’s led to speculation that Democrats might seek to move an energy bill but put off the fight over climate change.

The problem with that logic is that dozens of Democrats want to move a climate change bill, including centrists such as Sen. Arlen Specter (Pa.), who faces a tough primary fight and then a difficult general election battle.

“I think it [climate legislation] is important. I think we ought to take it up,” Specter said in a brief interview last week. He’s also said any final bill must protect manufacturers and provide a major boost for low-emissions coal.

White House officials also are calling for a combined energy and climate package, including an economy-wide cap-and-trade plan.

White House climate czar Carol Browner in November warned against “slicing and dicing,” and a White House aide said Monday that a combined energy policy and cap-and-trade package remains what the White House wants from Congress in 2010.

Linda Stuntz, an electricity industry lawyer who was an Energy Department official under President George H.W. Bush, believes the Senate will bring up a combined climate and energy bill, though she said it will face rough sledding.

“I am in the camp of those who think it is going to be very difficult after the really bruising fight over heathcare,” she said.

Stuntz does not see room in the Senate for a bill that mirrors the House plan. 

“I don’t see an economy-wide cap-and-trade bill happening in 2010,” she said, adding that a narrower emissions plan, perhaps covering only power plants, could be more viable.

Sen. Mary Landrieu (D-La.) said she has been discussing the shape of an energy and climate package with lawmakers including Sens. Bob Corker (R-Tenn.) and Graham.

“It is not off the radar screen,” Landrieu said Wednesday. “There have been quite a few informal meetings that have been going on through the fog of this healthcare bill.”

Reid hopes to bring legislation to the floor in the spring, but that will be difficult given the Senate’s schedule.

A former official in the Clinton White House familiar with the climate change efforts said key negotiations need to start next month on the difficult task of assembling a compromise bill.

“At some point before the end of January several new moderates from both parties have to be brought into the process if we are going to create a bill that can gain 60 votes in the Senate. What it will take to bring those votes into the process is unclear, but those conversations have got to start to happen in mid- to late January,” the former official said.

An aide to Kerry said he was not planning to conduct negotiations on the climate measure over the Senate’s holiday recess.

The sour economy could also complicate plans to impose mandatory emissions limits amid assertions by GOP leaders and many in the Republican caucus that such plans would stifle growth.

But Kevin Book, an analyst with the consulting firm ClearView Energy Partners, argues the reverse is true.

He said that with states hurting financially, the billions of dollars that House and Senate cap-and-trade plans would provide to states through emissions allowances will help boost the chances for legislation that greatly expands federal environmental regulation.

“A weak economy is the only time you can have this incursion into the state regulatory franchise,” he said.

And, he notes, supporters of climate legislation have another card to play: The Environmental Protection Agency’s plan to move ahead with emissions regulations if Congress does not act.

“It is going to be very hard for Democrats to come up with nothing,” he said. “The only really politically viable option for them, thanks to the White House choice to move ahead [with EPA regulations], is to pass something.”

Nonetheless, energy lobbyists are hedging their bets, looking to the jobs bill as well as the hoped-for comprehensive energy-climate package for their preferred provisions. On Monday, the American Wind Energy Association released a list of 10 trends to watch, including the fate of the renewable electricity standard (RES) that requires utilities to supply more renewable power, which the group has been seeking for years.

“Whether it is in job legislation or in comprehensive energy and climate legislation … a strong RES is urgently needed to create hard targets that will fortify our manufacturing base and create tens of thousands of jobs,” the group said.

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