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Gettin' down with cap 'n trade

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Brendon Bosworth | Oct 19, 2012 06:00 AM

Next month, California will hold the first auction as part of its carbon cap and trade program. The program, which will be the second largest CO2 emissions trading system in the world, has been in the works since 2006, when the Golden State passed the Global Warming Solutions Act, a piece of legislation that mandated chiseling down greenhouse gas emissions to 1990 levels by 2020.

A cap and trade system puts a limit on the total amount of carbon dioxide polluters can emit – that’s the cap. For its initial cap, the California Air Resources Board (CARB) set a CO2 limit of 162 million tons. That goes into effect next year, when the program kicks off. At first, only electrical utilities and large industrial plants will be capped. In 2015, companies that distribute fuels -- gasoline, diesel, natural gas and the like -- will be added. (The cap will rise when they enter the program.) The  cap amount is divvied up into a number of “allowances” or “credits” -- each allowance entitles the owner to emit one ton of carbon dioxide.To start, California will give carbon emitters allowances worth 90 percent of their yearly carbon emissions for free. If they need to emit more carbon than that, they can buy more allowances at auctions held every three months. Those who reduce emissions can sell their extra allowances at the auction and make money. Those who don’t have to pony up to pollute.

TraderOver time, the overall cap diminishes (by 2 percent in 2014 and 3 percent yearly from 2015 to 2020), which means there are less allowances to go round and it becomes more expensive to emit carbon based on standard supply and demand mechanisms. This, it is hoped, will lead to reductions in greenhouse gas emissions as emitters seek to cut the cost of doing so.

Cap and trade programs are not new. In the U.S., companies have been trading allowances for sulfur dioxide emissions, the gas produced by coal-fired power plants that causes acid rain, since the mid-90s. By 2009 that program had reduced emissions of the acid-rain causing gas by 67 percent from 1990 levels.

On the East Coast, power plants in nine states are trading carbon credits through the Regional Greenhouse Gas Initiative. (Initially there were ten member states but New Jersey bailed on the plan.) In the first three years, power plants in that program cut emissions by 23 percent. And in the European Union, states have engaged in carbon trading since 2005.

The possibility of a federal carbon cap and trade scheme, however, withered away and died a pauper’s death back in 2010, dragging the Chicago Climate Exchange, a voluntary emissions trading system that operated from 2003 to 2010, into the grave with it. But California has forged ahead, despite legal challenges and critics conjuring up an exodus of businesses out of the state to avoid costs that come with the system.

Like any market, there will be winners and losers. And like any market, there are also incentives to win by skirting the rules and exploiting any loopholes in the system. The California Air Resources Board maintains that the program is structured to minimize foul play. A report from researchers at the University of California Los Angeles confirms that it is “unlikely” that CARB “will experience market manipulation that can significantly affect the efficiency or fairness of the market.”

One weakness, however, lies in poor incentives to accurately report emissions, which participants can underreport up to 5 percent without penalty, according to the UCLA report. If all participants decide to underreport their emissions by 5 percent each year then it would mean that the program would be a year behind its reductions target, explains Rhead Enion, a Frankel Fellow in Environmental Law and Policy at UCLA School of Law, and one of the report’s authors. Companies should have to make up all of the difference in underreported emissions, he says.

The 5 percent buffer allows for inaccuracies in measuring carbon emissions at large plants, says Dave Clegern, a spokesperson for CARB. “We didn’t want to be so stringent that we wouldn’t be able to take into account normal kinds of variances you would have considering the volumes of heat and fuels that are being processed.” Third-party verifiers will be checking facilities and their emissions reports for accuracy, he adds.

When it comes to deterring companies from emitting carbon dioxide without buying allowances to cover those emissions, on the other hand, the program is strong, the UCLA researchers say. Emitters that fail to buy allowances for their emissions have to buy four times the number of allowances needed to cover the unaccounted emissions. The California Air Resources Board can freeze violators’ accounts if they continue to pollute without paying.

With safeguards against market manipulation in place, and the first allowance auction set to happen on November 14, supporters and foes of cap and trade are watching California with interest. “If the California market is deemed a failure, I just don’t see how, particularly in the U.S., you’d get anyone else interested in a cap and trade program,” says Enion. “If it goes well, then promoters of putting a price on carbon are going to point to the California model.”

Brendon Bosworth is a High Country News intern.

Image courtesy Andyhill8 via wikimedia commons.

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