The climate and clean energy bill that narrowly passed the House has three problems related to cost containment (CC) that the Senate should — and I expect will — address:

  1. Fence-sitting Senators (and industries) worry that its CC provisions aren’t hard-nosed and specific enough to protect the public and businesses from carbon prices that get too high too fast, possibly driven by speculators.
  2. Progressives worry that its CC provisions are already too strong and that some proposals floating around to strengthen CC would environmentally weaken an already weak bill.
  3. The major CC provision in the bill — the strategic reserve — is so opaque that it is understood by a handful of people at most and none of them are U.S. Senators.

I’m going to try to take the best of all the current CC proposals and propose an alternative that I think might actually be appealing to all sides, what I’m calling “price collar plus.”

Two weeks ago, the Brookings Institution — which I’d view as center-right on the energy and climate issue now that David Sandalow has left — proposed a traditional price collar in Politico, “Time for a price collar on carbon.”  To their credit, they did suggest this was a way to “rein in offsets” but offered no specifics on how to achieve that important end.

The benefit of a price collar to Brookings:

By preventing the policy from being either unexpectedly lax or unexpectedly stringent, a price collar protects both investors in green technologies and households and preserves strong incentives to abate.

The House climate bill already has a price floor for the auction, which starts at $10 a ton in 2012 and rises 5 percent plus inflation every year thereafter.  I believe most everyone understands the need for a rising price floor — giving some certainty to businesses about investment decisions they make, say, in biomass cofiring or natural gas fuel switching.  The floor in Waxman-Markey is, by almost every independent analysis, on the low side in the sense that the CBO and EPA and especially the EIA project the price for a CO2 allowance in 2020 will be above the floor — in EIA’s estimation, double the floor price.

The fossil fuel industry, of course, funds economic analyses that project incredibly high allowance prices to scare people into opposing the bill entirely.  If their analyses were anywhere near accurate, the floor in the House bill would be utterly irrelevant.  I’d love a higher floor, but since it has already passed the House, we’re probably stuck with it.

A price collar, of course, requires a ceiling to go with the floor.  Brookings explains:

 The price ceiling could work like the “safety valve” included in a 2007 bill introduced by Sens. Jeff Bingaman (D-N.M.) and Arlen Specter (D-Pa.), which would have allowed the government to sell additional emissions allowances if permit prices rose above a preset ceiling.

That kind of cap-busting safety valve is not good from an environmental perspective (see “Safety Valves Won’t Make Us Safer“).  That’s why I have long opposed such safety valves (see “The history of the ‘safety valve’ debate“), especially when set at ridiculously low levels, such as $7 per metric ton of CO2-equivalent (and rising a tad above inflation annually), as the National Commission on Energy Policy proposed in 2004.

NCEP’s new report, “Managing Economic Risk in a Greenhouse Gas Cap-and-Trade Program,” also endorses a safety-valve-type ceiling, but then wisely offers up this proposal:

An allowance reserve coupled with a price floor offers, in our view, many of the benefits of a simple price cap and has the not insignificant advantage of providing greater certainty about cumulative emissions reductions over the time horizon of the program.

Exactly.

You don’t want the government to sell an unlimited number of allowances that represent no emissions reduction whatsoever at the ceiling price.  You want to borrow the best feature of the strategic reserve, which is that the allowances the government sells are, to start, skimmed off of the emissions caps from 2012 to 2050.

In Waxman-Markey, a pool of allowances is made available for strategic reserve auctions consisting of

  • 1 percent of the allowances established for each year from 2012 to 2019
  • 2 percent of the allowances established for each year from 2020 to 2029
  • 3 percent of the allowances established for each year from 2030 to 2050

That was, I think, a good compromise by environmentalists.  It acts a lot like a safety valve, but maintains environmental integrity (at least to start).  The enviros (and whoever else signed off on this deal), however, made two mistakes.

First, in the final House bill, they set an initial trigger price for the strategic reserve of $28 — which is the equivalent of the “ceiling” or “safety valve” price — but that price quickly shifts to 160 percent of the average auction price of allowances over the previous 36 months.

Zzzzzzzzzz.  Crickets chirp.  Glaciers melt.

That approach was dissatisfying to everybody — or rather it was confusing to everybody and dissatisfying to the few people who wasted time figuring out what it meant.  For progressives who think there are an overabundance of domestic clean energy solutions available, and hence that the permit price will stay close to the floor for at least a decade (see here), it meant the reserve auction trigger price — aka the effective ceiling price for allowances — might be maybe only $22 a ton in CO2, a ridiculously low ceiling.  And that meant if we turned out to be wrong about, say, the supply of moderate-cost natural gas, then even a tiny allowance price spike would trigger the reserve auction.

But for moderates and conservatives, who tend to believe that the allowance price in 2020 will be much higher, even higher than EIA’s $36 a ton, then the ceiling in 2020 might be $60 a ton or higher, which for them is no protection at all from speculators or from the technology optimists being wrong or from offset prices being much higher than they thought.

The point is, the strategic reserve “ceiling” price in the House bill was designed in a manner to make everybody unhappy.  For instance, NCEP — which I’d characterize as center right today (see here) — was worried the ceiling/safety-valve price in 2015 might be as high as $49 a ton [though I think they did their math a little wrong].

Now NCEP does say:

We do not take issue with the initial allowance trigger price proposed in Waxman–Markey (at $28 per ton)—rather our concerns focus on the method used to calculate the trigger price in subsequent years.

Me, too.

A majority of House members voted for the reserve trigger price to rise 5 percent plus the rate of inflation for 2013 and 2014 until the complicated formula kicked in for 2015 on.

So I’m going to propose what I think is the simplest and most obvious fix: The floor price for the regular allowance auction should start at $10 a ton in 2012, and the reserve trigger price (aka the effective allowance ceiling price) should start at $28 a ton in 2012 — and those collar prices should rise 5 percent plus inflation every year thereafter.

NCEP elaborates on the benefits of a price collar:

A “price collar” retains the economic efficiency benefits of a price ceiling alone, which has been shown to be nearly as efficient as a carbon tax.  Moreover, recent research — [RFF’s“Alternative Approaches to Cost Containment in a Cap-and-Trade System“] — has demonstrated that a “price collar” approach has the additional benefit of reducing long-term emission abatement costs relative to expected long-term abatement costs with a price ceiling alone. This is because the policy provides more consistent financial incentives for sustained investment in low-carbon technologies that can reduce compliance costs in the long run: Rather than being subject to boom-bust cycles when allowance prices fall, new low-carbon technologies would be assured a certain level of market stability. This would allow them to develop in a more orderly and ultimately cost-effective way.

But NCEP also explains the value of the reserve:

… a robust, well-designed reserve auction mechanism could be extremely useful for increasing public confidence in the nascent greenhouse gas market. If true costs are much higher than projected, the reserve would provide a “cushion” while Congress considers whether further program adjustments are needed. On the other hand, if allowance prices are in line with, or modestly above expectations, the allowance reserve auction would never be triggered.

Price collar plus should be attractive to both sides.

Fence-sitting Senators and industries can legitimately see it as achieving stronger cost-containment protection than their analysis suggests the House bill now provides, including protection against speculators running the permit price up, while progressives can legitimately see it as achieving better environmental outcomes than their analysis suggests the House bill now provides.  Win-win.

TWO FINAL TWEAKS

I would keep the W-M provision that “the annual limit on the number of emission allowances from the strategic reserve account that may be auctioned is an amount equal to 5 percent of the emission allowances established for that calendar year.”  It is hard to see how one would need more than 5 percent in any given year, especially when there are so many domestic and international offsets available for emitters to purchase — and of course so many strategies emitters can use to reduce their emissions and hence their need to purchase permits.

BUT I would change how Waxman-Markey refills the reserve once the initial reserve is auctioned out.  W-M fills the reserve with “international offset credits from reduced deforestation.”

Bad idea.  Reduced deforestation should be utterly separate and additional.  We have no hope whatsoever of averting catastrophic global warming if we don’t sharply cut fossil fuel emissions here (and abroad) while simultaneously stopping deforestation [see “How the world can (and will) stabilize at 350 to 450 ppm: The full global warming solution“].  And one of the best things in the House bill is that it already devotes substantial funds generated from the allowances to stopping deforestation — achieving some 720 million tons of emissions reductions in 2020, equal to 10 percent of total current US greenhouse gases — all of which are additional to the domestic GHG reductions.  The notion that deforestation tons should be separate and additional should be be an inviolate principle of U.S. action.

No, I would fill the reserve with domestic offsets.  I’m not really expecting the initial reserve to sell out until well past 2020.  And I know the businesses who signed onto this deal wanted a large pool to refill the reserve — but at the likely trigger or ceiling price post-2020 (more than $40 a ton of CO2e), there would in fact be a lot of domestic offsets.  And I have more confidence in our ability to ensure the quality of domestic offsets than I do of our ability to ensure the quality of international offsets (though I do expect the quality of the latter to get better).  Moreover, if CBO is right, then half of the domestic offsets are going to be genuine emissions reductions in uncapped sectors.  And the other half will be soil/forestry/agricultural sequestration, which should make certain politically powerful domestic groups happy.

So this strikes me as both better environmentally and more attractive politically to US Senators.

Finally, I’d like to re-offer my suggestion of how to “rein in offsets,” as Brookings suggests.  I consider all of the following cost containment measures a major concession by those who want the strongest possible environmental integrity for the bill:

  • Price collar plus.
  • Too weak of a 2020 target.
  • Up to 1 billion domestic offsets in place of emissions allowances.
  • Up to 1 billion international allowances (a number that can be potentially revised upward to 1.5 billion if the domestic number is revised down).
  • Allowances distributed to regulated utilities and other entities to directly mitigate cost impacts on the public and businesses.
  • Tremendous energy efficiency efforts that will also directly mitigate cost impacts on the public and businesses.

So my final recommended change is one I have been proposing for a while — sunset the offsets. My more politically palatable version is to apply the same reduction to the offsets that you are applying to emissions in the bill:

  • a 17 percent cut by 2020 (to 1.66 billion tons)
  • a 42 percent reduction by 2030 (to 1.16 billion)
  • an 83 percent cut in 2050 (to 0.34 billion)

I am aware that the domestic offsets are probably too popular to sunset — so the sunsetting could be applied simply to international offsets.  The other advantage of that, as one economist told me, is that it would provide extra motivation to developing countries to engage in the process early, since they’d know that the U.S. wasn’t going to keep purchasing international offsets forever.

There it is — price collar plus.