This is another in a series of posts on the Regional Greenhouse Gas Initiative. Previous posts have looked at how the program has been working from the viewpoint of an outsider. This post is a technical discussion of two components of the system currently being discussed in the 2016 Program Design process: the Cost Containment Reserve (CCR) and the proposed Emissions Containment Reserve (ECR).
I have been involved in the RGGI program process since its inception. Before retirement from a Non-Regulated Generating company, I was actively analyzing air quality regulations that could affect company operations and was responsible for the emissions data used for compliance. The opinions expressed in this post do not reflect the position of any of my previous employers or any other company I have been associated with, these comments are mine alone. I am motivated to write these posts on RGGI because the majority of the stakeholder opinions expressed at meetings and in submitted comments are, in my opinion, overly optimistic about the potential value of continued RGGI reductions and ignore the potential for serious consequences if things don’t work out as planned.
Overview of Containment Reserves
The RGGI website has an overview of the cap and auction system that includes a description of the CCR. One of the original stakeholder concerns was cost. In order to put a limit on the cost of allowances the CCR was established to add allowances to the program when the cost exceeds a threshold. The theory is that adding allowances will reduce the allowance cost. The trigger price for adding 5,000,000 million allowances in 2014 or 10,000,000 allowances thereafter was $4 in 2014, $6 in 2015, $8 in 2016, and $10 in 2017, rising by 2.5 percent each year thereafter. The CCR has been triggered twice, in the first quarter of 2014 and the third quarter of 2015, adding 15,000,000 allowances to the system.
One of the primary stakeholder topics of the RGGI 2016 program review is future reductions in the cap. As it stands now the cap declines by 2.5% per year until 2020 and remains at the level. Proponents of future reductions claim that past performance suggests the cap can continue to decline. The ECR was proposed as a possible solution to the cap adjustments. In particular, the ECR decreases the number of allowances auctioned if the price gets too low. The theory is that if the costs are too low that means there is a surplus of allowances and the cap can be lowered accordingly. It seems to me that it could be used as the mechanism to adjust the cap in the future in addition to its price control aspect.
RGGI Allowance Status
The status of the cap and implications on compliance and cost need to be addressed in the context of these containment reserves. Another stakeholder topic in the 2016 Program Design Review is the appropriate size of the allowance bank. The allowance bank is the surplus allowances over and above the compliance requirements. In the first two compliance periods of RGGI the number of authorized allowances far exceeded actual emissions. As a result the bank of allowances was so large that the RGGI states made interim adjustments to subsequent auctions to lower the number of allowances available.
The appropriate size of the bank is controversial. Advocates for more reductions want a smaller bank so that reductions occur sooner. Proponents of higher allowance prices want to reduce the size of the bank because fewer available allowances should drive the price up. However, there are reasons that the bank should not get too small. Emissions are directly proportional to operating times which are strongly related to weather-related demand. Affected sources want to have sufficient banked allowances in their accounts to be able to supply power in periods of increased demand. In addition, companies prefer to have a margin in order to address monitoring problems. Ultimately, if insufficient allowances are available then affected sources will not be able to operate.
In that context consider the RGGI allowance status today. In the first compliance period (2009-2011), 429,381,635 allowances were auctioned, sold or awarded, the CO2 emissions were 382,075,544 tons so the margin between the available allowances and emissions (the allowance bank) at the end of the compliance period was 47,306,091 allowances. The allowance bank at the end of the second compliance period was 120,175,954 allowances. As it stood at the end of 2016 the allowance bank as defined as the difference between the allowances auctioned, sold, or awarded and the RGGI allowances retired was 173,105,751. Note, however, that there is a difference between the 2015-2016 allowances retired and emissions. RGGI retires 50% of the compliance obligation at the end of the year instead of waiting until the end of the compliance period to retire all the emissions. If all the emissions are withdrawn the allowance bank at the end of 2016 is 90,446,582 allowances. For comparison purposes the 2016 total emissions were 80,624,392 tons.
There is an affected source or compliance entity concern with the allowance bank trends. The RGGI allowance database is not as open and transparent as the EPA allowances databases for their programs. EPA provides ownership information on all allowances but RGGI does not. The RGGI market monitoring reports provide the only breakdown between the allowances held by compliance entities and that is only the percentage of the total bank held by compliance entities. At the end of the first compliance period 97% or 45,886,908 of the allowances were owned by entities that needed the allowances to comply with the requirements of the program. At the end of the second compliance period the compliance entity share was down to 81% or 97,342,522 allowances. At the end of 2016 the compliance entity share was only 54% or 93,477,106 allowances. However, remember that RGGI only considers the retired allowances so the compliance entities have to cover 82,659,170 tons of emissions with their share at the end of 2016. Consequently the true compliance entity share of the allowance bank is only 12% or 10,817,936 allowances and that concerns the compliance entities.
In particular, the trend shows that compliance entities will have to go to the non-compliance entities to obtain enough allowances to operate. This problem will be exacerbated if RGGI cuts the cap and/or makes adjustments to the allowance bank. In my former life I was responsible for trading program compliance tracking and had input into corporate compliance strategy. Environmental staff and all corporations I have dealt with consider compliance the highest priority and the only way to insure that is to only generate emissions less than allowances in hand. Theoretically, you could generate and then go out to the market to cover what you emitted but, especially in the case of a constrained market, there is a compliance risk. RGGI is evolving towards the ultimate constrained market and there are two serious potential consequences. Firstly, affected sources could be forced to purchase allowances from an entity that knows they have a compliance obligation and could require them to pay an exorbitant amount for the allowances. This has two downsides: the windfall of money is not anything that will be invested like the RGGI auction proceeds (i.e., there is no societal benefit to those higher priced allowances) and eventually the price will show up on ratepayer bills[1].
Secondly, a company could choose not to run because they don’t have the allowances and that will affect the power system badly, in the worst case it could even affect reliability. Were it up to me because environmental compliance is number one I would advise option 2.
Emission Containment Reserve
I think the ECR is an elegant solution to the issue of whether or not the cap should continue to decline. Ideally, the RGGI cap should create an allowance market where the price is within the acceptable range determined by the RGGI states. The CCR prevents the cost from getting too high. The ECR works on the lower end of the range to keep the price from getting too low. As an alternative to a declining cap the ECR determines the appropriate cap level by withdrawing allowances from the market to the point that the price rises above the low threshold of the target range. As proposed the withdrawn allowances are put into a reserve but it could be set up so that the allowances displace the allowances in the CCR and when there are more than 10,000,000 allowances displaced then allowances from the cap would be withdrawn. I want to emphasize however, that my support of this approach is in lieu of a specified declining cap.
In my opinion future reductions will not be as easy as the past. The majority of the reductions in the RGGI region to date have occurred because of coal unit retirements and cutbacks in the use of residual oil which were driven by the economics of low natural gas fuel prices. However, most of the coal facilities have retired and residual oil emissions are about as low as they can go so future reductions will have to displace more economic natural gas. Therefore, the ECR approach addresses this uncertainty. If further reductions are easily obtained then the ECR will lower the cap. If not then the RGGI program is not in danger of non-compliance meeting an artificial cap.
Unfortunately RGGI seems to be headed towards a mandated declining cap. The last round of proposed policy cases did not even consider the possibility that further reductions may not be available or even slower than expected primarily because all scenarios assume compliance with proposed state programs. While it is appropriate to include the scenario in which it is assumed that the state programs that propose to increase renewable power come to fruition, the fact is that they will necessarily have to increase costs. In my opinion a scenario which only considers economics of conversion also should be included to address the possibility that the political winds could change. In addition, the timing component should be included. Industry has had to deal with licensing delays for years and there is no reason to expect that the infrastructure necessary for the renewable deployments required will not also be affected.
Finally, the issue of the compliance entity share of allowances relative to a declining cap should be addressed. The unintended consequence of further reductions is to exacerbate the cost implications and increased reliability risks. Ultimately, society will pay those costs and I predict that the blame will fall back on the generating companies and not those who recklessly advocate more and more reductions. The existing program has worked as well. The CCR has limited allowance costs from increasing too much and the ECR seems to be a viable alternative to not only limit costs that go too low but also to be the mechanism that reduces the cap based on what is happening to the generating mix.
[1] There are those folks who would applaud increasing costs to the generating companies. To them I say that electricity is an essential driver to the health and welfare of our society. As with all essentials, electricity should be as reliable, secure and cost-effective as possible. It is no less important than food and water. Somehow, someway those increased costs will impact society, most likely impacting those who can least afford it the most.
Pragmatic Environmentalist of New York 