RGGI 2016 Program Review Completion

This is a post on the announcement of the completion of the second program review process of the Regional Greenhouse Gas Initiative (RGGI). The RGGI states completed their first program review process in 2013, and in Dec. 2017 completed a second program review process resulting in the 2017 Model Rule. This is another in a series of posts on RGGI that discusses how RGGI has fared so far (see the RGGI posts page).

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. As a result, I have a niche understanding of the information necessary to critique the operating plan. 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.

The 2016 program review page lists the following documents that summarize the results:

• Announcement: RGGI States Release Updated Model Rule
• Summary of Model Rule Updates
• Principles to Accompany Model Rule Amendments
• 2017 Model Rule  
• 2017 Model Rule (Redlined)

According to the announcement:

Overall, the RGGI program review has been a rigorous and comprehensive evaluation, supported by an extensive regional stakeholder process that engaged the regulated community, environmental nonprofits, consumer and industry advocates, and other interested stakeholders. The improvements arising from this process, now included in the updated 2017 Model Rule, will ensure RGGI’s continued success, cost-effectively reducing CO2 emissions while providing benefits to consumers and the region.

My biggest concern with RGGI is that the States seem to have convinced themselves that they have actually done a rigorous and comprehensive evaluation. Contrary to EPA and State agency rulemakings, RGGI does not formally and comprehensively respond to critical comments and rebut concerns raised by stakeholders.   On the other hand, the regulated community did not provide much in the way of critical comments. While RGGI claims engagement with the regulated community the fact is that comments from the affected sources are in the minority of the comments submitted. I believe that is because, after years of submitting comments and getting no, and I mean absolutely no, response or indication that the comments have even been read much less provide any feedback why the comments and recommendations have been ignored the regulated community has given up.

In addition there is a public relations concern. Advocacy groups, most of the media and many politicians constantly portray reducing CO2 emissions as an essential and noble objective. Any deviation from that goal can bring adverse publicity, accusations of denying the science, and, potential recriminations by the regulatory agencies for other projects. As a result there is a legitimate reason for affected sources to stay silent.

Importantly, however the proposed changes to the program are unprecedented in several ways that, in my opinion, have not been addressed in the program revisions:

• Supporters of the tighter caps want the cap so low that it will be a constraint but I am not aware of any cap and trade program that has set the caps so low that they constrain operations.
• This allowance program is different because in this allowance bank non-compliance entities that own allowances purchased them whereas in cap and trade programs the excess allowances enter the market because they were deemed excess by a compliance entity. At some point the regulated sources are going to have to rely on non-compliance entities for allowances necessary for compliance and it is not clear how the market will react (but my suspicion is that it will cost a lot more than we have seen to date.)
• Arbitrarily adjusting the allowance bank because it is “too” big is unusual for cap and trade programs. Whether they got the adjustment right and how it plays out in this unique system are unknown.
• The containment reserve provisions are another unique aspect of RGGI. This is particularly worrisome because the academic theory on how the program should work is not supported by the history of the program. This new adjustment certainly is another substantial uncertainty.
• Finally, the analysis of the impacts of RGGI are determined using the Integrated Planning Model.  The problem with the model is that it has perfect vision so it predicts the power sector will react perfectly. This certainly is not supported by past history.

Because I have spent a lot of time with those comments that were not addressed, I want the record to show exactly what the regulated community and one retired guy who no longer has any ties to that community were worried enough about to submit relative to the following changes described in the summary of model rule updates. A reminder the issues highlighted below represent my opinion only and not necessarily the position of any RGGI-affected source or even the current position of the organizations that submitted the comments.

 Size and Structure of Cap and Allowance Apportionment (XX-5.1)

The regional emissions cap in 2021 will be equal to 75,147,784 tons and will decline by 2.275 million tons of CO2 per year thereafter, resulting in a total 30% reduction in the regional cap from 2020 to 2030.

• One major concern of environmental staff in the regulated community is an environmental constraint that cannot be achieved by the actions of the affected sources. Ultimately this is the biggest worry about any CO2 control program because there is no cost-effective add on control option available to reduce CO2 so that limits what an individual affected source can do. The largest emission reduction option available is to switch fuels either directly by changing the fuel used or indirectly by running at higher emitting fuel units less and lower emitting fuel units more. There are some options available for increased efficiency but because fuel costs are a major cost driver most of the big impact efficiency possibilities have already been implemented. The ultimate compliance option for an affected unit in any cap and trade program is to simply stop running when the allowances run out.
• As a result of this concern the Environmental Energy Alliance of New York (EEANY) submitted a White Paper in June 1, 2016. That analysis showed that of the observed emission reductions RGGI was only responsible for somewhere between 24% predicted by an econometric modelling analysis by Murray and Maniloff and 3%, assuming that energy savings estimated by RGGI are replaced entirely by natural gas. The primary driver of lower CO2 emissions since RGGI’s inception was fuel switching from coal and oil to natural gas and that was the result of lower relative fuel prices independent of RGGI. The problem that should be addressed is that future emission reductions will not be able to rely on fuel switching.
• EEANY comments on 10/16/2017 pointed out that the Investment Status Report for the period ending 12/31/2015 claims that the annual benefits of 2015 annual investments avoided 298,410 tons of CO2 which is 13.1% of the 2,275,000 proposed annual reductions starting in 2021. The concern is that the investment reductions have not been very large and it is not clear what could be done to dramatically increase those reductions.
• I also submitted comments on this problem that made the same points. “The proposed program revisions released last month for RGGI call for an annual post-2021 cap reduction of 2,275,000 tons per year. In the Proceeds Investment Report, Table 1: Benefits of 2015 RGGI Investments Program, it lists the annual benefits of 2015 investments and shows an annual CO2 reduction of 298,410 tons. As also shown in the white paper submitted to RGGI by the Environmental Energy Alliance of New York the affected electrical generation units have made most if not all of the cost effective reductions possible from their operations. As a result, future reductions will have to come from sources outside the affected units and RGGI has no track record providing any assurance that its investments will be sufficient to meet the targets proposed. The fact is that RGGI has not provided a roadmap for the 30% reductions that they have proposed so it is not clear how this will work.
• The majority of the commenters during the program review claimed that even greater emission cap reductions were appropriate because of the observed reductions. The model rule reflects that position. RGGI never responded to the EEANY White Paper analysis of historical reductions and ignored their own analyses that showed that relying on past investments have provided relatively small emission reductions.
• Therefore the most important uncertainty is where are the emission reductions going to come from?

Budget Adjustments (XX-5.3)

The Model Rule contains language to address the private bank of allowances through one additional, distinct budget adjustment.

The Third Adjustment for Banked Allowances, would adjust the base budget for 100 percent of the pre-2021 vintage allowances held by market participants as of the end of 2020, that are in excess of the total quantity of 2018, 2019, and 2020 emissions. The third adjustment timing and algorithm is spelled out in the Model Rule and would be implemented over the 5-year period, 2021-2025, after the actual size of the 2020 vintage private bank is determined.

• Banked allowances are surplus at the time the bank is determined. Compliance entities bank allowances to provide margin for future operating variations and potential monitoring problems. Proponents for tighter emission limits seem to want the available allowances to exactly match emissions but that is unprecedented in all previous trading programs.
• The EEANY White Paper noted that: “In cap and auction programs that distribute the allowances directly to compliance entities the allowance market consists primarily of surplus allowances from compliance entities that do not need them for compliance. In the RGGI auction scheme allowances are available to anyone willing to purchase them. In the worst case non-compliance entities could purchase all the allowances in the auctions then charge affected sources above market prices. That has not happened and is unlikely to happen in the future. Importantly we have no data to indicate what level of non-compliance entity holdings would adversely affect the market.”

Cost Containment Reserve (XX-5.3(d) and XX-9)

The Model Rule contains language for the continued use of a cost containment reserve (CCR) that will provide flexibility and cost containment for the program. The CCR would consist of a fixed quantity of allowances, in addition to the cap, that would be held in reserve, and only made available for sale if allowance prices exceed predefined price levels.

The Model Rule contains language for an annual CCR allowance quantity of 10% of the regional cap beginning in 2021 and each succeeding year thereafter.

Allowances from the CCR would be fully fungible.

The CCR allowances would be made available immediately in any auction in which demand for allowances at prices above the CCR trigger price exceeds the supply of allowances offered for sale in that auction prior to the addition of any CCR allowances.

If the CCR is triggered, the CCR allowances would only be sold at or above the CCR trigger price.

The CCR Trigger Price will be $13.00 in 2021 and rise at 7% per year, so that the CCR will only trigger if emission reduction costs are higher than projected.

 Emissions Containment Reserve (XX-5.3(e) and XX-9)

The Model Rule contains language for the creation and use of an emissions containment reserve (ECR) that will respond to supply and demand in the market if emission reduction costs are lower than projected. States will withhold allowances from circulation to secure additional emissions reductions if prices fall below established trigger prices. At this time, Maine and New Hampshire do not intend to implement an ECR. Allowances withheld in this way will not be reoffered for sale.

The Model Rule contains language for an annual ECR allowance withholding limit of 10% of the budgets of states implementing the ECR.

The ECR trigger price will be $6.00 in 2021, and rise at 7% per year, so that the ECR will only trigger if emission reduction costs are lower than projected.

Containment Reserve Comments

• The RGGI states have relied on academics to evaluate their program. Dr.William Shobe at the University of Virginia can run allowance behavior simulations with students acting as affected entities and presented results of a Resources for the Future and University of Virginia ECR analysis in a RFF webinar on June 14, 2017. EEANY raised an important point about a misconception in the academic perception of allowance management. In particular, there is a potential disconnect between the economic theory of allowance management and the reality of compliance entity allowance management. Economic theory presumes that allowance management decisions depend on long-run future outlooks of allowance supply and demand whereas in reality most compliance entity allowance management is determined almost entirely by short-term requirements, particularly for the current compliance period.

 

• In Dr. Shobe’s June 14th presentation he draws the analogy between allowances and commodities. In the commodity world the decision between selling and storing the commodity today is determined by the long run anticipated future price of that commodity. If it is expected that there will be less of the commodity available in the future then the price will likely go up over time and entities will stockpile now to sell at a later time when the price is higher. In putting forth this economic theory, Dr. Shobe postulates that if compliance entities know that the allowance supply is going to be reduced in the future then current behavior will reflect that and they will purchase additional allowances now to bank for future use. Clearly, this describes the motivation and analysis of non-compliance entities but it is not driving allowance-buying decisions by compliance entities.
• This “allowances are like commodities” theory is highlighted on Slide 19 in the presentation which states that it is the long-run supply that counts. “In markets for storable commodities (like allowances, for example), the current price and the plan for accumulation of a stock of the commodity depend on
  • The expected long-run total supply compared to
  • The expected long-run total demand.”
• The reality of compliance entity management is that there is rarely long-term planning on the time scale envisioned by Dr. Shobe. RGGI allowances are typically purchased by the compliance entities for the current compliance period. Compliance entities do not want to tie up capital in allowances because they have other more pressing needs for that money. As compliance entities have become familiar with the auction system and their operational needs their share of the allowance bank has shrunk. Simply stated, the analogy between storable commodities and allowances is not appropriate.
• Compliance entities have long commented that the perfect foresight of IPM which predicts that affected sources will buy allowances in early years because there will be a shortage in the future is not representative of actual behavior. It appears that this is also an issue with academic theories of allowance management. At timestamp 44:10 of the June 14th webinar recording, Dr. Shobe states that “students understand the ECR and they make coherent inter-temporal decisions” in the allowance management lab. Intertemporal is an economic term describing the “concept of how the current decisions made by an individual can affect the options that become available to them at a future time.” The student behavior is consistent with Dr. Shobe’s expectation that current allowance purchases will be dictated by long-run perceptions of supply and demand.

Offsets (XX-10.2 and XX-10.5)

The Model Rule contains language that eliminates two offset categories, the “SF6 Offset Category (XX-10.5(b))” and the “End-Use Energy Efficiency Offsets Category (XX-10.5(d)),” and updates and retains three categories that some States may continue to implement. Any awarded offset allowances would remain fully fungible across the states.

• No reason was given why the SF6 offset category should be eliminated. It was a small category but several companies asked for it to be retained.

Other critical comments not addressed

• Constrained allowance market
  • EEANY comments July 17, 2017 : Presuming that the analysis in the last program review was correct, the number of surplus allowances available should approach zero by 2020. How the auctions and the secondary market will respond to the first-ever scarcity situation is an unknown.
  • The Alliance recommended that the RGGI States would be wise not to significantly alter the parameters of the RGGI market until this condition is fully explored in real-time.
• Compliance entity share of the allowance bank
  • EEANY comments June 6, 2017: The compliance entity share of the market is an even more pressing concern. Table 1a shows that the compliance entity share of allowances could be less than 20% as soon as 2018 and Table 1b shows that even if the Cost Containment Reserve is triggered each year from 2017 to 2020 the compliance entity share of the allowances will be less that the recommended 20% by 2020.
  • This trend shows that compliance entities will have to go to the non-compliance entities to obtain enough allowances to operate. It is not clear how this will affect market prices.
• Allowance management theory
  • EEANY comments August 3, 2017: Economic theory presumes that allowance management decisions depend on long-run future outlooks of allowance supply and demand whereas in reality most compliance entity allowance management is determined almost entirely by short-term requirements, particularly for the current compliance period.
  • The Alliance recommended that RGGI sponsor an allowance management lab test with Dr. Shobe that uses compliance entity allowance managers. We believe that it would be a learning experience for everyone and that the result would be a better representation of what could happen with an ECR and CCR.
• Integrated Planning Model
  • EEANY comments June 29, 2016: IPM presents the best case scenarios to determine the viability of further reductions because it has perfect vision. Because it “knows” that the emissions have to be at a certain level by 2030 the model predicts that more renewables will be built sooner so that an allowance bank is built up for the later years when the cap is smaller. It also assumes that affected sources will purchase allowances and bank them for the smaller cap years down the road.
  • These flaws are related to the allowance management theory argument described above. As a result the Alliance suggested that it would be prudent to wait and change major parameters individually until the effects of each change are known.

Conclusion

The program changes in the 2016 RGGI review affect multiple moving parts at the same time. The result will be several unprecedented aspects of the program. Despite assurances from the agencies I remain unconvinced that the “rigorous and comprehensive evaluation” touted by RGGI will in fact preclude the possibility of significant problems. Rather than taking a measured systematic implementation approach RGGI has chosen to change everything simultaneously. I am not optimistic that these changes will all work out as planned and think there is a chance that the success of RGGI to date will be endangered.