I recently had a simple version of this RGGI article published at Whats Up with That . This article provides more details and considers other issues with the Regional Greenhouse Gas Initiative (RGGI). The program is ten years old and has been touted as a successful example of a “cap and dividend” pollution control program and now it is being proposed as the model for a similar control program in the Transportation Control Initiative (TCI). This post looks at the numbers to see if this praise is warranted and whether RGGI is a good model for the proposed TCI. Ultimately the question is whether any cap and trade program for carbon dioxide (CO2) can be successful.
I have been involved in the RGGI program process since its inception. I blog about the details of the RGGI program because very few seem to want to provide any criticisms of the program. I have extensive experience with air pollution control theory and implementation having worked every cap and trade program affecting electric generating facilities in New York including the Acid Rain Program, Regional Greenhouse Gas Initiative (RGGI) and several Nitrogen Oxide programs. Note that my experience is exclusively on the industry side and the difference in perspective between affected sources trying to comply with the rules and economists opining about what they should be doing have important ramifications. 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.
RGGI is a market-based program to reduce greenhouse gas emissions. It is a cooperative effort among the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont to cap and reduce CO2 emissions from the power sector. According to a RGGI website: “The RGGI states issue CO2 allowances which are distributed almost entirely through regional auctions, resulting in proceeds for reinvestment in strategic energy and consumer programs. Programs funded with RGGI investments have spanned a wide range of consumers, providing benefits and improvements to private homes, local businesses, multi-family housing, industrial facilities, community buildings, retail customers, and more.”
The RGGI states developed a cap during a long stakeholder process that was based on historical operations and emissions. The cap is the regional budget for CO2 emissions. The Nine-State RGGI Region Emissions, Original RGGI Cap, and the Adjusted RGGI Cap table lists observed emissions and two caps. The original cap was developed before the fracking revolution changed the cost of natural gas such that it became significantly cheaper than coal and residual oil. After natural gas prices dropped so much the original projections for emissions were so out of tune to what was happening the RGGI states developed an adjusted cap to account for that development.
In order to determine if RGGI is successful and a program to emulate let’s define some metrics. The primary goal of the program is to reduce greenhouse gas emissions (GHG) from the electric generation sector so quantifying the emissions change from before the program to the present is a key metric. Another appropriate metric is cost efficiency per ton of CO2 reduced compared to the Social Cost of Carbon (SCC). This parameter is an estimate of the economic damages from emitting a ton of CO2 and is widely used to justify GHG programs. For a comparison metric I will ignore issues with this parameter even though I agree with the following by Paul Driessen and Roger Bezdek: “The SCC assumes fossil-fuel-driven carbon dioxide emissions are causing dangerous manmade climate change, and blames U.S. emissions for every conceivable climate-related cost worldwide. But it fails even to mention, much less analyze, the tremendous and obvious benefits of using oil, gas and coal to power modern civilization.”
In addition to these metrics we have to look at lessons learned and considerations that are not yet resolved to determine whether RGGI is a good model for future control programs. I address the following: the theory and reality of historical trading programs, control options for affected sources, allowance management, allowance ownership and allowance costs. Most of these issues were not discussed in the What’s Up with That post.
Theory and Practice
I agree with the argument that economic incentives or market trading programs reduced emissions more cost-effectively than a command and control program. However, it is instructive to look at the reasons why emission reductions occurred because the theory does not necessarily drive the observed reductions. It is necessary to review historical performance of RGGI to determine why CO2 emissions reductions have occurred so we can reasonably expect a similar result in other applications like the TCI..
Let me first point out that there is a fundamental difference between the way affected sources operate in emissions trading markets and the way economic theory predicts they should operate. I believe that electric generating affected source allowance management is different than theory because the affected sources do not treat allowances as a storable commodity or a financial asset in the usual sense of the term. Instead allowance management is overwhelmingly driven by regulatory requirements for the current compliance period. i.e., do I have enough allowances to cover expected emissions? Financially it is simply another cost of operating and not a potential profit center. The important difference is that the academic economic theory holds that affected sources are looking years into the future, but in reality, there is no such long-term time horizon for affected sources. Their decision on the quantity of allowances to buy is driven by their expected operations in the period between auctions and, at most, the entire compliance period. Also note that most companies include a small margin for operational variations and regulatory compliance considerations. Because of the differences between the way affected sources operate and the way economic theory says they should operate, I have little faith in the models that predict future allowance margins.
The Acid Rain Program (ARP) was undoubtedly a successful program because it lowered emissions more than expected at far lower costs than predicted. This program was open and transparent so all emissions and allowance data are available. In order to meet the initial emission cap target of a 50% reduction, affected sources were awarded half of their historical emissions. Although it is common practice to vilify this program for giving away the allowances for free the rationale is still valid today. The concept for the acid rain program was that power plants would install SO2 control equipment and if they over-controlled their emissions, they could sell the excess allowances earned to other facilities that could not install the control equipment as cost-effectively. This approach incentivizes over-control because affect sources can subsidize control equipment investments they made by selling excess allowances. This cost reduction efficiency brings down overall costs. It turned out that fuel switching and technological improvements were so effective that far greater than expected reductions occurred. Fuel switching occurred because technology to burn lower sulfur coal was developed and railroad de-regulation opened the market to transporting coal cost-effectively over very long distances. Another subtle point is that the ARP allowance bank was earned, that is to say excess allowances in the bank represent over-controlling emissions lower than the cap limits.
The Regional Greenhouse Gas Initiative (RGG) is a cap-and-invest program that has been touted as a model for a TCI cap-and-invest trading program because of its “success”. Although the RGGI states claim that the program is open and transparent the fact is that there is no allowance ownership information available. There is no question that CO2 emissions have come down in the RGGI states since the inception of the program but it is important to determine why they have come down. I will address that point later on. There is a fundamental difference in the way that affected sources treated RGGI as opposed to ARP, namely ARP was considered a control program and RGGI was considered a tax. Because there are no cost-effective add-on controls for CO2 at existing power plants there are limited options to meet the cap. Because allowances all have to be purchased and the incremental cost was low plant control programs to reduce CO2 through efficiency were not implemented. The allowance bank does not represent earned reductions below the cap limits. Instead the bank is made up of allowances purchased at auctions and on the market. The RGGI states in their program reviews were very concerned that the allowance bank was large and have taken steps to adjust the allowances sold at auction to force the bank smaller. In the naïve belief that RGGI investments significantly reduced emissions the RGGI states have also reduced the cap going forward. As a result. RGGI going forward is going to be significantly different that RGGI in the past and that has ramification on its value as a model for TCI or any other future emissions trading program.
I noted above the distinction between the ARP “earned” allowance bank and the RGGI allowance bank. Because the ARP affected sources over-controlled emissions below their cap levels, they earned the allowance bank. That means the bank represents surplus allowances that are not needed for compliance so it does not matter who owns them. On the other hand, all RGGI allowances were purchased at one time or another by anyone who offered a high enough price at an auction or on the market. Because allowance ownership is not transparent, we only know the number of allowances owned in the following three categories:
- Compliance-oriented entities are compliance entities that appear to acquire and hold allowances primarily to satisfy their compliance obligations.
- Investors with Compliance Obligations are firms that have compliance obligations but which hold a number of allowances that exceeds their estimated compliance obligations by a margin suggesting they also buy for re-sale or some other investment purpose. These firms often transfer significant quantities of allowances to unaffiliated firms.
- Investors without Compliance Obligations are firms without any compliance obligations.
To this point in 2019 the affected sources with compliance obligations have been able to get the allowances needed to cover their emissions from auctions and the market. However, at some point going forward this will change and it will make a difference. I have addressed the status of RGGI emissions and allowances elsewhere but briefly because the allowance cap is being reduced so much, the affected sources are going to have to go to the investors without compliance obligations. This is uncharted territory and, at a minimum, I expect that the allowance prices will spike upwards. Note that this price spike provides no dividends for CO2 reduction investments because the dividends are earned at the initial sale. But it could be even worse if the entities without compliance obligations withhold allowances and create a shortage such that affected sources do not have enough allowances to run.
RGGI supporters who claim it is successful point to emission reductions of 40 to 50%. In order to evaluate the RGGI emissions reduction claims I used data from the Environmental Protection Agency Clean Air Markets Division air markets program website. Emissions data from the electric generating unit (EGU) sector are available from before RGGI started to the present, so I downloaded all the EGU data for the nine states currently in RGGI from 2006 until 2018. In order to establish a baseline, I calculated the average of three years before the program started. As shown in the RGGI Nine-State EPA CAMD Annual CO2 Emissions table the total emissions have decreased from over 127 million tons prior to the program to just under 75 million tons in 2018, for over a 40% decrease. Note that these numbers are slightly different than the previous table because different sets of sources are used.
However, when you evaluate emissions by the primary fuel type burned it is obvious that emissions reductions from coal and oil generating are the primary reason why the emissions decreased. Note that both coal and oil emissions have dropped over 80% since the baseline. Natural gas increased but not nearly as much. I believe that the fuel switch from coal and oil to natural gas occurred because natural gas was the cheaper fuel and had very little to do with RGGI because the CO2 allowance cost adder to the plant’s operating costs was relatively small. There is no evidence that any affected source in RGGI installed add-on controls to reduce their CO2 emissions. The only other option at a power plant is to become more efficient and burn less fuel. However, because fuel costs are the biggest driver for operational costs that means efficiency projects to reduce fuel use means have always been considered by these sources. Because the cost adder of the RGGI carbon price was relatively small I do not believe that any affected source installed an efficiency project as part of its RGGI compliance strategy.
As a result, the only reductions from RGGI that can be traced to the program are the reductions that result from direct investments of the RGGI auction proceeds. Information necessary to evaluate the performance of the RGGI investments is provided in the RGGI annual Investments of Proceeds update. In order to determine reduction efficiency, I had to sum the values in the previous reports because the most recent report only reported lifetime benefits. In order to account for future emission reductions against historical levels the annual reduction parameter must be used. The Accumulated Annual Regional Greenhouse Gas Initiative Benefits table lists the sum of the annual avoided CO2 emissions generated by the RGGI investments from three previous reports. The total of the annual reductions is 2,818,775 tons while the difference between the baseline of 2006 to 2008 compared to 2017 emissions is 59,508,436 tons. The RGGI investments are only directly responsible for less than 5% of the total observed reductions!
In order to argue that RGGI emission reduction programs are a good investment relative to the expected societal cost of CO2 emissions the Social Cost of Carbon (SCC) parameter can be used. SCC values range widely depending on assumptions, but if you use a discount rate of 3% and consider global benefits like the Obama-era Environmental Protection Agency (EPA) did then the 2020 SCC value is $50. The Accumulated Annual Regional Greenhouse Gas Initiative Benefits table lists the data needed to calculate the RGGI CO2 reduction cost per ton. From the start of the program in 2009 through 2017 RGGI has invested $2,527,635,414 and reduced annual CO2 emissions 2,818,775 tons. The result, $897 per ton reduced, is 18 times than the current EPA SCC value for United States benefits.
There is another key lesson from RGGI that applies to any CO2 emissions marketing control program. There is an important difference between cap and trade programs for SO2 and nitrogen oxides (NOx) emissions and cap and invest programs for GHG emissions. There are add-on control options for SO2 an NOx whereas there isn’t any cost-effective option for CO2. In the ARP the affected sources could directly control their compliance. In RGGI there were limited direct options for the affected sources and, going forward especially, they are going to have to rely on indirect reductions, i.e., someone will build a zero-emitting plant that displaces enough output from a fossil plant that enough allowances are available to cover the affected source requirements. The ultimate control strategy for a emissions marketing CO2 control program is to run less and hope power is available from somebody else.
I believe that RGGI is not the success that its adherents believe. Based on the numbers there are some important caveats to the simplistic comparison of before and after emissions. Fuel switching was the most effective driver of emissions reductions since the inception of RGGI. Emission reductions from direct RGGI investments were only responsible for 5% of the observed reductions. RGGI investments in emission reductions were not efficient at $897 per ton of CO2 removed. In my opinion those are not the hallmarks of a successful program.
I want to highlight a related point. In order to determine emission reduction efficiency from the RGGI investment reports, I had to sum the values in the previous reports because the most recent report only reported lifetime benefits. The RGGI website only lists the lifetime benefits of RGGI investments in 2017 but those parameters are useless for the most obvious application. In order to account for future emission reductions against historical levels the annual reduction parameter must be used. It is hard to not believe that excluding the accumulated annual reductions was deliberate because the numbers are so poor.
As a model for future programs, RGGI successfully proved that a regional entity could implement a cap and auction program. However, the actual cause of observed reductions and ability of affected sources to make the reductions proposed should be considered before other programs adopt the RGGI model. I considered the use of the RGGI model in Transportation Climate Initiative Draft Framework Cap and Invest Caiazza Comments that were submitted as part of their stakeholder process. I concluded that there are so many differences between a program for mobile sources and electric generating units that simply implementing a tax and investing the proceeds as proposed would be less likely to have serious problems with unintended consequences and unanticipated issues.
As a result of the issues raised in this post, I believe that it is fair to ask whether any cap and trade program for CO2 can be successful if the ultimate goal is a significant reduction in emissions. Because CO2 from fossil fuels is such an integral part of our lifestyles a large reduction in emissions is going to have to require changes in lifestyles. Therefore, the question becomes will people accept lifestyle changes such as giving up the gas automobile with all its current advantages over any alternative as a result of indirect CO2 pricing?