Category: NY Carbon Price Initiative

On November 28, 2023, the Citizens Budget Commission released Keys to a Cap-and-Invest Design That’s Earth- and Economy-Focused (“Keys Report”) that examines the potential benefits and problems associated with the New York Cap-and-Invest Plan (NYCI).  If you want a summary of this program I recommend reading the report.

NYCI is a primary tool for the Climate Leadership & Community Protection Act (Climate Act or CLCPA) net zero transition mandate.  This report does an excellent job describing the basics of cap-and-invest programs, issues that need to be considered during NYCI implementation, and makes recommendations that I believe should be incorporated.  My comments on this report support their work and provide context that shows that their concerns are warranted. 

I have followed the Climate Act since it was first proposed, submitted comments on the Climate Act implementation plan, and have written over 380 articles about New York’s net-zero transition including a number on various New York cap-and-invest proposals.  In addition, I have been associated with every cap and trade control program affecting the electric generating sector in New York including the Regional Greenhouse Gas Initiative (RGGI) which is frequently touted as a successful prototype for NYCI.  I have written about the details of the RGGI program because very few seem to want to provide any criticisms of the program.  I think that background enables me to provide some added value to the CBC report.  The opinions expressed in this post do not reflect the position of any of my previous employers or any other organization I have been associated with, these comments are mine alone.

Overview

The Climate Act established a New York “Net Zero” target (85% reduction and 15% offset of emissions) by 2050.  It includes an interim 2030 reduction target of a 40% reduction by 2030 and a requirement that all electricity generated be “zero-emissions” by 2040. The Climate Action Council (CAC) is responsible for preparing the Scoping Plan that outlines how to “achieve the State’s bold clean energy and climate agenda.”  In brief, that plan is to electrify everything possible using zero-emissions electricity. The Integration Analysis prepared by the New York State Energy Research and Development Authority (NYSERDA) and its consultants quantifies the impact of the electrification strategies.  That material was used to develop the Draft Scoping Plan.  After a year-long review, the Scoping Plan recommendations were finalized at the end of 2022.  In 2023 the Scoping Plan recommendations are supposed to be implemented through regulation, PSC orders, and legislation.  NYCI is one of these components.

The Keys Report describes the status of NYCI:

New York is currently developing the rules and regulations for NYCI. Very few details are known; almost all programmatic details of NYCI will be determined by forthcoming regulations developed by the Department of Environmental Conservation (DEC), as directed by the CLCPA. The Final Scoping Plan (FSP) provides some insight into potential design parameters. The FSP envisioned a program that would cover all major sectoral emissions sources that can feasibly be regulated and an emissions cap designed to be consistent with CLCPA emissions limits. Furthermore, the New York State Fiscal Year 2024 Enacted Budget established three distinct accounts within a newly created special revenue fund into which any proceeds raised by NYCI would be transferred.

The Keys Report addresses key aspects of NYVI and “provides guidance on how to design and evaluate the effectiveness of NYCI by:

• Providing context and background on the development of cap-and-invest programs;
• Explaining major risks to cap-and-invest programs;
• Identifying the goals that should be used to guide NYCI design choices;
• Describing the design choices that need to be made; and
• Recommending specific design choices and features.”

This article supplants that guidance with additional context. Note that I emphasize the issues associated with the electric sector but similar issues will occur in all sectors. I highlight their main points and provide my insights below.

The Basics of Cap-and-Invest

The overview in the Keys Report does a good job describing the fundamental aspects of market based emission reduction programs.  It notes:

The theory behind cap-and-invest is relatively simple: the State sets a cap on allowable emissions, distributes allowances—the permits that allow firms to generate a specified amount of emissions—to large-scale emitters via auction, and uses the proceeds of the auction (and penalties for non-compliance) to invest in programs to reduce emissions. Companies that can reduce their marginal emissions at a lower cost than purchasing allowances will be incentivized to do so, while emitters that cannot reduce their emissions as easily will opt to purchase allowances to cover all of their emissions.

There are three things that should be kept in mind about the theory relative to NYCI. The Keys Report states: “Companies that can reduce their marginal emissions at a lower cost than purchasing allowances will be incentivized to do so.”  In the Environmental Protection Agency trading programs for sulfur dioxide (SO2) and nitrogen oxides (NOx), the allowances are allocated for free but that does not mean that affected companies don’t have to pay anything.  A company can invest in pollution control equipment to reduce their emissions and if they believe that allowances might not be available or could be more expensive than investing in control equipment, then their compliance strategy would be to install control equipment.  If a company does not have a cost-effective control option, then they can decide to purchase allowances as their compliance strategy.  There are some caveats.  This only works if the companies that can install control equipment can create reductions beyond their compliance requirements so that they can sell to those who don’t have that option.  If the compliance obligation or emissions cap is too tight, then too few sources can over-comply and there will not be enough allowances available.  There also are technological considerations to cap limits that must be considered.

The second nuance is that in the proposed cap-and-invest program the allowances must be purchased.  There is no direct incentive to over-control and sell allowances to fund the installation of additional control equipment. You can argue that installing controls to exceed the limits will affect the market price of allowances that will incentivize over-control but that is an indirect effect.  In my opinion, that makes the business case more difficult to justify added expenses for over-control.  The requirement to purchase allowances in cap-and-invest programs adds a complication to the economics of compliance strategies.

The final and most important issue that must be kept in mind is that CO2 compliance strategies are different than SO2 and NOx.  There are no cost-effective add-on control systems for CO2 so affected sources have fewer options to comply.  It boils down to operate less or retire.  In the electric sector, that is only appropriate if an alternative source of electricity is available.  The Scoping Plan proposes to use the revenues from the cap-and-invest program to fund the infrastructure to produce “zero-emissions” generation or reduce the electric load so not as much generation is needed.  If the investments in wind and solar resources are insufficient to deploy the necessary resources, then it is impossible to shut down or reduce operations at electric facilities by limiting allowances.  If existing fossil-fired units cannot run because they don’t have allowances then there will be an artificial energy shortage and a real blackout.

Emissions Leakage and Related Adverse Economic Impacts Can Threaten Effectiveness of Cap-and-Invest Programs

The Keys Report explains the problem of leakage:

Cap-and-invest programs impose new direct or indirect costs on businesses and individuals. In response, those businesses or individuals may seek to avoid costs by looking beyond the borders of the cap-and-invest program. This is called leakage; economic activity continues elsewhere but avoids emissions reduction policies. When leakage occurs, it appears that emissions reductions have taken place, but they have simply been exported outside the borders of the program.

In my opinion, this is an insurmountable flaw to NYCI.  Because of the limited opportunity to reduce GHG emissions, New York companies will simply treat the allowance requirement as a tax and raise their prices to account for the increased cost of doing business.  If the cost of the allowances is sufficient to fund the emissions reductions, then everything I have observed indicates that the costs will be so high that economic activity will be forced to leave in order to stay competitive with jurisdictions that don’t have this tax.

As noted in my introduction I have spent a lot of time analyzing RGGI.  I do not agree with all the discussion of RGGI leakage:

Leakage can affect all emissions trading schemes to some degree, but it is a pronounced threat to the effectiveness of RGGI due to its confinement to the electricity generation sector. Given the interconnected nature of electricity grids, power generated in non-member states can replace generation in member states when their relative costs change. It is difficult to measure leakage, but clearly some occurs. For example, one analysis estimated that between 43 percent and 86 percent of emissions reductions benefits within the RGGI region were offset by increased emissions in neighboring states.

I disagree with the cited analysis that claims emission reductions benefits were largely offset by leakage.  If that were true, then there should be a substantive increase in generation imports displacing RGGI sources.  In late November RGGI released CO2 Emissions from Electricity Generation and Imports in the Regional Greenhouse Gas Initiative: 2020 Monitoring Report.  According to this report: “Annual average net imports into the nine-state RGGI region from 2018 to 2020 increased by 19.4 million MWh, or 34.7 percent, compared to the average for 2006 to 2008.”  However, import levels have not changed over the last seven reporting periods.  The report also notes that: “Changes in these data over time may point to potential CO2 emissions leakage as a result of states implementing the CO2 Budget Trading Program, or a lack thereof, but may also be the result of wholesale electricity market and fuel market dynamics unrelated to the implementation of the CO2 Budget Trading Program, or a combination of these factors.” 

Furthermore, my analysis of RGGI emissions over time directly contradicts the referenced paper and shows that the primary reason for RGGI emission reductions has been fuel switching from coal and residual oil to natural gas.  Most of the load reductions at the coal and oil plants was offset by increases from in-state natural gas production.  Consequently, I believe that while leakage may be occurring its effect on emissions is small relative to wholesale electricity market and fuel market dynamics unrelated to RGGI.

Program Goals to Guide the Design of a Successful Cap-and-Invest Program The Keys Report states that:

NYCI’s primary objective is to reduce greenhouse gas emissions by increasing costs to emit GHGs and spending the proceeds to facilitate further emissions reductions. These higher costs are spread across the economy, and the program must be designed well to prevent possible unintended adverse effects.

I agree that the program must be designed well to prevent adverse effects but think the problem is even more difficult than described because of the differences between a CO2 allowance trading program and other pollutant programs described previously.  NYCI is a blunt pollution control approach.

The report describes five critical goals should be considered when assessing the design choices and proposed NYCI program.

• Maximize GHG emissions reduction: Cap-and-Invest is likely to be the primary regulatory vehicle for accelerating GHG emissions reduction in New York. The success of the program will largely hinge on how effectively it incentivizes the mitigation of emissions that can feasibly be reduced. However, there are practical limits to what can be achieved, especially in the near-term, due to technological constraints and the availability of low-emissions energy.

This is an excellent summation of the problem.  Unfortunately, the practical limitations may be insurmountable on the mandated schedule.

• Minimize the financial cost to businesses and households: Regulators should consider how much the program will cost businesses and households, to avoid putting New York’s economic competitiveness and affordability at risk. Pushing to achieve overly aggressive environmental goals would result in substantial and unproductive direct financial costs. Emissions reductions should be brought on by the lowest-cost decarbonization, energy efficiency, and conservation strategies, rather than being the result of declines in economic activity or population.

I completely agree with this recommendation.  In order to implement the recommendation, the Hochul Administration should set affordability standards now and incorporate a feature to modify the auction if the standard is exceeded.

• Prevent emissions leakage: NYCI’s environmental benefits and cost-effectiveness could be undermined if emissions leakage is not adequately limited. If the emissions reduction targets are set too aggressively, economic activity, jobs, and emissions could be pushed out of the state to neighboring regions with less stringent regulation.

I do not think that emissions leakage can be prevented in any cap-and-dividend program in a small jurisdiction if the allowance prices are high enough to reduce emissions.

• Minimize adverse economic impacts: Beyond the direct financial costs, wider economic disruptions such as reduced employment or instability in emission-intensive industries must also be considered. The program should aim to prevent these adverse effects to ensure that the energy transition does not come at the cost of economic vitality.

I agree.  The problem is that the prevention program should lay out a plan to prevent the adverse effects which is easier said than done.

• Maximize benefits to disadvantaged communities: Low-income households spend a greater share of their income on energy, making them more vulnerable to the costs imposed by a cap-and-invest program. At the same time, disadvantaged communities are likely to feel more of the effects of emissions. NYCI should (and is required to) minimize the burden imposed on the communities that are most sensitive to increased costs of necessities, like home heating and transportation, and maximize economic and environmental benefits within those communities.

There will be a balancing act relative to disadvantaged community funding.  In the first place NYCI necessarily will increase energy costs that will affect those least able to afford those increases the most.  Therefore, there is a moral imperative to reduce those affordability impacts as much as possible.  The tradeoff is that funding for low- and middle-income citizens is not a particularly effective way to reduce emissions.  Consequently, there might not be enough funding available to make the reductions necessary to meet the Climate Act mandated schedule.  If the allowance auctions follow the schedule and not the actual emission reduction trajectory, then there might not be enough allowances available which could lead to an artificial energy shortage that will cause blackouts.  Blackouts disproportionately impact the disadvantaged communities so the balancing act must consider this interaction.

Design Parameters

The Keys Report program identified seven program design parameters that will be critical to NYCI’s success.  I agree that these parameters are important.  However, there are aspects of these parameters that run contrary to the climate activist constituency that appear to be driving the Climate Act implementation bus.  It will be fascinating to see how the Hochul Administration resolves the differences between activist demands and the reality of a functioning cap-and-invest program.

Sectoral and Geographic Scope

NYCI will be designed to cover a range of economic sectors, and its rules will determine whether it can be expanded geographically. The geographic and sectoral scope of a cap-and-invest program significantly affects both its emissions reduction potential and imposed costs. An emissions-trading system with broad coverage will be able to tap into a wider array of emissions reduction opportunities that can be achieved at a lower cost, because the tools available to reduce emissions vary across economic sectors or across regions. Including more jurisdictions can also help to reduce the risk of emissions leakage, which arises when regulatory conditions differ among regions. Including more sectors is preferable, as it spreads the cost of emissions reduction, minimizing the financial burden on any single sector.

The reality is that there are advantages to a New York program that is included with programs in other jurisdictions.  In addition to the reasons mentioned, if New York could join the California program, then it would not be necessary to develop a reporting system, an auction system, or a compliance tracking system.   The time, effort, and expense for those three components is significant.

GHG Emissions Accounting and Linkage

New York’s CLCPA employs a unique method for GHG emissions accounting, utilizing a Global Warming Potential (GWP) over a 20-year horizon (GWP-20) and including emissions from electricity imported from other states, exported waste management services, and from biogenic sources. The GWP-20 accounting method emphasizes the short-term impacts of greenhouse gases and is particularly sensitive to gases like methane that have a higher warming potential but shorter atmospheric lifespan.

This is a significant reality slap for NYCI.  New York’s unique GHG emission reporting requirements are incompatible with other jurisdictions so we cannot take advantage of increasing the geographical scope.  I believe that it would be impossible to incorporate New York’s reporting approach into any other cap-and-invest program.  As proof note that last spring the Department of Environmental Conservation floated the idea of changing the GWP approach and the usual suspects melted down.  If this idea is suggested again, the outcry will be the same. 

Emissions Cap Setting

The level of the initial emissions cap and its trajectory over time will play a large role in shaping the price of allowances and the cost of compliance with NYCI. To incentivize investment in emissions reduction, the cap must decline over time. A steeper decline increases the rate of emissions reduction, but also likely leads to a higher price of emissions allowances in auctions and in trade, increasing the financial cost imposed on businesses complying with the program.

This is another reality tradeoff has already been addressed.  Clean energy resources need to be deployed to displace existing sources of GHG emissions.  There are a whole host of reasons that those resources may not be deployed on the schedule necessary to meet the Climate Act legal mandates.  If the emission cap reduction trajectory blindly follows the legal mandate with no provision to account for deployment delays, then there will be insufficient allowances necessary to meet energy demand.  The resulting shortfall would result in consequences more severe than the alleged problems the Climate Act is supposed to mitigate.

Allowance Allocation Method

NYCI regulations must determine how the program will allocate allowances. While that is almost certain to include an auction, it could also include various methods of free allocation. Early cap-and-invest programs, including the European Union ETS, primarily allocated allowances for free to regulated businesses. Over time this has changed; most existing emissions trading systems now utilize auctions to allocate most emissions allowances, while distributing a portion for free to alleviate leakage risk or consumer costs. The benefits of allocation by auction from the perspective of governments is obvious: cap-and-invest can generate substantial revenue. Since it began operating in 2013, California’s system has generated more than $38 billion.

I think this description addresses the issues associated with allowance allocations correctly. 

Price Stability Mechanisms

NYCI’s design can also affect the volatility of allowance prices in the market. Cap-and-invest gives the government some certainty over the level of emissions within the scope of the program, but the price of allowances will be variable. Allowance price volatility is a concern because it adds risk to the decision to invest in technologies that could reduce emissions—especially investments that have high upfront fixed costs. Extreme allowance prices on the high end raise the costs imposed on businesses and households. While businesses may be primarily concerned with high allowance prices, sudden price swings may discourage them from making investments if they expect the cost of compliance in the long-run to change. An excessively low allowance price indicates that the supply of allowances (the emissions cap) may closely mirror, or exceed, market demand for allowances, meaning there’s a weak incentive to invest in emissions reduction. Mechanisms to rein in excessive auction volatility and price extremes can mitigate these risks.

Price stability is important and this description accurately points out why.  However, controversy is inevitable for this mechanism. It appears that NYCI is being modeled after the California cap-and-trade program with many of the same features mentioned for potential inclusion.  California incorporates automatic allowance adjustments to address cost volatility that may be incompatible with the Climate Act and are certainly at odds with an allowance distribution that meets the Climate Act schedule.  The article CA Carbon Cap it not really a cap explains:

You see, the so-called emissions “cap” in the program automatically adjusts so that it is actually very unlikely to set a hard limit on emissions. If the state’s greenhouse gas (GHG) emissions are lower than the emissions cap, the program puts a floor on the price of the tradable emissions allowances, essentially shrinking the cap to soak up extra allowances at the floor price. And if emissions are high, it automatically expands the cap by selling all allowances demanded at a pre-determined ceiling price.

Also see The Limits of Carbon Trading Limits that argues that the cap is elastic for good reasons:

California’s CO2 market has the most sophisticated, and arguably most successful, system of emissions price-collars of any cap-and-trade market. The price-collars are designed to regulate the CO2 price so that it doesn’t reach economically – or politically – unacceptable extremes by making the cap elastic. If the price is too low, the system automatically withholds additional CO2 allowances to tighten supply. If the price is too high, it supplies more of them. This means, as Severin Borenstein and I have laid out in the past, that California’s CO2 “cap” is more accurately thought of as a progressive carbon tax, where the price of CO2 goes up at higher levels of statewide CO2 emissions.

I think these features may be incompatible with the Climate Act law if the Climate Action Council interpretation is followed.

Emitter Compliance Flexibility

Providing emitters with various ways to achieve compliance can improve the overall cost-effectiveness of NYCI without compromising its objective of emissions reduction. Allowance trading, carbon offsets and allowance banking can help to lower compliance costs and enhance the efficiency of the program. These flexibility mechanisms allow the artificial market created by the cap-and-invest program to emulate real market behavior. This can help to ensure that sudden changes in the market don’t lead to extreme price volatility, making the program more predictable and manageable for participating businesses. This adaptability has been key to the success of existing emissions trading systems.

This is another inevitable reality confrontation.  These are absolutely necessary components of any cap-and-invest program but they are opposed by New York’s climate activist constituency.  It is unclear how the Hochul Administration can continue to cater to those folks when they demand to remove the tools that make market trading programs work. 

One of the demands by this constituency is to forbid the use of offsets as noted in the Keys Report description.  I think this is flawed.  The Climate Act is net-zero which is defined as an 85% reduction in GHG emissions with the remaining 15% of emissions counterbalanced by offsetting emissions.  I guess they want to limit offsets to particular sectors, but the following description explains all the benefits that prohibiting offsets will prevent:

Carbon offsets can also be a valuable flexibility tool in a cap-and-invest program. Offsets allow regulated entities to meet a portion of their compliance obligation by investing in or purchasing emission-reduction credits from projects outside of the capped sectors. These might include forestry projects or agricultural practices that sequester carbon, or methane capture from landfills. If the agriculture and waste sectors are not required to comply with NYCI, creating a secondary market for offsets could incentivize these sectors to improve their efficiency. Offsets can provide an affordable alternative for compliance, but they have been the subject of frequent scrutiny due to concerns that the emission benefits they generate would have occurred regardless of investment in the credited activity.40 Research on offsets does indicate establishing equivalency of offset projects to more direct emissions reduction is a challenge. Despite their imperfection, offsets can provide a real value, especially in the near term when strategies to reduce emissions are more limited. The CLCPA addresses these concerns by requiring that DEC verify that any emissions offsets used to comply with environmental regulation are, “real, additional, verifiable, enforceable, and permanent.”

Tradeoffs from Limiting Flexibility

The possibility of including a trading mechanism in NYCI, rather than setting facility-specific caps in the program, has drawn scrutiny. This is largely out of concerns that polluters in or near Disadvantaged Communities (DAC) would be able to continue polluting, and instead simply buy allowances and maintain their current emissions levels. Historically, these communities have often been disproportionately exposed to air and water pollution, giving reasonable rise to this concern.

Another reality is that allowance market programs are trading programs.  The idea that there should be limits on trading is inimical to the very concept of a trading program.  This is a GHG emissions trading program that is appropriate to use for pollutants that influence global warming. The location within New York State for the GHG emissions does not matter.  In order to curry favor with more political constituencies, the Climate Act includes provisions to address disadvantaged communities.  This includes the idea from members of the Climate Action Council who had no trading program experience to somehow include site-specific limits on trading.  I personally see no practical way to implement such a scheme.  As noted below there are other regulations in place that ensure that all regions in the state meet air and water quality standards that protect health and welfare so the idea that GHG emissions trading should also address local effects is counter-productive and unnecessary.

Revenue Management and Use

Ensuring the transparent, accountable, and efficient use of the revenue generated is critical to the success and legitimacy of a cap-and-invest system. If auction prices are similar to those in the state-level cap-and-invest systems in California and Washington, NYCI could generate billions of dollars annually.

I have no doubt that NYCI will generate billions of dollars.  Unfortunately, New York’s record of RGGI investment proceeds has been dismal. According to the New York State Regional Greenhouse Gas

Initiative-Funded Programs report, since the inception of the program, total investments from New York’s RGGI auction proceeds programs is $825 million and the claimed savings are 1,731,823 tons of CO₂e with a calculated cost per ton reduced of $476/ton.  At that rate, investments to provide the reductions necessary will be unaffordable.

Monitoring, Evaluation, and Modification

All existing GHG emissions trading systems began operating in the last two decades, and significant changes have been made to all of their structures since being implemented. While evidence supports many of the design parameters discussed in previous sections, it is limited by the short time these policies have been in operation and the unique environmental and economic characteristics within each region. It is crucial that robust monitoring and evaluation mechanisms be incorporated with cap-and-invest to assess the program’s performance over time and inform any adjustments to the program as necessary.

I agree with these comments.

Recommendations

The Keys Report includes recommended cap-and-invest design features.  The following paragraph sums up the issues I believe must be addressed.

While the Cap-and-Invest program proposed by the State could reduce emissions more cost-effectively than other regulatory approaches, its success will depend greatly on its design. Efforts to make the program more stringent by limiting trading of allowances, or imposing source-specific emissions limits, while well intentioned, would ultimately increase the costs imposed on New Yorkers and may exacerbate emissions leakage and economic competitiveness risks.

It is important to also recognize NYCI would not exist in a vacuum. NYCI is a central component of New York’s efforts to reduce emissions, but alone, is unlikely to ensure CLCPA goals are met. If additional regulations are pursued that include facility-specific limits or energy standards, the interaction with cap-and-invest could render it less cost-effective. Traditional regulatory standards could require some firms to reduce their emissions beyond what they otherwise would have under only cap-and-invest. This would reduce demand in the allowance market, pushing down prices and undermining the incentive for businesses only covered by cap-and-invest to reduce their emissions. Facility-specific regulations may still be appropriate if there are local health impacts or other negative externalities not adequately covered by the emissions market.

I want to make one point about the final sentence.  The Climate Action Council health impact arguments ignore the fact that there already are regulations in place to address local impacts.  Every facility in New York has had to prove that its emissions do not cause exceedances of the National Ambient Air Quality Standards.  This condition is ignored in these arguments.  The Department of Environmental Conservation is developing regulations and guidance to deal with these concerns and this has to be considered as NYCI is implemented.

The CBC recommends the State follow these approaches when designing the Cap-and-Invest program:

1. Allow and pursue linkage with other emissions trading programs. While a national cap-and-invest program that covers all economy-wide emissions is optimal, broadening the scope of Cap-and-Invest beyond the boundaries of New York, by linking with other programs, would enhance the program’s cost-effectiveness by providing a larger pool of emissions reduction opportunities. The State should ensure that NYCI regulations are designed to be consistent with emissions trading systems in other states to enable future linkage.

I agree with this recommendation.

• Keep sectoral coverage as broad as possible. NYCI should cover emissions from as many sectors as is feasible. Exceptions should only be made if inclusion is exceedingly difficult or expensive to administer. Excluding certain sectors could shift the entire burden of reducing economy-wide emissions onto sectors with a compliance obligation. Sectors that face a greater emissions leakage risk could instead be given a share of allowances for free to alleviate this risk, but they should still have an obligation to comply with the program.

I agree with this recommendation.

• Maintain flexibility in compliance through trading, banking, and verifiable offsets. An efficient Cap-and-Invest program should provide businesses with multiple options for compliance to accommodate the differences in their conditions. Trading should not be restricted; limiting this critical component of cap-and-invest would add uncertainty to the market, and potentially drive up the price of allowances without increasing the environmental benefits of the program. Permitting banking of allowances can encourage early emission reductions and help companies smooth out their compliance costs over time. Allowing the use of verifiable offsets to meet a portion of firms’ compliance obligation can reduce the cost of compliance and incentivize emissions reduction in non-regulated sectors.

I agree with this recommendation,  If these are not accepted, this is no longer a market trading program and none of the observed benefits of previous successful programs should be expected.

• Allocate revenue on budget, but free from capture. Revenues generated through NYCI should be included and appropriated within the State’s regular budget process, as other taxes and fees are within the financial plan, to promote transparency and accountability and ensure that funds are not spent wastefully. Furthermore, this revenue should be allocated to costs related to administering and evaluating the program, and investments that further the goals of the program, such as energy efficiency programs, development of low-carbon energy infrastructure, and incentives for the adoption of clean technologies. These investments can accelerate the transition towards a low-carbon economy, reduce the burden of compliance costs, and deliver additional environmental and economic benefits. The revenue generated by NYCI should be free from capture and diversion to short-sighted spending endeavors and unrelated political priorities.

I also agree with this recommendation.  I did not mention that New York has diverted the RGGI allowance proceeds in the past.  In addition, to the overt diversion to the general fund, the Agencies continue to use RGGI revenue as a slush fund to cover costs more appropriately covered by other programs.  Importantly this means less money for the stated purpose of the program.

• Regularly monitor, publicly report, and evaluate program data and modify the program based on evidence. Effective monitoring and evaluation are key to the success of the Cap-and-Invest program. Regularly reporting on the program outcomes, including emissions reduction progress, the functioning of the allowance auction and secondary market, and the use of auction revenues, can ensure transparency, accountability, and inform adjustments to improve NYCI. Data collected from auctions and programs receiving revenue should be publicized to allow for adequate public scrutiny.

I agree with this recommendation.

• Align the program with other regulations implemented in accordance with the CLCPA. Any additional climate policies that may be pursued to meet CLCPA goals should be considered holistically when designing Cap-and-Invest to minimize overlapping regulatory costs and improve overall policy effectiveness. This approach can help ensure that the program complements rather than conflicts with, or inappropriately compounds the costs of, other measures.

I think this recommendation makes sense.

• Finalize clear and comprehensive rules and give adequate time for businesses to prepare. Predictability and certainty are necessary for businesses to plan their compliance and emissions reduction investments. Finalizing clear and comprehensive rules in a timely manner can reduce uncertainty and facilitate a smooth transition for the carbon market. The State should finalize regulations well in advance of the first compliance period.

This is a common sense recommendation but I fear the desire to get something up and running as soon as possible will mean that implementation will be rushed.

Conclusion

The Keys Report is an excellent summation of NYCI and I recommend reading the original document.  I know how much work went into this report because have tried to describe the issues covered in this report myself. I find it encouraging that a non-partisan organization with no preconceived notions on the benefits and risks of the cap-and-invest programs is in close agreement with my concerns.  My comments on this report support their work and provide context that shows that their concerns are warranted.  If anything, their concerns are understated. However, because there are significant differences between their recommendations and the Hochul Administration narrative I am not optimistic that their recommendations will be considered and implemented.

Personally, I think NYCI is not going to work as its supporters think. I agree with Danny Cullenward and David Victor’s book Making Climate Policy Work  that the politics of creating and maintaining market-based policies for GHG emissions “render them ineffective nearly everywhere they have been applied”.  I have no reason to believe that NYCI will be any different even if all the recommendations suggested by the Keys Report are implemented.  Because I think that political considerations will preclude those recommendations, I think that NYCI will cause a dramatic increase in New York energy costs, fritter the revenues away on politically convenient projects, and fail to support renewable energy resource development sufficient to meet the mandated goals of the Climate Act.  I expect no good outcomes.

One of my pragmatic interests is market-based pollution control programs. As part of New York’s budget process Governor Kathy Hochul announced a plan to use a market-based program to raise funds for Climate Leadership & Community Protection Act (Climate Act) implementation.  It has been touted as a solution for funding and compliance requirements because other market-based programs have been successful.  Even though it has drawn widespread support I think the faith in the mechanism is mis-placed because the numbers do not add up.

This article was also published at Watts Up with That.  I submitted comments on the Climate Act implementation plan and have written over 290 articles about New York’s net-zero transition because I believe the ambitions for a zero-emissions economy embodied in the Climate Act outstrip available renewable technology such that the net-zero transition will do more harm than good.  I also follow and write about the Regional Greenhouse Gas Initiative (RGGI) market-based CO2 pollution control program for electric generating units in the NE United States.    I have extensive experience with air pollution control theory, implementation, and evaluation having worked on every cap-and-trade program affecting electric generating facilities in New York including the Acid Rain Program, RGGI, and several Nitrogen Oxide programs. 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.

Climate Act Background

The Climate Act established a New York “Net Zero” target (85% reduction and 15% offset of emissions) by 2050. The Climate Action Council is responsible for preparing the Scoping Plan that outlines how to “achieve the State’s bold clean energy and climate agenda.”  In brief, that plan is to electrify everything possible and power the electric gride with zero-emissions generating resources by 2040.  The Integration Analysis prepared by the New York State Energy Research and Development Authority (NYSERDA) and its consultants quantifies the impact of the electrification strategies.  That material was used to write a Draft Scoping Plan that was released for public comment at the end of 2021 and approved on   December 19, 2022. 

The Final Scoping Plan noted:

The Climate Action Council (Council) has identified the need for a comprehensive policy that supports the achievement of the requirements and goals of the Climate Act, including ensuring that the Climate Act’s emission limits are met . A well-designed policy would support clean technology market development and send a consistent market signal across all economic sectors that yields the necessary emission reductions as individuals and businesses make decisions that reduce their emissions. It would provide an additional source of funding, alongside federal programs, and other funding sources, to implement policies identified in this Scoping Plan, particularly policies that require State investment or State funding of incentive programs, including investments to benefit Disadvantaged Communities.  Equity should be integrated into the design of any economywide strategy, prioritizing air quality improvement in Disadvantaged Communities and accounting for costs realized by low- and moderate income (LMI) New Yorkers. Pursuant to the Climate Act, a policy would be designed to mitigate emissions leakage. Finally, an economywide strategy would be implemented as a complement to, not as a replacement for, other strategies in the Scoping Plan. A well-designed economywide program will bring about change in the market and promote equity in a way that does not unduly burden New Yorkers or with the global economy.

Hochul’s address stated that “New York’s Cap-and-Invest Program will draw from the experience of similar, successful programs across the country and worldwide that have yielded sizable emissions reductions while catalyzing the clean energy economy.”  Subsequently other legislators have jumped on the bandwagon and offered legislation to modify the Hochul proposal.  My problem is that the perception that these programs have yielded sizable emission reductions while providing funds needed for the transition are misplaced.

Emissions Market Program Background

The concept of emission markets is relatively simple.  EPA explains that:

Emissions trading programs have two key components: a limit (or cap) on pollution, and tradable allowances equal to the limit that authorize allowance holders to emit a specific quantity (e.g., one ton) of the pollutant. This limit ensures that the environmental goal is met and the tradable allowances provide flexibility for individual emissions sources to set their own compliance path. Because allowances can be bought and sold in an allowance market, these programs are often referred to as “market-based”.

This is a fine overview but the details are what is important for New York’s plan.  I have been following these programs since 1993 because I was responsible for submitting compliance reports from that point until my retirement in 2010.  New York State has embraced this approach and I was involved in the stakeholder process associated with multiple rule-makings.  Finally I have been tracking the performance of the Regional Greenhouse Gas Initiative (RGGI).  All of my findings are based on observations of the inner workings of these programs.

A recent book Making Climate Policy Work comes to many of the same conclusions and raises concerns similar to mine based on economic theory.   The description of the book states:

For decades, the world’s governments have struggled to move from talk to action on climate. Many now hope that growing public concern will lead to greater policy ambition, but the most widely promoted strategy to address the climate crisis – the use of market-based programs – hasn’t been working and isn’t ready to scale.

Danny Cullenward and David Victor show how the politics of creating and maintaining market-based policies render them ineffective nearly everywhere they have been applied. Reforms can help around the margins, but markets’ problems are structural and won’t disappear with increasing demand for climate solutions. Facing that reality requires relying more heavily on smart regulation and industrial policy – government-led strategies – to catalyze the transformation that markets promise, but rarely deliver.

The authors recognize the enormity of the challenge to transform industry and energy use on the scale necessary for deep decarbonization.  They write that the “requirements for profound industrial change are difficult to initiate, sustain, and run to completion.”  Because this is hard, they call for “realism about solutions.”  Cullenward and Victor recommend clear thinking and strategy as opposed to “Efforts spent tilting at ephemeral, magical policy solutions waste scarce resources that should instead be invested in things that work.”  The goal of their book is to explain how market-oriented climate policies have fallen far short and how they might be modified so that they work. If you are interested in more information about emission markets I recommend this book.

General Market-Based Program Concerns

I submitted comments on the Draft Scoping Plan chapter on a market-based approach for the transition plan based on my observations of similar programs.  The EPA Acid Rain Program was a cap-and-trade control program that enabled affected sources to meet their compliance options efficiently.  Affected sources could purchase allowances from a facility that had more cost-efficient control options to meet the overall cap.  EPA notes that the program “has helped deliver annual SO₂ reductions of over 93% and annual NO_X emissions reductions of over 87%” since the start of the program.  The costs have been far lower than expected in no small part because the affected sources figured out how to use fuel switching to coal with lower sulfur content.  The success of the Acid Rain program led to similar programs for NOx both nationally, regionally, and limited to just New York State.

Despite the fact that these programs provided significant emission reductions at a lower cost to the affected sources the environmental community felt it was somehow unfair that some facilities made money selling allowances that had been given to them for free.  That ignores the fact that those facilities selling the allowances made investments to get lower emissions.  The idea that the polluters had to be made to pay led to cap-and-invest programs where the allowances are mostly available through an auction.  The Regional Greenhouse Gas Initiative (RGGI) is a good example of that approach.

On the face of it, RGGI appears to provide emission reductions while also raising revenues so that model appeals to legislators.  However, my observations of RGGI indicate that the theory of this approach is not matched by reality.  Even though the CO2 emissions in the RGGI states have gone down substantially that was mostly because the effected sources switched from coal and residual oil to natural gas with lower CO2 emissions.   The investments made with the auction proceeds that were supposed to fund emission reductions were only responsible for ~15% of the observed reductions.    The accumulated total of the annual reductions from RGGI investments is 3,658,696 tons through December 31, 2020. The sum of the RGGI investments is $2,991,215,917 over that time frame.  The cost per ton reduced $818 exceeds the societal cost of carbon so they are not justified by those societal benefits.  Emission reductions in the future are going to have to rely on investments of the RGGI auction proceeds but at those high cost per ton reduced rates the costs may be too high for public acceptance.

One major difference between controlling CO2 and other pollutants is that there are no cost-effective control technologies that can be added to existing sources to reduce emissions.  Combine that with the fact that CO2 emissions are directly related to energy production, the result is that after fuel switching the primary way to reduce emissions is to reduce operations.  Consequently, CO2 emission reductions require replacement energy production that can displace existing production.  If existing generation is not displaced with zero-emissions resources then energy production must be capped.

New York Numbers

The first numbers consideration is the cap itself.  EPA explains that “The cap is intended to protect public health and the environment and to sustain that protection into the future, regardless of growth in the sector.”  For the Acid Rain Program the cap was originally intended to reduce emissions by 50% but later was tightened down.  In the NOx cap and trade programs the caps were set based on a technological evaluation of the control technology available to affected sources.  The industry – agency issues with those caps centered on whether the agency estimates for additional control levels were reasonable.  Importantly, the SO2 and NOx caps were based on the feasibility of affected source characteristics and were not binding in and of themselves.

On the other hand the CO2 cap in RGGI and the New York cap-and-invest caps are not based on feasibility.   I define a binding cap as one chosen arbitrarily without any feasibility evaluation.  In 2030 New York GHG emissions must be 40% lower than the 1990 baseline but this is an arbitrary target mandated by the Climate Act.  The state’s Scoping Plan for this transition did not include an analysis to see if this target was feasible so I think this will be risky.

The following graph lists NY GHG emissions by sector from 1990 to 2030.  The data from 1990 to 2020 is from the New York 2022 GHG emission inventory.  Electric sector emissions are available through 2022 and I used those with estimates based on recent averages to project emissions for the other sectors in 2021 and 2022.  The emissions shown for 2023-2030 simply represent the straight-line interpolation between the 2022 emissions and the 2030 emission limits consistent with the state’s Climate Act mandate that 2030 emissions must be 40% less than the 1990 baseline emissions.

I estimate that meeting the 2030 emissions limit will require a 4.5% annual decrease from each sector from 2023 to 2030.  That is an unprecedented reduction trajectory.  Those percentages translate to annual reductions of 2.73 million metric tons of CO2e (MMT) for the electricity sector, 0.97 MMT for agriculture, 5.32 MMT for buildings, 1.59 MMT for industry, 4.89 MMT for transportation, and 1.88 MMT for the waste sector. 

The Climate Act has exemptions for certain sectors.  All components in the agriculture sector are not required to meet the 40% mandate and energy-intensive and trade exposed industries also get some sort of a pass.  Even a cursory examination of the data in the graph suggests that the presumption that a binding cap will necessarily ensure compliance is magical thinking.  The historical trend in electricity sector emission reductions appear similar to the trend necessary to meet the 2030 target but the historical trend was caused by fuel switching and there are no more reductions to be had in that regard.  In order to reduce electricity sector emissions the energy output will have to be displaced with wind and solar.  Waste sector emissions have been more or less constant since 1990.  An entirely new technology has to be implemented in the next seven years to get a 4.5% per year reduction in emissions.  Transportation can only reduce emissions if the transition to zero-emissions vehicles accelerates a lot.  When I point out that there has been no feasibility analysis I am concerned because the Scoping Plan did not analyze whether the necessary technologies are likely to be available and deployed as needed and there was no consideration of what if questions.  At the top of that list is “what if the technology rollout is delayed?”

It is beyond the scope of this analysis to consider potential control strategies for every sector.  I did investigate one proposed strategy for the building sector transition that was included in Hochul’s proposal.  Part VI-B:, Decarbonize New York’s Buildings states:

Building electrification and related upgrades improve interior comfort, reduce exposure to air pollution, and support local jobs. But right now, only about 20,000 New York homes install modern heat pumps for heating and cooling each year.  While New York is making progress through programs like NYS Clean Heat, more must be done to cut emissions in our buildings.

To accelerate green buildings in New York, Governor Hochul is setting an unprecedented commitment of a minimum 1 million electrified homes and up to 1 million electrification-ready homes by 2030, and ensuring that more than 800,000 of these homes will be low- to moderate-income households. This target will be anchored by a robust legislative and policy agenda, including: raising the current rate of electrification of approximately 20,000 homes per year more than tenfold by the end of the decade.

I evaluated this component of the plan and the emissions reductions that could be expected for comparison to the annual 5.32 million metric ton of CO2e reduction required to meet the binding cap.  Instead of using the confusing and poorly documented Scoping Plan estimates of residential energy use I used the New York State Energy Research & Development Authority Patterns and Trends document.  Appendix B, Table B-1 lists the average household consumption by fuel type.  I calculated the GHG emissions (CO2, CH4, and N2O) for direct emissions and New York’s required upstream emissions for each fuel type to get an estimate of residential electrification impacts on emissions.

I assumed that the two million homes initiative would convert 250,000 homes per year (two million divided by eight years).  I apportioned the type of fuels used by the observed number of residences using each fuel type in the Scoping Plan.  In other words, for this analysis, I maximized the potential emission reductions by eliminating the average fuel use in Table B-1 to zero.  I found that these conversions would reduce GHG emissions by 1.3 million metric tons of CO2e per year.  The Building sector has to reduce emissions 5.32 million metric tons of CO2e per year so the two million home initiative will only reduce emissions 25% of the amount needed when it gets cranked up from 20,000 homes to 250,000 homes per year.

I also took a shot at the costs.  I assumed that the two million homes would be converted over to electricity for heating, cooking, hot water, and clothes dryers.  I calculated the differential cost between replacement of existing fossil-fired technology with heat pumps and included $6,500 for upgrades to the electric service.  Following the Scoping Plan recommendations, I also accounted for improved building shells.  I estimate that the average cost to electrify a single residence is $42,777 all in. Multiplying that cost by 250,000 homes per year gives $10.7 billion per year in residential electrification costs for one quarter of the reductions needed.  If the building shell is not upgraded the average price increase drops to $24,750 and the total annual cost drops to $6.2 billion per year.  Even if you assume that my cost estimate is 25% high and the building shell is not included the costs are $4.6 billion per year.

Another thing to consider is the costs per ton for emission reductions in the buildings sector.  In the best case, not including building shells and 25% below my estimates, the cost is $3,500 per ton reduced.  That is on the order of 28 times higher than the New York value of carbon which is $126 per ton in 2023.

Discussion

One of the talking points of the Scoping Plan was that emissions from the Buildings Sector was the largest source of emissions in New York.  However, the difficulty getting reductions from the sector was not discussed.  There are two ramifications of that overlooked challenge.

In the first place the cap and invest binding cap has set an ambitious emissions reduction trajectory of 4.5% reductions per year to ensure compliance with the 2030 Climate Act mandated cap equivalent to a 40% GHG emission reduction from the 1990 baseline.  That equates to 5.3 million metric tons per year.  I estimate that electrifying 250,000 homes per year that are currently burning fossil fuels will only reduce emissions 1.3 million metric tons per year or one quarter of the amount needed.

Where are the rest of the building sector emission reductions going to come from?  The lack of specificity in the Scoping Plan documentation precludes an easy response to that question.  There is another aspect of this even if there is some sort of technology available for the remaining reductions required.  The current NY rate of electrification is 20,000 homes per year and Hochul’s two million homes per year program will increase that by more than ten times someday.  The trained labor and supporting infrastructure necessary is simply not available at this time.  Providing training for staff takes time and money and companies have to invest more time and money in the infrastructure to do the work.  It is impossible to go from 20,000 to 250,000 homes per year overnight. 

The theory of a market-based carbon emissions reduction program is that the higher cost of the fossil fuels with the allowance adder will incentivize innovation to get the most cost efficient solution.  Even if someone were to develop a magical solution that dropped the costs to electrify an order of magnitude, there just are not that many emissions from an individual residence available.   As a result, the cost per ton reduced will still be well in excess of the New York Value of Carbon, $471 per ton reduced vs. $126 per ton in 2023.  If the costs to make these reductions exceed the societal benefit of the reductions then the reductions are not cost-effective.

The second ramification is equally troubling.  It is not clear at this time exactly how the program will be rolled out.  The state will put allowances up for auction annually equal to the reduction trajectory amounts needed to meet the 2030 emission limits.  I am guessing that the providers who supply fossil fuel to the building sectors will be responsible for building sector compliance.  They will purchase allowances for each quantity of fuel purchased.  If they purchase fuel and have insufficient allowances to cover that energy then they cannot sell the fuel. 

I don’t think the advocates for a binding CO2 cap really understand that limiting the number of allowances also places a limit on fuel use.  In theory scarcity will drive the prices up incentivizing innovation for lower carbon solutions but the ultimate compliance strategy is to simply not burn fossil fuels.  If the emission reduction control strategies are developed slower than the arbitrary compliance trajectory then there will be an inevitable artificial shortage of fuel.  If a power plant has insufficient allowances, it cannot run and provide energy when needed.   When the fuel providers don’t have enough allowances, then they will have to limit how much fuel aka energy they can provide to homes and other users.  Given that the trajectory is so ambitious and the options to make reductions appear to be so limited I don’t see any way this will not result in artificial fuel shortages.

Even if there are sufficient allowances the artificial scarcity will drive up prices.  One of the great unknowns of the Hochul proposal is the revenue target.  A feature of most cap and invest programs are limits to constrain the auction price.  However, the market price has no such limits.  The impacts of a binding cap on costs is another unknown with likely bad consequences.

Conclusion

New York policy makers have glommed on to Cap and Invest because they think it is a solution that will easily provide revenues  and compliance certainty.  Unfortunately, that presumption is based on poor understanding of market-based emissions programs.  The reality is that successful programs used emissions reduction strategies that are not available in the quantity or quality necessary for New York. Presuming that past performance would be indicative of future reduction success and establishing an arbitrary emissions target that is incompatible with realistic emission reduction trajectories is not going to end well because the numbers simply do not add up.