Unexpected Consequences of Climate Change

I’ll bet CBO didn’t consider avoiding these kinds of problems when they estimated the benefits of climate change legislation.

H/T bizarro for having a great comic and blog

How Allocations to Protect Households Can Actually Hurt Them

A previous post gave a small introduction to Local Distribution companies (LDCs) and allowance distribution.  I would recommend checking it out since LDC allocation is central to Waxman-Markey.  It is so important, that I would wager quite a bit that Waxman-Markey or any climate bill will NOT pass without some sort of LDC allocation built in.

One area which hasn’t received that much attention is how LDC allocation affects the incidence of the policy.  LDC allocation is hailed as a method to protect households from higher electricity prices, but ultimately it can make them worse off compared to cap-and-dividend.

A new technical memo that Rich and I worked on finds that the average household could find itself $157 worse off under LDC allocation.  This number shrinks to $66 if there is widespread reform of electricity pricing by separating fixed and variable charges, and if industrial and commercial customers respond rationally (more on this in a subsequent post).  These values are compared to a full cap-and-dividend, where all permits are auctioned and carbon revenue is redistributed to households through a per-capita dividend.

How could households be worse off under LDC allocation?  First, a bit of background.  Households feel the burden of climate policy through two large categories: direct expenditure on electricity/heating and indirect costs associated with higher good prices.  The direct prices are easy to account for since they are on utility bills, but the indirect costs are a bit trickier.  Every good and service you consume has an embedded carbon content due to the energy and emissions associated with its production.

When permits are allocated to LDCs to keep down the direct energy costs, the indirect energy costs a household pays will increase.  This increase will ultimately overshadow the savings a household receives from direct energy costs not increasing.   So, while under LDC allocation, households might think they are better off since their utility bills aren’t increasing, they ultimately are worse off since everything else in their life is now more expensive.

This result is not exactly what policy makers want to hear.  One of the arguments for LDC allocation is to protect electricity consumers.  While LDC allocation accomplishes this for direct expenses, it backfires in ultimately protecting households.  On the political side of things, it spreads out the household burden of carbon policy and silences enemies of climate policy who simply claim “cap-and-trade makes your utility bills go up.”  In the end, this might be what really matters, and the loss in efficiency is just another sacrifice necessary to pass climate policy.

A Primer on Allowance Distribution in Waxman-Markey

For the last month I’ve been spending a lot of time studying and modeling various allocation schemes for carbon allowances.  This kind of a big topic, so I’m going to aim this post at talking about Waxman-Markey and what its distribution plan might mean.  The current version of Waxman-Markey allocates 35% of permits to “electricity consumers” through Local Distribution Companies (LDCs).   LDCs are highly regulated entities that take power from high-voltage transmission lines, and distribute it in a usable form to Industrial, Commercial or Residential customers.  The details of how LDCs function aren’t that important, since the legislation lays out how the money should be used:

Emission allowances distributed to an electricity local distribution company under this subsection shall be used exclusively for the benefit of retail rate payers of such electricity local distribution (p575).

To the extent an electricity local distribution company uses the value of emission allowances distributed under this subsection to provide rebates, it shall, to the maximum extent practicable, provide such rebates with regard to the fixed portion of rate payers’ bills or as a fixed credit or rebate on electricity bills (p576).

To understand this, a little background on how electricity bills work is necessary. Unfortunately, every state has a different system, so forgive me if I misrepresent your state.  The basic concept is that electricity bills have a fixed portion, and a variable portion.  The fixed portion covers capital costs like transmission lines and maintenance etc.  The variable part covers the cost of generating electricity like fuel costs and other variable operating costs.

The legislation above stipulates that as much as possible, the allowance revenue should go to subsidize the fixed portion of a bill instead of the variable cost.  This is meant to allow the variable price of electricity to increase with carbon policy (and hence decrease consumption), but not increase the overall burden on consumers.

The reason why one might want the variable cost portion of a bill to increase is that it allows for a more efficient carbon policy.  As consumers face higher costs, they will reduce their consumption and emissions.  If consumers don’t face this higher variable cost, consumption will stay high, and emissions reductions under a cap and trade policy will have to come from other sectors of the economy.  This is a less efficient overall outcome since the lower hanging fruit of reduced electricity consumption cannot be taken advantage of, and other less efficitn mitigation is necessary.  This also results in a higher emissions allowance price.

The legislators seem to be somewhat aware of this, and hence the bill stipulates that money should go to reduce the fixed portion of a bill.  In practice, this isn’t exactly what will happen.  First off, residential consumers (around one third of consumption) probably aren’t sophisticated enough to think on the margin in electricity consumption decisions.  I study energy and I just look my bill total, not the individual components.  Industrial and Commercial customers, however, spend a lot more money on electricity and it is reasonable to assume that they would take higher variable costs into consideration.

The second important part is “to the maximum extent practicable.”  This is tricky since in practice very few LDCs fully separate the fixed and variable portions of their bill.  Instead, LDCs usually have some small fixed portion, but end up recovering a large portion of their fixed costs through the variable section of the bill.  Other states hardly differentiate at all.  In order to appropriately apply the allowance value to the full fixed portion of the bill, massive electricity billing reform would be needed.

If you have made it this far, you might be asking why this is important.  I come at this issue from the income distribution perspective, and these small pieces of legislative language and assumptions about consumer behavior have huge impacts on who bears the cost of carbon policy.  (In an effort not to write an essay for a post, I’ll touch on that next time.)

From the larger policy perspective, it looks like LDC allocation will be a part of Waxman-Markey as a compromise of sorts, but it doesn’t seem that the full effects of this policy have been fully analyzed.  The bottom line is that LDC allocation is a less efficient mechanism for climate policy, and will force other sectors to abate more emissions to compensate.  If we are ok with that as a compromise, so be it, but policy makers should at the very least know what they are compromising on.

Offsets, offsets, offsets

Offsets.

Offsets.

(related to) Offsets.

It seems like all anyone can do anymore is talk about offsets (at least in my sheltered life). Partially that’s because they are emerging as the key issue that could make or break the Waxman-Markey bill, and possibly a future Senate bill (which may make a splash before the end of the summer).  The three links above provide a good snapshot of the world of offsets as it stands now.

The first link is a rundown of the lobbying brawls surrounding the amount of offsets in Waxman-Markey. It does a good job of highlighting the difference between industry lobbyists (they heart offsets) and environmental lobbyists (they don’t trust them). One thing the article gets wrong, however, is who decides what is an offset:

Near the top of the lobbyists’ wish list is persuading Congress to specify which projects would be eligible as offsets. The bill creates large categories, then allows third parties to decide what is eligible as an offset. Those third parties probably would be similar to groups in the voluntary offset market like the Chicago Climate Network or the Climate Action Reserve in California.

That is an incorrect statement. Third party standards will probably be followed closely or entirely, but it is the Offsets Integrity Advisory Board (OIAB) that will be housed in the EPA that will be the the final authority that determines what is an offset. Thankfully, the bill itself does not say what counts as an offset, but you can imagine the fury that will burn around the OIAB if they make a decision that enrages a powerful and well-endowed interest group.

Actually, you need not imagine that because it has already occurred, which brings us to the second link above. Way back when Waxman-Markey emerged from committee markup, Collin Peterson (D-MN), chariman of the House Agriculture Committee started throwing a hissy fit about the supposed lack of role for agriculture offsets. He basically threatened to torpedo the whole bill if it gave offset market oversight to the EPA. Peterson is still stewing about an EPA rule that may make biofuel producers responsible for their full carbon footprint, including the possible indirect landuse changes resulting from ethanol production, so his solution is to bring down Waxman-Markey unless he gets his way. Discussions between Peterson and Henry Waxman’s staff have been on-going, but as of today, it sounds like Waxman is done playing with Peterson and House leadership may look to take their chances with a floor debate.

At this point, it can feel like using economic arguments is sort of like sternly yelling at a freight train, but I’ve got a loud voice, so I’ll give it a shot. This bill in no way excludes agricultural offsets. It doesn’t exclude any kind of offsets, nor should it. The point is to establish a market system where offsets can be brought, and let the market decide what makes a good offset. The role of OIAB is essentially quality control and setting standards. If your offset is legit, then you don’t need to worry. If it’s just a play to get make more money for Monsanto without any real carbon benefits, then there’s a chance it won’t make the cut.

Even though the offset language in the bill doesn’t favor a certain kind of offset, it contains a number of additional standards for forest offsets. That’s probably because everyone recognizes landuse and forest emissions are a big slice of the climate pie (20% of global emissions), but it also because we have a ways to go before we figure out how to make international forest offsets and REDD (Reducing Emissions from Deforestation and forest Degradation) work effectively.

The third link connects to the latest and greatest studies related to REDD and offsets. Basically, if we want to keep temperature changes below 2 degrees C, we need forest carbon. In the short term, capacity building, establishing pilot projects, and setting baselines for forests are the priorities. In the long term, international offset markets are going to sustain efforts to reduce emissions, so long that enough revenues make their way to indigeneous communties to compete with other land uses.

How well can these international offset markets work? According the authors of the economics study, offset prices between $10-$30 may capture 1-4 billion tons of CO2 per year, or 12-20% of current global emissions. Additionally, international links between markets may significantly reduce global allowance prices (by about 40%). Not bad. It’s important, however, to view these studies in context of the others. If we don’t get local buy-in and solid capacity building, we don’t get our offset markets. Conversely, if the market benefits don’t make their way down to the people on the ground, then all those forests (and investments) could go up in smoke. An when indigeneous people feel like they are being exploited by foreign investment, it’s none too pretty.

New Blog of the Month: Weathervane

Take CT, add a few more decades of experience and study, keen insights from established experts in the world of climate and energy, a dash of nuance, and the intellectual backing of an institution like Resources for the Future, and what do you have? Well, my friends, you have a recipe for Weathervane, the recently resurrected RFF climate policy blog.

Weathervane was originally established in the late 1990s and quickly became a primary source for quality policy discussions on climate change and other environmental issues on Web 1.0. With the myriad sources of climate news out there, this new iteration is now looking to foment thoughtful and robust conversation and highlight the latest insights from RFF’s stable of scholars. If you want a mature perspective of the nexus of climate and economics, then Weathervane is the place to be. Check it out.

Full disclosure: Occasionally, we CTers may cross-post between our autonomous blog and Weathervane (see Andrew’s last post for an example). CT remains an independent blog that in no way represents the opinions of RFF.

NPR channels DM

NPR’s Morning Edition has run a number of pieces this week trying to illuminate the mechanics of cap-and-trade for the masses. I applaud their efforts and wish more media outlets would take the time to explain to non-practitioners how these lovely econ tools we use work. The Planet Money C&T piece this morning was especially effective at cutting through my morning fog because there’s a good chance I would explain cap-and-trade to my less enlightened acquaintances in a similar manner. Also, as one who has been known to occasionally use the word ‘dude’ excessively, it touches me in a special place in my heart. Sweet.

Chu revives FutureGen

Not shocking. There’s a lot for CCS in the stimulus bill ($3.4 billion including the $1billion for FutureGen), Waxman-Markey, and S.1013.  This is both in terms of incentives and setting regulations to reduce future uncertainty.

In keeping with the theme of digging up old forgotten things, here’s some vintage (c.2008) CT discussion of CCS/FutureGen here, here, and here.

H/T: Green Inc.

Update: Environmental Capital has a post up which, unlike mine, has more than a link to a story.

http://blogs.wsj.com/environmentalcapital/2009/06/12/clean-coal-fresh-legs-for-futuregen-project/

Moment of clarity

Something was made very clear to me last night, courtesy of Coors Light (it was not the kind of moment of clarity referred to at 4:09 in this video). As part Coors’ bludegeoning advertising campaign surrounding  cans that turn blue when cold, the announcer in at least one tv commercial claims the cans offer an ‘insurance policy for cold beer.’ Sounds pretty awesome, right? Not so fast. At that exact moment, fine print appears at the bottom of the screen to inform viewers:

There is no insurance policy for cold beer.

My first thought was ‘That’s a huge bummer.’ Then my inner nerd kicked in and brought about my moment of clarity. My corresponding thought was ‘There’s no real insurance policy for climate change either.’

The environmental news gods are smiling on today because the first article I saw on ClimateWire was a rundown on a new study (sub req’d) being conducted by FEMA on the effects of climate change on the National Flood Insurance Program. In my past ravings about insurance and climate change, I haven’t made much mention of the flood insurance program, but it is a massive piece of the puzzle to figure out how the nation can adapt well to climate change.

The NFIP was designed to protect people from being totally exposed to losses from major floodsthat tend to hit the southeast and midwest every year or so. Unfortunately, because people no longer had to worry about losing everything (i.e. they could not fully internalize their risk), they moved into floodplains and coastal areas that before were too dangerous to live in. Now, you have trillions of dollars in sunk capital all over the nation in areas where the risk is changing rapidly and in a way that we don’t fully understand.

The new FEMA study is trying to identify how climate change will affect inland floodplains, coastal areas, and how sea level rise will affect the program. The outcomes of the study could lead to redrawing of 100-yr floodplain boundaries, resulting in higher premiums. The study will not be complete for another year or so, but things do not look good already. According to one of the authors:

“There may be no solid projections. We’re not even coming up with squishy assumptions.”

Imagine, if you will, the political catfight that could surround this study when it’s completed. Here you have FEMA (not the most popular or trusted agency in the land) potentially coming out and saying we need to redraw our flood maps, but they don’t even have squishy assumptions. Perhaps as the study progresses, they will develop slightly more solid assumptions (think jello vs. pudding), but this may be one of the big climate change issues we have to grapple with domestically in the future and it is going to be messy. At least, that’s clear to me.

Back online

Yeah, I know. We’ve been gone for a while. Lots of things have been happening over the past few weeks and any marginally smarmy/useful insight you were hoping to get from the CT crew wasn’t there. Here’s my apology:

Well, don’t worry. We’re back and we promise to do better in the future. It’s going to be a long, hot brutal summer, and we intend to offer some soothing and cool perspective. stay tuned.

Tropical Forest Conservation in Waxman-Markey

Originally posted on RFF’s climate policy blog Weathervane.

For many environmental advocates, the generous forest conservation provisions in the Waxman-Markey energy bill (summary here) are a no-brainer. They target one of the world’s largest—20 percent of the global total—and most cost-effective—about half the world’s deforestation at under $10 per-ton—sources of greenhouse gas emissions reductions while protecting some of the world’s most treasured natural places.

It seems these provisions provide something for everyone, as they have found support from a broad coalition of stakeholders. U.S.-regulated entities like the potential cost-containment benefits from offsetting up to 1.5 billion tons of their emissions by paying for cheaper reductions in developing nations, and that forest conservation does not create competitiveness concerns. The global development community likes the possible poverty reduction benefits of channeling an additional $10 billion per year by 2015 in what could be seen as U.S. foreign aid to tropical forest nations. Climate policy wonks like that this forest financing will strengthen U.S. participation in ongoing global negotiations.

Is it possible, therefore, that these provisions could survive attacks from equally-strong skeptics of offsets, foreign aid, and climate action during House and Senate debates?

 

As the debate unfolds, expect three key issues to come into play:

 

1) Whether the uncertainties in Waxman-Markey’s forest “set-aside” provisions can be clarified.

Currently the bill allocates 5 percent of allowance values (Section 753(b)(1)) for the purchase of “supplemental emissions reductions”—not offsets—solely from international forest conservation. This “set-aside” must be used to purchase 720 million tons of emissions reductions per year from 2020 to 2025 and 6 billion tons overall from 2012 to 2025, and the EPA administrator is required to increase the allowance allocation if necessary to meet this target.

Based on reasonable assumptions about the size of the cap-and-trade program and cost of forest tons, including analysis done by EPA, the U.S. will be lucky to purchase half that amount (about 300 million) with the current 5 percent set-aside. Meeting the required amount may require saving up money in the initial years to spend later, but even this approach cuts it close, and will take away funds from needed capacity building in early years. Does the EPA have the authority or the will to actually follow-through with this requirement? Where will these allowances come from (they’re certainly not going to come without a fight)? 

 

2) Whether the U.S. can demonstrate a plausible pathway to delivering offset tons from forests when cap-and-trade kicks off in 2012.

 

Forest carbon transactions in voluntary carbon markets accounted for about 7.5 million tons in 2007. With the relatively stringent requirements in the bill for developing countries’ participation in U.S. carbon markets—and the current low levels of market-readiness in many of these countries—how will they be ready to potentially deliver 1 billion or even 100 million tons in 2012? One answer is that they need funding for policy-planning and capacity building, on the order of several billion dollars per year between 2010 and 2012.

The good news is that these needs are being addressed by international negotiators in Bonn as we speak—including a strong U.S. forest team—and through other initiatives. The question is, will it be enough? Should the U.S. allocate substantial additional funds in its FY10, FY11 and FY12 foreign aid budgets to specifically target this issue? Or is there another innovative solution out there?

 

3) Whether the institutional structure that manages these forest programs can be strengthened.

 

Currently, the bill places authority to manage the forest set-aside and offsets programs with the EPA, in consultation with the State Department and several other departments. This is not ideal for several reasons. First, although the EPA has expertise in environmental markets, these forest programs will require much greater on-the-ground international development and conservation experience, and international environmental negotiation experience than it possesses. With the amount of funding on the table—about $10 billion per year, as stated before—and the need to get the most bang for the buck, it may make sense to create a specialized agency with expertise in all of these key areas. What should this agency look like? How should it be structured to most effectively manage these new funds and programs?

 

These are some of the key questions that academics and environmental organizations—including RFF’s climate and forest carbon policy teams—will be seeking to answer over the next several months. If policymakers are going to continue to support strong forest conservation provisions in U.S. climate policy, which many stakeholders would argue are absolutely essential from a scientific and economic perspective, these salient questions will need good, robust answers.