Common Tragedies

Thoughts on Environmental Economics

Allocation Mechanisms – The Details Really Matter

Posted by jab12004 on July 22, 2009

A few days ago I received an e-mail from a reader asking about allowance distribution mechanisms in Waxman-Markey.  As I wrote a response, I thought it would make more sense to make a post out of it.

As it stands in Waxman-Markey, allowances will be distributed to LDCs based on a 50/50 split of their emissions and deliveries.  This is often overlooked, but it is important as to where in the country allowance value is allocated, and ultimately how prices will change.  Below i’ve listed three allocation mechanisms, their benefits and some of the problems.  Keep in mind that a “benefit” in this discussion has to do with receiving more allowances ($) and hence has to do with more consumption/emissions (which we usually consider bad).

Consumption based – This metric benefits those who consume a lot of electricity, and are really inefficient at doing so. This is bad for states like California who have invested a lot in demand side energy efficiency.  Consumption weighting also benefits those regions that already generate a lot of electricity from low carbon sources.  If you could imagine a region that only generated electricity from zero carbon sources, they would get a whole lot of free permits, and they could turn around and sell them for pure profits.  Some might argue this is unfair, but personally I think this can almost be seen as a reward for states which have spent the money to make low carbon generation investments.

Emission based – This metric is great for those states who haven’t invested money in low carbon sources of power.  Think the Midwest and the Southeast.  Some might argue that these are the states that need the most help, and that climate policy is going to hurt them the most in percentage terms.  While I think that it is important to protect coal states, it is also important to acknowledge the expensive investments some states have made in low carbon generation.

Population based – This is not a part of Waxman-Markey, but I think it deserves a bit of discussion.  This clearly would benefit those states with a high population.  In some ways, this is the fairest system since one might assume that more energy is consumed in higher population areas.  It does, however, disadvantage low population states that emit a lot of carbon.  For example, Wyoming [remember this?] with its high emissions per capita would receive a very small amount of allowances even though it emits a ton of carbon.

At the end of the day, which system you pick depends on what you think is important.  Personally (if you can’t tell already), I think it makes sense to reward those states that have already invested in lower carbon sources of power.  These states typically face much higher electricity prices than the rest of the country.  My personal feelings aside, there is an equally valid argument that the regions with lower electricity prices (and more emissions) also tend to have a lower cost of living.  Large increases in electricity prices in these areas will constitute a larger burden as a percentage of income.

In the end, it is probably a political compromise which decided the 50/50 split, so there isn’t much we can do about it.  It is just interesting that while a lot of the debate surrounds percent allocations, much less discussion has foused on the mechanism behind the allocation.

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3 Responses to “Allocation Mechanisms – The Details Really Matter”

  1. Josh said

    Man, this is great analysis, to-the-point, simple, and also something to get more people involved.

    Thanks.

  2. Mike Lengowski said

    I agree with your assesment, Josh. After I sent you the question I found a presentation by Jeffry Sterba on behalf of EEI. (See excerpt below.) I also spoke to a regulatory expert who advised me not to overthink the issue as its impossible to tell how much of this is related to winning votes for passage of the bill.

    “Why do we rely upon both sales and emission levels? Frankly, it is a compromise. With the exception perhaps of a few totally hydroelectric-based entities, all LDCs will earn allowances based on both sales and emissions factors. The emissions factor gives weight to concerns of utilities with significant fossil generation that their customers will face higher compliance costs and serves to help offset those costs. The sales factor gives weight to the concerns of other utilities that their customers already face higher prices because those utilities already have invested in non-emitting resources, and their customers have not been compensated for such investments. The 50-50 allocation recognizes the validity of both views.”

    On another topic, I’m curious on how emissions factors on purchased power will be determined when the counter-party is a power marketer. It’s nearly impossible to connect the dots on a source-to-sink emissions trail between generating facility and LDC when a marketer is involved.

  3. Q said

    So which state has “already invested in lower carbon sources of power” and should be more “rewarded” — California or Texas?

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