In USGBC's series on cap and trade in California, we've covered the recent 10-year extension, as well as revenue distribution. Cap and trade is one of many climate strategies in California. Unlike the Greenhouse Gas Reduction Fund, which is a direct result of cap and trade, government regulations and programs are running in parallel, sometimes synergistically and at other times creating interference.
The markets or mandates debate
The Global Warming Solutions Act of 2006 (AB32, updated with SB32) codifies California’s ambitious climate goals, equipped with complementary measures for achieving them. During drafting, there was a debate over whether market-based or regulatory-based mechanisms were superior for reducing emissions.
Market-based controls are attractive because they reward innovation, favoring low-cost solutions and picking the “low-hanging fruit” first, which reduces the cost of compliance. On the other hand, mandates provide more control and certainty, and there is less risk of carbon leakage, contract shuffling and market volatility.
In the end, California opted for a combination of mandates and market schemes, with the rationale that the shortcomings of each can be covered by the other within a mutually reinforcing relationship. For example, there are non-price-related market obstacles that come into play, such as perceived projections of future price and availability.
Balancing markets and mandates
Regulations have made impressive greenhouse gas reductions in California. The Renewables Portfolio Standard (RPS) was first set in 2002 and then ratcheted up over time to the current target for 50 percent renewable energy by 2030. California is now ahead of schedule, already at 27 percent, giving steam to a current proposal to commit to 100 percent renewables by 2040.
The success of the RPS and other regulations may, in fact, be overshadowing cap and trade. As a result, the price of allowances dropped to the floor in 2014, where it has remained, leaving many allowances unsold. This is a good sign for meeting emissions targets ahead of schedule, but not necessarily through the path of least resistance.
For example, renewable energy is typically not as cost-effective as energy efficiency improvements for reducing emissions. In this case, the extra costs to comply with the RPS are internalized by electricity rates. In contrast, cap and trade could have incentivized the lowest cost interventions to keep emissions under the cap.
A look at subsidies
Subsidies for green products (e.g., hybrid or electric vehicles, smart thermostats, solar panels) are like mandates in that they are prescriptive and do not encourage competition for lowest-cost solutions. The extra costs of the program are essentially transferred to those who don’t purchase the green product. This is a logical solution, but it also carries equity considerations if low-income individuals can’t easily afford the product and effectively subsidize it for wealthier individuals.
Subsidies also may not encourage actual behavioral changes. Those who would have already purchased an environmentally friendly product can take advantage of the subsidy, making it difficult to measure the actual impact.
On the other hand, subsidies can easily promote energy efficiency in existing buildings, an area that’s been hard to reach in California. The Weatherization Assistance Program, for example, provides funds to make energy efficiency improvements for low-income residents, addressing the equity consideration as well.
Cap and trade also functions using economic incentives, but the advantages are that cap and trade finds the lowest-cost solution, and it generates revenue instead of transferring costs. Part of these revenues would have to be carefully distributed to offset disproportionate economic burdens to residents and businesses.
Overcoming market barriers
The power sector is not alone in its contributions to building-related greenhouse gas emissions; it is joined by other fuels providers and material industries. Government intervention can be used to specifically target the market barriers that cap and trade faces.
For example, the cement industry has high standards for returns on investment, which weakens the market signal from cap-and-trade that reduces the payback period of investments. Policy intervention such as abatement programs, green bonds and public financing schemes could serve as a catalyst to overcome this barrier. In addition, government support for alternative fuels investment could help overcome supply uncertainty and price instability, establishing a reliable and affordable supply for the cement industry that only a high carbon price would otherwise do.
Another example many industries face is irrational consumer preference for products that have a large carbon footprint, due to traditional habits and a lack of education. Mandates could be a solution here, as they can curb actions that are certain to produce emissions, reaching into an area that markets cannot.
The political and economic complexities make it difficult to identify one mechanism as a panacea, and ultimately a variety of approaches are needed. The next article will explore an additional dimension: the role of utility providers in cap and trade.