Soapbox

Markets point to leaning more on cap and trade

The Fresno Bee

There has been much dismay and a good deal of hand-wringing since the election of Donald Trump. Specifically, policymakers, activists, scientists and citizens concerned about the effect of greenhouse gases on climate are concerned that the new administration may overturn or simply ignore efforts aimed at stopping or limiting global warming.

At least one important appointee is said to doubt the existence of climate change altogether; another has sued to stop former President Barack Obama’s Clean Power plan and many others don’t seem to view climate change as an immediate or urgent concern.

Fortunately there is a great deal that states can do independently. California, for example, is already way out ahead on initiatives aimed at reducing the effects of climate change. Policymakers intent on continuing to fight for change in the next four years – at a national and a state level – would do well to consider these programs.

California has two well-known policies aimed at reducing greenhouse gases: a statewide cap-and-trade market and a low carbon fuel standard. California’s cap-and-trade market requires firms that emit greenhouse gas emissions to buy allowances to cover their pollution. Firms can either buy these allowances from a state-run auction or buy them from other firms that have a surplus.

The basic economics of such a system is that it raises the cost of emitting greenhouse gas emissions from zero (no regulation) to the price of the allowances. As such cap and trade “puts a price on carbon”; economists have shown that this is the most efficient way to reduce greenhouse gases.

California’s Low Carbon Fuel Standard operates somewhat differently. The fuel standard forces fuel providers to reduce the average greenhouse gas intensity of their fuel. They can do that by selling more low-carbon fuel, selling less high-carbon fuel, or buying LCFS greenhouse gas credits from firms that have a surplus. The key difference between the two programs is that cap and trade regulates total emissions, while the LCFS regulations average emissions.

This distinction may not sound substantial, but it is. For example, permit prices for California’s cap-and-trade program have traded recently at $12.95 per ton of carbon dioxide. Basic economics tells us that means that the marginal cost of reducing greenhouse gas emissions under the cap-and-trade program is $12.95 per ton. In stark contrast, the prices for LCFS credits during the past 30 days have averaged $88.60 per ton and have been as high as $125 per ton. (www.arb.ca.gov/fuels/lcfs/credit/lrtweeklycreditreports.htm)

Converting this to a marginal cost of reducing greenhouse gases requires an addition step outlined in a recent paper, but the numbers imply that the marginal cost averaged over $57 during the past month, with a high of $81. The prices of their respective allowances allow us to see the actual cost of incremental greenhouse gas reductions under both policies. The data from this experiment have shown us two things: the power and efficiency of pricing carbon and the huge inefficiency of a low carbon fuel standard.

The bottom line: Emissions reductions under the LCFS are costing us over six times more than under cap and trade.

Policymakers – in California and in other states seeking solutions to global warming – should learn from these market outcomes by scrapping the low carbon fuel standard and leaning more heavily on the cap-and-trade market. This would save the California economy billions. Moreover, it would send a powerful message to other states looking to make progress in what may prove to be a challenging new administration.

Christopher R. Knittel is the George P. Shultz Professor of Applied Economics at the Massachusetts Institute of Technology. He can be reached at knittel@mit.edu.

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