What to Watch For in EPA’s Final Clean Power Plan: Trading

Clayton Munnings and Anthony Paul

Later this summer, the US Environmental Protection Agency (EPA) will release its final Clean Power Plan, setting carbon emissions goals for existing power plants. This is the ninth post of ten in a series—What to Watch For in EPA’s Final Clean Power Plan—in which RFF experts address what to look for when the final regulations are released.

An important mechanism for containing costs under the Clean Power Plan is the trading of CO₂ emissions allowances between states. Trading can offer cost savings to any group of states that chooses to trade allowances, and the gains from trade can be shared among all cooperating parties. Trading was explicitly invited by EPA in the proposed rule via state coordination that would aggregate or average abatement obligations. To enable trading, a group of states must write a coordinated plan that aggregates its goals under mass-based trading or averages its goals under rate-based trading.

Since the proposed rule was published, two important issues have emerged that were not addressed specifically by EPA. Allowance trading could be enabled 1) for “trade-ready” states with plans that contain “common elements” instead of requiring a formally coordinated plan across the states, and 2) among states with rate- and mass-based policies. A trade-ready approach has been proposed and supported by many states, while rate-to-mass trading has been roundly criticized by most commentators. We offer additional background and our expectations regarding how EPA will treat these issues in the final rule.

Trade-ready

The concept of trade-ready is to allow states to trade emissions allowances without formally submitting a compliance plan that is coordinated across states. Under such an approach, EPA would establish a set of common elements that must be in state plans for them to receive trade-ready approval. It would also allow for a state to exceed its goal by buying emissions allowances from another state that is below its goal. The economic expectation is that a uniform allowance price will emerge across all states that are approved as trade-ready and take advantage of the opportunity, just as if they had submitted a compliance plan coordinated across the states. One of the virtues of trade-ready in lieu of coordinated plans is that states can bypass political barriers that prevent them from constructing a coordinated plan while still harvesting the cost savings that come from allowance trading. A previous blog post delves further into the details of the trade-ready approach. We are expecting EPA to enable a trade-ready system for states that adopt mass-based policies; however, it seems that the likelihood is lower for rate-based states and not very likely at all for trading among states that would mix rate and mass policies.

Mass-to-mass, rate-to-rate, rate-to-mass

Trading among states with mass-based policies is straightforward, whether under a coordinated plan or a trade-ready configuration, since allowances are denominated in tons of CO₂. Under rate-based policies, denominating allowances in tons of CO₂ is still the simplest approach; generators earn (or owe) allowances (tons) on the product of (1) the difference between their own emissions rate and the emissions rate goal (tons/MWh), and (2) their electricity production (MWh). If allowances are denominated in tons of CO₂, then trading among states with rate-based policies (see the working paper published by Western Resource Advocates) and among a mix of rate- and mass-based states is straightforward from a compliance standpoint (i.e. trading itself is easy). From an administrative standpoint, a rate policy is more complicated than a mass policy because of the additional burden of counting MWhs, with or without interstate allowance trading. Also, because the emissions rates goals vary across states, interstate trading with rate states can lead to emissions leakage, potentially undermining the environmental integrity of the program.

Emissions leakage—an increase (or decrease) in total emissions across states that trade relative to emissions if they choose not to trade—can occur under rate-to-rate and rate-to-mass trading. The possibility of leakage under rate-to-rate trading was implicit in the proposed rule because it allows for the possibility of trading among rate-based states. Whether allowing for leakage is wise depends on whether the costs savings from trading exceeds the costs of any increased emissions.

We expect EPA to continue to invite trading among mass-based states and to still allow for the possibility of trading among rate-based states. Since EPA did not discuss rate-to-mass trading in the proposed rule, and because of the administrative and environmental integrity issues associated with rate programs, we are not expecting to see rate-to-mass trading to emerge in the final rule.

Read the other posts in the series, What to Watch For in EPA’s Final Clean Power Plan:

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