Cost Containment for the Carbon Market: A Step Toward Cap-and-Trade

Yesterday, four moderate-to-conservative senators -- John Warner (R-Va.), Lindsey Graham (R-S.C.), Mary Landrieu (D-La.), and Blanche Lincoln (D-Ark.) -- proposed a measure to achieve "Cost-Containment for the Carbon Market."

I wanted to spend a bit of time on what's in it and what it means.

You might think, given the business-friendly senators involved, that the measure's going to be a gimmick to let industries off the hook. Happily, it was jointly developed with the Nicholas Institute for Environmental Policy Solutions, a sharp new outfit at Duke University. It appears to be a credible attempt to devise a system that will prevent severe economic pain while holding fast to environmental targets.

It's immensely preferable to the loopholes, escape clauses, and off-ramps we've seen in some previous bills. If this is what it takes to get a cap-and-trade bill in place, I'd consider it a fantastic bargain.

It's an addendum

The proposal is meant to work with any cap-and trade system that:

  1. sets a mandatory, scientifically credible cap on carbon emissions;
  2. establishes a timeline to achieve the cap, with the emission limits ratcheting down in phases;
  3. enables market participants to bank (set aside to accrue interest), borrow (to be repaid with interest), and trade (exchange for freely agreed price) credits.

The various C&T bills introduced thus far, the authors note, have had their strengths, but lacked in crucial areas. Presumably Lieberman and Warner are trying to stitch together all the good bits.

At the core of the proposal are two measures that can be invoked to relieve costs and a governing board that can invoke the measures.

Two measures to relieve cost pressure

As summarized in the Q&A (PDF):

• First, if prices went high and stayed high, the plan would expand companies' ability to borrow emissions permits and pay them back in future years with interest, and/or purchase more "offsets" to meet their emissions reduction obligations.

For example, if I'm a power company and I know I'm building a new plant that can capture and store carbon emissions that will be ready in eight years, I can borrow a few more permits now, knowing I'll be able to pay them back when that low-emissions plant is up and running. This remedy allows companies more flexibility in making those individual decisions but does not change the national environmental objective.

• Second, if that didn't work and there were a true emergency, the plan would temporarily release a small increase of emissions permits into the market.

Those extra permits would be "paid back" by reducing permits allowed in future years. That's how we guarantee the environmental goal.

The latter measure is known as "bending the curve" -- changing the emission reduction trajectory in the short-term while preserving the long-term target.

A market governing board

The Carbon Market Efficiency Board would be modeled on the Federal Reserve Board. It would be a presidentially appointed board of seven members with 14-year terms, "observing the market, providing information on trends or problems, applying these economic relief measures if needed, and making sure we continue to pursue the environmental goals."

Similar to the Fed, this Board will give industry, their investors, and the public up to date information on how the market is going, where technology investments are being made and what's likely to be available soon, and it will make limited corrections if necessary to relieve prices and preserve the market.

Things that make me feel better

Importantly, the cost-relief measures would:

  • be invoked only if average prices exceed a pre-set range, established by Congress and updated regularly by the board, for a period of six straight months; they are explicitly not intended to shield the market from short-term price volatility;
  • not be invoked on behalf of individual industries or sectors; no rent-seeking;
  • be explicitly temporary; any expansion of credits or borrowing limits can last only a single year, and is treated as borrowed from the future, to be repaid, not as an expansion of the net total.

Reasons for concern

  • The board will be politically appointed; that opens the door to politicization, though with 14-year terms, the degree to which one administration can affect the board is limited.
  • Cost-relief measure #1 opens the door to more offsets, and forestry is specifically mentioned; I think we all agree by now that tree-based offsets are less than ideal.

Overall

The measure is responsive to legitimate cost concerns without opening the door to gaming or weakening of long-term environmental goals. If this is what it takes to get a majority of stakeholders on board with a cap-and-trade program, it's worth celebrating.

Now the key is getting a cap-and-trade program with appropriately ambitious targets.