Do you need an emissions trading scheme to trade emissions?

Emissions performance standards for power plant could be given considerable flexibility by allowing trading between emitters that are covered by a standard.  This would achieve many of the benefits of emissions trading, at least in the power sector, without the need for a full-blown cap-and-trade scheme.  In the US this could be implemented by the EPA using existing powers under the Clean Air Act without the need for legislation in Congress.

My previous post looked at the spectrum of possibilities between emissions trading and taxes.  This post looks at the potential overlap between emissions trading and performance standards.

Emissions trading is usually considered to offer a more cost-effective means of reducing emissions than prescribing performance standards, because trading allows flexibility to achieve reductions wherever the costs are lowest.  However a Federal emissions trading scheme for greenhouse gases in the USA still appears to be a distant prospect.  Instead the Environmental Protection Agency (EPA) is required under the Clean Air Act to impose performance standards, with a duty to regulate emissions from existing power plants under Section 111(d).  Under this Section of the Act the EPA sets guidelines, and individual states must come up with State Implementation plans (SIPs) that conform to these.  If the EPA guidelines are inflexible, following a traditional approach, this has the potential to lead to inflexible regulation, and consequently either limited effectiveness or a risk of high costs.  However Section 111(d), which has rarely been applied in practice, appears to offer substantial flexibility around the type the performance standards that can be imposed.

In particular, tradable emissions standards appear to lie within the legal scope of Section 111(d).  Such tradable standards could be implemented by the EPA for the power sector without further authorisation from Congress, unlike a cap and trade system.  Indeed they have previously been used in a limited fashion to implement the phase-out of lead in gasoline[i].

Under this type of approach the EPA would set a standard, but allow emitters to trade so that the standard is achieved on a sector or sub-sector wide basis, rather than by each emitter individually.  Those with emissions lower than the performance standard would be able to sell credits to those with emissions higher than the performance standard.  As multiple such trades were established this would effectively create a carbon price, in the form of a price for credits generated by entities outperforming their standard, for which entities with emissions above their standard would be willing to pay.  Regulation would thus in effect enable a per MWh emissions limit (i.e. an emissions intensity cap) on the all or part of the power sector that would be very similar to a sectoral baseline and credit trading scheme.  However, unlike a cap-and-trade scheme it would not impose an absolute limit on emissions.

The least contentious form of tradable standard for the power sector would probably set separate standards for coal and gas fuelled plant, and perhaps further differentiating standards by plant technology.  Trading would only be allowed between plants using the same fuel and technology.  This would allow some flexibility in complying standards, for example by improving thermal efficiency and adjusting plant dispatch.  However gains may be relatively small in view of the similarity in performance of much US coal plant.

Much greater gains would be possible if the EPA were to impose an average performance standard covering all fossil fuel generating plant and allow trading between coal and gas plant.  Crucially, this would allow standards to be met by displacing coal with natural gas, taking advantage of the lower emissions and higher efficiency possible with generation from natural gas.  It would in principle also be possible to set separate standards for different types of plant, but with trading between the different types of plant still allowed.  However this would risk displacing relatively inefficient gas plant with coal plant that is efficient relative to its own standard, but still with higher emissions than the gas plant, making such an arrangement a poor policy choice.

A recent proposal from the Natural Resources Defence Council (NRDC) [ii]  goes further in suggesting the inclusion of actions by the utilities to increase the deployment of low carbon power and to improve end use energy efficiency.  NRDC’s modelling shows that energy efficiency has the potential to displace a large amount of generation from coal plant. However, extending credit for emissions reduction effectively allows for offsets from outside the scope of regulated activity of fossil fuel generation.  It is not clear that EPA has the power to implement such as solution, even if it allows for lower cost emissions reductions.  If the EPA were judged to have such power this approach would still raises significant challenges in implementation.  Although there are already protocols in many US states for calculating efficiency gains there may be substantial administrative challenges in adopting and adapting these in the context of a tradable standard.  However, meeting such challenges may be justified if the substantial gains indicated by NRDC’s modelling could indeed be realised.

There will be other issues to resolve in designing tradable standards, including whether credits can be banked from one year to the next, how standards will change over time, and how standards will interact with State level cap-and-trade schemes such as the Regional Greenhouse Gas Initiative (RGGI) and the California ETS.  However, each of these appears tractable.  For example, state level schemes could simply be required to demonstrate equivalence with the EPA rule.

Tradable standards appear to offer substantial advantages over less flexible regulation, and show that some of the advantages of emissions trading can be realised without a full cap-and trade scheme.  And they appear legally and politically much more tractable than a cap and trade scheme for the USA.  In the context of current US politics they represent a compelling policy choice.

[i] A good overview of the use of tradable performance standards is given in Burtraw et. al.  Tradable Standards for Clean Air Act Carbon Policy, Resources for the Future, February 2012


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