While a great deal of attention has focused on international negotiations to lower emissions of carbon dioxide (CO2), little attention is being paid to how reductions might be accomplished domestically. Key to success will be to design a policy that limits emissions from the major source—burning fossil fuels for energy—with minimal impact on the economy.
To lower emissions, several policy choices are possible. First, the United States could restrict the amount of carbon in fossil fuels that enters the economy. Energy prices would rise, providing an incentive for users to switch to fuels with less carbon and to use less energy. Second, we could directly limit carbon emissions from large users—electric utilities and heavy industry. Finally, we could impose stricter efficiency standards on such energy-using equipment as cars and appliances.
Trading of control requirements—whether limits on the sale of fuel, allowable emissions of carbon, or even of regulatory standards—is an effective way to introduce flexibility into a control system and thereby lower costs. With trading, a company that can easily reduce emissions or improve efficiency beyond its own requirements can do so and then sell the rights to those emissions. Likewise, a company that finds reductions expensive can buy permits instead. Both companies benefit because the emissions goal is met at lower cost than if both companies had to meet a fixed reduction target.
The Heinz Center and a group of research collaborators from industry, environmental groups, government and universities designed four alternative control systems incorporating emissions trading and one or more of the broad approaches discussed above. Two of the alternatives focus on companies that either burn fossil fuel or manufacture energy-using equipment, such as cars. The other two control plans focus on fuel producers and sellers. In both cases, one of the alternatives is relatively simple, the other incorporates illustrative political compromises that may be needed to be perceived as fair as well as efficient.
Option I is a hybrid system that "caps" (limits) emissions from large combustors and controls smaller energy consumers through efficiency standards. Under this system, utilities and large industrial facilities must possess permits to emit carbon. Permits are allocated (directly given) to them, based on past levels of emissions or energy use. Permits may be used directly or sold to others. Controls on vehicles would also be tradable. Vehicle manufacturers that can beat their standard can generate permits to sell or bank; those unable to meet the standards can buy permits from others, including utilities and large industrial facilities.
Option II caps the amount of carbon in fossil fuel that can enter the economy by imposing sales limits for energy companies. Coal producers, oil refineries, and natural gas pipelines must obtain permits for the carbon they produce or transport. Permits are purchased either directly at a federal government auction or through resale.
Option III, like Option II, caps carbon on the supply or fuel side. Unlike Option II, however, emissions permits are allocated both to producers and to some consumers of fossil fuels (i.e., large coal combustors.) Permits are given to both coal extractors and combustors because these are two groups likely to be most negatively affected by carbon controls. In addition, manufacturers of energy-consuming equipment (for example, cars and home furnaces) must meet efficiency standards.
Option IV is a hybrid system similar to Option I. Here, however, the cap expands to vehicles by requiring manufacturers to obtain permits on the basis of total future emissions from the vehicles they sell. Option IV also gives permits to both producers and combustors, and to both those newly entering the market and historic emitters.
Under Option I, about half of current emissions would be covered under the cap. Most of the remaining emissions are controlled through standards for manufacturers of energy-consuming equipment (e.g., motor vehicles, furnaces, air conditioners, and hot water heaters). Option II’s economy-wide cap on carbon sends a price signal to all emissions sources, inducing them to either reduce energy consumption or switch to fuels with lower carbon content. Under Option III, most emissions sources see both a price signal from energy suppliers as well as emissions standards for energy-consuming equipment. Option IV differs from Option I mainly in the cap on the transportation sector and the procedure for allocating permits to sources.
Each of the four proposed systems has particular advantages. Option I incorporates familiar regulatory mechanisms. Capping CO2 emissions from utilities and large industrial sources is similar to the approach used to control acid rain. The standards that apply to other CO2 sources under Option I are similar to efficiency standards currently in existence for light-duty vehicles and some appliances. This compatibility with current regulatory systems should ease implementation of Option I. However, under this approach, many discrete types of regulations and control programs must be developed and adopted.
Option II relies solely on price signals to induce emissions reductions, though by many analysts
to be the most economically efficient way to lower emissions. Option III also uses price signals as its main control mechanism. Under Options II and III, all fossil fuel prices would rise: coal the most, followed by oil, and natural gas the least.
Options I and IV circumvent gasoline price increases (in fact, gasoline prices may actually drop because improved mileage will result in lowered demand). This effect could represent a significant political advantage. Of course, not all energy price increases would be avoided. The price of electricity will rise under all of the options; providing incentive to reduce consumption.
Options III and IV incorporate more complex approaches for allocating permits in order to partially compensate those hurt most by changes in policy. Any emissions reduction program will have relative "winners and losers," and these last two options include examples of political compromises that may be needed to enact controls.
Table 1 shows basic design differences among the four options. For example, Options II and III cap carbon sold by fuel producers, and Options I and IV cap CO2 emissions from large combustors and control more diffuse emissions sources through energy efficiency or carbon emission rate standards. Another difference is that Options I and II are relatively simple designs, and Options III and IV include such political compromises as the sharing of emission permits by both producers and large combustors of fossil fuel.
Table 1: Comparison of Control Options |
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| Option I | Option II | Option III | Option IV | |
| Economy-wide fuel carbon cap and trade | ü | ü | ||
| Partial emissions cap on utilities and other individually large sources (about half of emissions) | ü | ü | ||
| Product standards for individually small sources (including cars) | ü | ü | ü | |
| Trading between utilities and automakers | ü | ü | ||
| Allowances allocated (given) to sources | ü | ü | ü | |
| Allowances auctioned (sold by the government) | ü | |||
| Relatively simple design | ü | ü | ||
| Design includes political compromises (primarily through distribution of allowances) |
ü | ü | ||
| Price increases on all fuels and electricity | ü | ü | ||
| Price increases on electricity alone | ü | ü | ||
Printed copies of this report may be obtained from:
The H. John Heinz III Center for Science, Economics and the Environment
1001 Pennsylvania Ave. NW, Suite 735 S
Washington, D.C. 20004
Telephone: 202-737-6307
Facsimile: 202-737-6410
The full report is also available online at: gc_emissions_trading.pdf