jennifer morgan - cap and trade

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Cap and Trade: Managing

Decisions around Allocation

Jennifer Morgan

Director, Climate and Energy ProgramJune 23, 2011

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IDENTIFY ENTITIES TO BE COVERED IN ONE OR MORE SECTORS

REQUIRE ENTITIES TO MEASURE, MONITOR & REPORT EMISSIONS

BASIC BUILDING BLOCKS

OF CAP-AND-TRADE

ENFORCEMENT & PENALTIES FOR NON-COMPLIANCE

ESTABLISH AGGREGATE EMISSIONS BASELINE FOR SOURCES

DETERMINE THE REDUCTION OVER TIME (i.e., SUCCESSIVE BUDGETS REDUCED)

ESTABLISH COMPLIANCE PERIOD FOR SOURCES

SOURCES “TRUE UP” AT END OF EACH COMPLIANCE PERIOD

DISTRIBUTE OR AUCTION ONE “ALLOWANCE” FOR EACH TON IN BUDGET

ESTABLISH ANNUAL EMISSIONS CAP (OR ANNUAL ALLOWANCE BUDGET)

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3

• Allowances are assets created by

government

• Value is not known in advance• Distribution is much like handing out money

• Distribution is inherently a political exercise

Allowance Distribution Key Concepts

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4

• Should allowances be divided among covered sectorsand/or other entities or should they be put up forauction?

• If apportioned among sectors, then how many

allowances does each covered sector get? – What are the key criteria for dividing up allowances amongsectors to establish sectoral allowance budgets?

• Emissions baselines for each sector?

• Relative competitive posture of each sector?

• Relative ability to reduce emissions?

• Ability to pass through costs?

• Other?

• How will subsequent sectoral allowance budgets bedetermined? i.e., what reductions will take place

where?

Allocate Allowances to Sectors



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• How should allowances bedistributed?

– Allocate to covered entities based on:• Past emissions, or “grandfathering”?

• “Recent” emissions relative to output on an updating basis?

• Output only

– Auction?

• Will amount auctioned increase overtime?

Distributing Allowances

to Covered Entities



Summary of primary distribution options

Type Description Examples

Grandfathering Allocations to existingsources, based onpast emissions.

U.S. SO2 Program;Most EU ETSMembers

Output-based,

Updated

Allocations to existingemissions sources,

based on recentemissions per unit ofoutput; updated everyX years

Certain NortheastStates in NOx

Program, Waxman-Markey for industry

Input-based,Updated

Allocations to existing

sources, based onrecent heat input;updated every X years

Certain Northeast

States in NOxProgram.

Auction Allowances sold atauction

Most RGGI states;Partial Auctions in EU;Small US SO2 Auction



Pros and Cons of Distribution Options

Type Pros Cons

Grandfathering Familiar approach,insures proportionaldistribution for all emitters

May penalize earlyaction, reward largeemitters

Output-based,

Updated

Rewards and incentivizesefficiency

May generate windfallsfor low-emitters

Input-based,Updated

Avoids penalizingcogeneration

Does not fully rewardefficiency

AuctionPrice discovery, revenuegeneration for costmitigation, otherprograms

May adversely affectGHG intensive sourcesin early years,internationalcompetitiveness issues



Allocation to non-regulated

entities• Allowances can be distributed to mitigate cost toaffected groups

• Examples – Consumers

– States

– Displaced workers

– Local governments

– Internationally competitive industries

• Allowances can also be distributed to reward GHGreductions

• Examples: – Increased carbon sequestration

– Low carbon technology deployment

– Energy efficiency



Allowances are directed to dozens of

purposes

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Example: Waxman Markey Allowance

Distribution



Why Auction?

• Avoids politics of allocation butintroduces politics of revenue

distribution• Price discovery

• Raise revenue for complementary

purposes• Most economically efficient way todistribute allowances but not alwaysmost politically viable



RGGI approach: Nearly 100% auction

• Deregulated electricity market means statescannot control generators‟ electricity bids

• Value of allowance ends up in bid becauseallowances have value

• Therefore, consumer pays cost whether

allowance is given to generators or thegenerators pay for them at auction

• Revenue for program administration, energyefficiency, renewables



Cantwell-Collins: 100% auction w/

dividend

• Auction all allowances to regulated entities(with minimum and maximum prices)

• 75% of proceed are divided equally amongall lawful U.S. residents

• Other 25% set aside for Congress to use for

a variety of purposes through theappropriations process.



EU ETS Timeline

2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 20202007

EU ETS PHASE 1 EU ETS PHASE 2

1st KYOTO COMMITMENT PERIOD KYOTO PROTOCOL POST-2012 FRAMEWORK?

EU ETS PHASE 3? EU ETS PHASE 4?

January 2005 - EU ETS commences

• Phase 1 EU ETS – 2005-2007 „learning phase‟

• Phase 2 EU ETS – 2008-2012 „Kyoto Commitment

Period‟

• Phase 3 and beyond….



Sector Coverage

• Covers CO2 emissions from combustion processes(approximately 50% of EU CO2 emissions, 30% of EU greenhouseemissions)

• Covers approx 12,000 installations across the EU from thesesectors:

– Electricity generators

– Other combustion installations (heat & steam production)

– Mineral oil refineries – Iron and steel production and processing

– Cement & lime

– Glass & ceramics

– Pulp & paper sector



Allocation of Allowances

• National Allocation Plan (NAP) sets out thetotal number of allowances to be issued anddistributed to national installations

• Member States may auction up to 5% ofallowances for Phase I, up to 10% for PhaseII

• Majority of allowances allocated for free – Member States used a range of methods for allocation –

including historical emissions, projected emissions, sectorbenchmarks etc


http://slidepdf.com/reader/full/jennifer-morgan-cap-and-trade 18/22Percent emissions below allocation Percent emissions above allocation

% difference between Member State allocations and emissions in 2005

Lithuania

Denmark

Latvia

Finland

Estonia

Slovak Republic

Czech Republic

Hungary

Sweden

France

Netherlands

Belgium

Germany

Portugal

Slovenia

Greece

Italy

Austria

Spain

UK

Ireland

-50 -40 -30 -20 -10 0 10 20

M e m b e r

S t a t e

Surplus of

allocatedallowances

Shortfall in

allocatedallowances



Impact of EU ETS to date

• Very high compliance in first 2 years

• Improved emissions data across Europe

• Internalising cost of carbon in price of electricity generation

• Driving investment in Kyoto project credits (CDM)

• Behavioural change – mainstreaming?

“Carbon dioxide has moved out of the domain of the environmentalofficer at a company to the boardroom and the chief financial officerand the chief executive officer”

Head of Director General Environment, European Commission



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Future of the EU ETS

• Phase III: 2012-2020

• At least a 21 percent reduction from 2005 levels for coveredsources

• New: single EU-wide cap instead of 27 caps set byMember States

• CO2 allowances available in 2020: 1720 Mt

• Linear decrease – predictable trend-line to 2020 and beyond – can be adjusted to stricter target

• Emissions from all flights taking off or landing in the EU tobe included



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Phase 3 allowance distribution

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• Harmonised allocation rules ensure level playing field across the EU

• Basic principle for allocation is auctioning:

– Eliminates windfall profits

– Simplest and most transparent allocation system

• Full auctioning for sectors able to pass on costs

– E.g. Power sector

• Partial free allocation to industry as a transitional measure

– Phased out by 2020 for “normal industry”

– Exception: possibly higher levels (up to 100%) of free allocation to industriesparticularly vulnerable to international competition („carbon leakage‟) to be

determined in 2010

• European Commission to report on „carbon leakage‟ by 2011 and make a

proposal, if appropriate:

– To review free allocation levels and/or

– To introduce system to neutralise distortive effects



Simplified Allocation Decision Tree

new entrants

renewable energy

CCS

efficiency

mitigation of price impacts

Will allowancesbe distributedfree of charge?

Government auction

Who willreceive theallowances?

downstreamemitters

& non - emitters

upstream fuelsuppliers

Will the allocation formula beupdated over time? How?

no

yes

1

3 4

5

2

Distribution of revenue

consumers &end - users

carbon content

emissions

fuel input

output efficiency

load consumption per capita

ALLOCATION FORMULA

On what basis willallowances bepro-rated amongrecipients?

Will allowancesbe designatedfor specialincentives?

market share

Allowance distribution in 5 steps

gov. agencies / states

discretionary lump sums

international programs

jennifer morgan - cap and trade

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