November 13, 2008
Cost-containment is Inevitable - So What’s the Alternative?
By Teryn Norris
A new study by Dr. Gregory Nemet, "Cost Containment for Climate Policy Requires Linked Technology Policies," questions the efficacy of a federal emissions cap-and-trade system and concludes that achieving IPCC emissions reduction targets will require a federal clean energy technology development fund. Nemet proposes an innovative solution that would supplement the inevitable cost-containment provisions in cap-and-trade with a proportional level of federal investment in low-carbon energy technology.
Nemet cites compelling evidence that the dominant cap-and-trade climate policies, including those currently under consideration in the U.S. Congress, will not meet their own targets. The source of the problem is cost-containment provisions, which set a safety valve on the price of carbon or delay action into the future. These provisions have been used in cap and trade policies all over the world, as they are the best way to reduce the cost of climate policy to gain support from industry and the public. But they limit the effectiveness of any cap and trade system. According to Nemet:
A variety of countries have implemented mechanisms, which, though they vary in their implementation details, fall under the rubric of efforts to limit the cost of climate policy... Most [climate policies] consist of aspirational emissions reductions targets with little or no enforcement mechanisms and as a result, cost containment is less of a concern. But for those with the most ambitious and mature proposals, cost containment is high on the agenda.
Canada, Denmark, New Zealand, Australia, Germany, California, the Northeast Regional Greenhouse Gas Initiative, and the entire European Trading Scheme (ETS) have used safety valves and other cost containment mechanisms to reduce the cost of their cap and trade policies. In Canada, a safety valve price of $C15/ton was set to secure passage of Kyoto in 2002. By 2006, Canada announced it would not meet its goal for 2012 and was abandoning its Kyoto targets. The ETS originally reduced costs by issuing an excessive number of emissions permits, which sent the price per ton of CO2 down to 0.10 euros in September 2007. Europe, which saw its emissions rise twice as rapidly as the U.S. between 2000 and 2005, is not on track to meet its Kyoto targets and was recently reported to be constructing 50 new coal plants.
Cost containment provisions in U.S. climate bills
The overwhelming reliance on cost containment results in cap-and-trade policies very unlikely to achieve their goals. Nearly every recent cap and trade policy proposal in the United States (above) includes a cost containment provision, and efforts to eliminate these have run against stiff opposition from legislators and industry.
Breakthrough performed an analysis of the current cap-and-trade bill, Lieberman-Warner, and found that it would allow firms to delay action into the future, purchase emissions allowances at low cost, and satisfy 30% of emissions reductions with cheap and unreliable carbon offsets. "Proposed safety valves would cause climate policy to miss reduction targets by substantial amounts," Nemet concludes.
Even at a safety valve carbon dioxide price of $100/ton, the probability that emissions targets will be met for 2030 is less than 50%.
The popularity and failings of cost containment have evoked two primary responses from climate policy advocates. On one hand, there are those who believe that any cap and trade proposal without a safety valve is politically unfeasible and thus continue to focus on cost containment as a way to secure political support. On the other hand, there are those who see a stringent cap and trade system as the top priority for climate policy. These advocates have insisted that as public opinion shifts on global warming there will be enough support for a higher carbon price.
Nemet, however, proposes an alternative. He argues that a viable compromise should supplement any cost-containment with public investments in low-carbon technology innovation. Cost containment discourages this type of investment, and in order for emissions reduction targets to be met, large direct public investments will be necessary:
Under safety valve levels such as these, innovators, who decide whether to make investments in innovation for low-carbon energy technologies, will invest less... Because these clauses limit the payoffs to innovation for low-carbon energy technologies, they will reduce our societal capacity to affordably mitigate climate change through technology improvement...
If cost containment measures are to be employed at levels currently being discussed in policy debates, then complementary policies to invest in technology improvement directly, such as R&D, will be needed.
Nemet recommends that these public investments be directly tied to containment clauses so that the level of technological investment rises as the cost containments become greater. He writes:
The more heavily we rely on a price cap to reduce the cost of climate policy, the more we need to invest in complementary policies. In practical terms, when the price cap is reached, and the government starts printing more emissions permits to reduce the market price, it also needs to invest in technology development for mitigation. This fund would be used for activities such as investments in research and development, creation of technology prizes, funds to pay for inappropriable learning investments through buy downs and demonstration projects.
This logic rests at the heart of the climate policy strategy Breakthrough and others have supported. Indeed, political realities must guide any effective policy strategy. The evidence overwhelmingly suggests that industry, policymakers, and the public will continue to demand measures to reduce the costs of any climate policy. Major public investment to reduce the price of clean energy - as opposed to carbon prices that increase the price of dirty energy - is not only a more viable political strategy, as numerous polls have shown. It is a policy necessity that should be accorded the privileged status usually reserved for cap and trade.
Dr. Gregory Nemet is a professor of public affairs and environmental studies at the University of Wisconsin-Madison. One of his recent papers on U.S. energy research and development policy won a best paper award from the U.S. Association for Energy Economics. He holds a master's degree and doctorate in energy and resources from the University of California, Berkeley.