Northeast Cap-and-Trade Program Offers Lessons for Congress

The Regional Greenhouse Gas Initiative – a ten-state experiment in crafting a U.S. cap-and-trade program – will mark its one-year anniversary on Sept. 25. Last week the group, known as RGGI, held its fifth auction of pollution permits, an event that highlighted one of the flaws in the program thus far – which is, they have more permits available on the market than are actually needed, which has caused a major drop in permit prices.

The Wall Street Journal’s Environmental Capitol blog has the basics. As expected, the price of permits hit an record low last week, caused by both the over-abundant credits and the falling demand. Credits sold for $2.19 per ton, down 30 percent from the last sale in June, when they went for $3.23 per ton.

This is interesting because RGGI is essentially the Northeast’s pilot project for a larger federal program that Congress is considering enacting. There are also several lessons here. One is that the overabundance of credits on the market mirrors one of the early problems in the European Union’s Emission Trading System. The failure to properly determine the necessary number of credits is what prevented the program from being effective in reducing greenhouse-gas emissions in its early years. If credits are cheap and plentiful, the market does not create the need for industries to lower emissions as quickly.

But it also speaks to two other issues more relevant to the current situation in the United States, as WSJ’s Keith Johnson points out. One is that the recession had decreased demand for electricity, which in turn has reduced emissions and thus, demand for emission permits. He also notes that new discoveries of natural gas reserves in the U.S. have lowered the cost of that fossil-fuel alternative, which burns cleaner than coal. More power companies are switching to natural gas to meet emissions-reduction requirements, which has also lowered the demand for credits.

Most important, though, is that the businesses covered under the cap are on a path to meet their emissions reduction goals at a much lower cost than anticipated. They’re also looking to come in well under the cap that the plan sets out, in fact. This should be a relief for businesses, but is not necessarily a good thing for the environmental goals, since a tight cap is what drives innovation and the development of new energy sources.

What are the lessons for a federal plan? Foremost is the need for an accurate inventory of greenhouse gas emissions before a cap is put in place, and for the number of credits put on the market to reflect that. The EPA already puts out an annual inventory, but they’re still in the process of developing a new rule that will require each major emissions source in the United States to report its output – which will provide a more accurate starting point for a federal cap-and-trade system.

It also demonstrates the need for a cap-and-trade program to include regular revisits to the policy to update it as needed. These are often called “look-back” provisions, and they allow the program to be tinkered as necessary to meet the stated goals. A RGGI review is not scheduled until 2012, which means it’s unlikely that administrators will be able to tighten the program before then.