Addressing Uncertainty is Key to the Success of California’s Cap-and-Trade Program
In a new report, RFF scholars examine how some suggested—and alternative—reforms to California’s cap-and-trade program could affect greenhouse gas emissions, government revenue, allowance banking, and the price that emitters pay for emission allowances.
💡 What’s the story?
California’s cap-and-trade program is an important part of the state’s regulatory landscape. Recently, the California Air Resources Board (CARB), which regulates air quality and leads climate change–mitigation efforts in the state, suggested potential reforms to the program. CARB’s suggestions include reducing the number of emissions allowances auctioned to emitters with the goal of reducing greenhouse gas emissions by 48 percent below 1990 levels over the next two decades.
In a new report, scholars at Resources for the Future (RFF) examine some of these suggested reforms—and alternative reforms—to assess how changes to the cap-and-trade program could affect greenhouse gas emissions, government revenue, allowance banking, and the price that emitters pay for emission allowances.
In particular, the authors emphasize that future energy demand and associated emissions (and therefore the demand for emissions allowances) are uncertain and illustrate designs for the market that enable the state to achieve its climate goals despite this uncertainty.
📊 What are the key findings?
In their analysis of policy pathways for the future of California’s cap-and-trade program, the research team came to the following conclusions based on their modeling.
- Uncertainty about future emissions leads to uncertainty about allowance prices under CARB’s cap on auctioned emissions allowances. Market design that accounts for this uncertainty can mitigate effects on revenues, prices, emissions reductions, and distributional outcomes.
- CARB has considered removing allowances slated to be sold at high prices and maintaining the same schedule of free allocation of allowances. RFF modeling shows that these choices would lead to higher emissions, lower prices, and lower revenues to the state’s Greenhouse Gas Reduction Fund than alternative reforms.
- An emissions-containment reserve, which reduces the number of emissions allowances sold at low prices, can make the market more robust in the face of uncertainty, ensure greater emissions reductions, and increase revenues to the Greenhouse Gas Reduction Fund.
- Facility-specific caps (which were not considered by CARB) concentrate emissions reductions in disadvantaged communities and have minimal impact on market outcomes compared to proposals CARB has considered.
Author Perspective
“California’s cap-and-trade program provides important funding and credibility to the state’s climate plans. While no one can predict all the factors that will help California achieve its overall emissions-reduction goals, sound policy decisions can help reduce uncertainty where possible. Our new report highlights some of these uncertainties and potential designs that can make the cap-and-trade program more reliable.”
—Nicholas Roy, RFF Research Associate
🔎 How was the analysis conducted?
The research team analyzed three supply policy scenarios that CARB identified in its recent Standard Regulatory Impact Assessment that may affect the supply of auctioned emission allowances. The team also took a wider perspective and analyzed five more allowance-supply policy options that CARB considered before narrowing its options.
Across all of these scenarios, the authors considered how two additional program-design mechanisms—emissions-containment reserves and facility-specific emissions caps, neither of which CARB has proposed—may affect emissions reductions, costs, and other factors.
The team also analyzed how alternative program features would perform under different technology and regulatory scenarios and different levels of economic activity.
By plugging these scenario combinations into RFF’s Haiku Emissions Market Model, the research team was able to address interactions among the electricity, transportation, building, and industry sectors in California. By mixing and matching different policy choices and technology pathways, the team analyzed 168 possible outcomes for the state’s cap-and-trade program and reached key conclusions that could help CARB make informed decisions about the program’s future.
Author Perspective
“California’s climate policy is at a crossroads. The state seeks to accelerate emissions reductions while facing unknown technology, economic activity, and companion regulations. These uncertainties heavily influence emissions and costs. Cap-and-trade is the policy tool that can respond to uncertainty and maintain emissions reductions at a cost that protects the economy, but it must be designed to do so effectively.”
—Dallas Burtraw, RFF Senior Fellow
📚 Where can I learn more?
For more information, read the report, Designing for Uncertainty: Amendments to California’s Cap-and-Trade Market, by Nicholas Roy, Maya Domeshek, and Dallas Burtraw.
Resources for the Future (RFF) is an independent, nonprofit research institution in Washington, DC. Its mission is to improve environmental, energy, and natural resource decisions through impartial economic research and policy engagement. RFF is committed to being the most widely trusted source of research insights and policy solutions leading to a healthy environment and a thriving economy.
Unless otherwise stated, the views expressed here are those of the individual authors and may differ from those of other RFF experts, its officers, or its directors. RFF does not take positions on specific legislative proposals.
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