As Carbon Pricing Proposals Multiply, What’s the Right Carbon Price?

New carbon pricing initiatives in Washington set ambitious price targets that may not fly in the current political climate. Existing cap and trade markets may show what pricing will work.

This piece was first published in Forbes on March 20, 2019. It is reprinted with their permission.

Carbon pricing proposals seem to be a dime a dozen lately, at least in relative terms, with two serious proposals to tax carbon emissions now making the rounds in Washington. They include the Baker-Schultz plan that would put an initial $40 per ton cost on carbon emissions while providing fossil fuel companies immunity from climate-related lawsuits. A second plan from a bipartisan pair of Florida congressmen, democratic representative Ted Deutsch and republican Francis Rooney, would begin by pricing carbon at $10 and zoom up to $115 over a decade.

The wide carbon price range suggested in these two proposals hints at the biggest challenge to any effort to attach a value to carbon emissions, and that’s getting the carbon price right. Set prices too low and industry has little incentive to invest in energy efficiency and clean technologies to limit exposure to a carbon tax or, in the case of cap and trade markets, limit the need to buy emissions allowances. Price carbon too steeply and industry can respond to the burden by moving itself elsewhere, ultimately transplanting emissions rather than limiting them.

The Regional Greenhouse Gas Initiative, the carbon cap and trade market covering nine eastern states, has been wrestling with the issue of carbon pricing for more than a decade. Its experience provides a reality check on what carbon price might be politically and economically feasible, at least in the near term. RGGI also shows how getting the carbon price right isn’t a one-and-done event, but an ongoing process that requires creativity, flexibility and constant fiddling.

In RGGI, member states periodically auction off allowances – the right to emit CO2 – to electricity generators. Over time the number of allowances released in each new auction falls, driving up both the allowance price and the cost of polluting.

Yet it’s worth noting that the carbon price in RGGI has been low, well below $5 for much of the market’s history. That level of pricing looks particularly unambitious given that the U.S. Department of Energy’s social cost of carbon, which reflects the environmental and health damages projected to accrue from climate change, is about $40 per ton of CO2.

“It’s neither economically or socially sustainable to implement a carbon cost today that equates to the social cost of carbon,” says Dallas Burtraw, Chair of California’s Independent Emissions Market Advisory Committee and a consultant to both the RGGI and California carbon cap and trade markets. Chalk up the low ambition to concerns over lost competitiveness and jobs.

And the truth is that, while power plant emissions within the RGGI footprint have fallen by 40% since the market began operating in 2009, the amount of direct emissions reductions generated by RGGI has been difficult to pinpoint, but is likely low as well.

But the challenge isn’t simply one of getting the number of allowances to be offered in an auction right. There are unforeseen developments that can rob a market of its ability to impact climate well after allowances are auctioned off.

The last decade is abundant with examples, including an economic recession that cut energy demand and the demand for allowances. And, when RGGI rolled out in 2009 the shale gas boom had yet to really materialize and displace heavily polluting coal generation. Robust growth in renewables and energy efficiency, some due to chance and some to determined policies, also caught market designers off guard. Yet, ironically, these outside forces accomplished much the same emission reductions that RGGI would have generated on its own, had the outside forces not been in effect.

RGGI responded in 2014 by substantially cutting its emissions cap – reducing the number of available allowances – to keep up with the pace of emissions reductions. And all along RGGI, and California, have relied on price floors to maintain pressure on industry to seek additional emissions reductions. Accordingly, they’ve avoided the fate of the world’s largest carbon cap and trade market, the European Emissions Trading System where prices fell to zero a decade ago.

Yet moving forward, cap and trade’s ability to more actively respond to forces outside the market will be crucial to meeting robust climate targets. RGGI, housed within the climate progressive Northeast, has set a more ambitious climate goal for its second decade. It aims to lower emissions by an additional 30% by 2030, bringing cumulative emissions cuts to 65% compared to 2009.

To help achieve that goal, in 2021 the market will implement what it calls an emissions containment reserve, a first of its kind carve-out of 10% of available emissions allowances to be removed from the market when it falls to a $6 trigger price. Those allowances would later be available to the market, albeit at a higher price. In the end, RGGI will be better equipped to respond to outside forces and incentivize emissions reductions in addition to those already taking place.

RGGI’s price reserve reflects a reality that “you’re going to have companion policies continuing to play a really important role going forward,” says Burtraw. And even a modest carbon price plays an important role. “It sets a signal that we are committed to moving away from an economy that does not put any constraints and entering a carbon constrained future.  That really changes the investment behavior of firms.”

And, while political reality makes the $40 per ton carbon price proposed by the Baker-Schultz plan look unlikely right now, the adaptive approach of RGGI and its emissions containment reserve should help cap and trade squeeze the most emissions cuts from modest carbon prices while the political climate catches up.

Andy Stone

Energy Policy Now Host and Producer
Andy Stone is producer and host of Energy Policy Now, the Kleinman Center’s podcast series. He previously worked in business planning with PJM Interconnection and was a senior energy reporter at Forbes Magazine.