Marc Rigsby
Energy Law
Cap-and-Trade in the United States: What Type of System (if any) Should We Use?
What is Global Warming?
Global warming is the gradual increase in global average temperature. It is a
controversial topic. Within the scientific community there is a general consensus that the Earth’s
temperature has increased over the last several decades. The Environmental Protection Agency
(EPA) reports an average surface temperature increase of about 1º Fahrenheit since the 1970s,
and says that the Earth’s surface is “currently warming at a rate of about 0.29ºF/decade or
2.9ºF/century.”1 Moreover, according to the EPA the eight warmest years on record (between
1880 and 2008) have all occurred since 2001.2 However, despite the acknowledgment by many
that the temperature is in fact rising, there is an ongoing and heated (no pun intended) debate
regarding its cause.
What is causing the global average temperature to increase?
The conventional and oft-repeated story is that global warming is a result of human
activity, or, more specifically, the increase in the concentrations of atmospheric greenhouse
gases.3 Greenhouse gases are global pollutants that contribute to climate modification by
absorbing long-wave (infrared) radiation from the Earth, thereby trapping heat that would other
radiate into space.”4 Notable “greenhouse” gases include water vapor, methane,
chlorofluorocarbons, and, most notably, carbon dioxide. Carbon dioxide is constantly and very
naturally being emitted into the atmosphere by outgassing from volcanoes, combustion and
natural decay of organic matter, and respiration of aerobic organisms.5 However, the burning of
fossil fuels (i.e., oil, coal, and natural gas for use in the transportation and industrial sectors) has
lead to unnaturally high levels of atmospheric carbon dioxide, and thus, global warming.
Opponents (read: skeptics) have a different take. Scientists on the other side of the
debate believe that global warming is nothing more than the result of “natural variability, where
a planet goes through phases of warming and cooling.”6 Regardless, if the temperature continues
to increase it will have visible and potentially catastrophic consequences. For example, rising
temperatures could lead to the melting of glaciers and a subsequent rise in the sea level, changes
in weather patterns and the intensity and frequency of extreme weather events, as well as a
changes in the composition of land biomes and biodiversity.
Climate Change, THE ENVIRONMENTAL PROTECTION AGENCY,
http://www.epa.gov/climatechange/science/recenttc.html.
2
Id.
3
Global Warming: A natural cycle or human result?, CNN, http://articles.cnn.com/2007-0711/tech/globalwarming.overview_1_average-surface-temperature-warming-united-nations-intergovernmentalpanel/2?_s=PM:TECH.
4
TOM TIETENBERG, ENVIRONMENTAL ECONOMICS & POLICY 316 (Fifth ed. 2007).
5
Id.
6
Global Warming, supra note 3.
1
Marc Rigsby
Energy Law
Whether or not human activity really is the culprit, the fear of anthropogenic global
warming has been, and continues to be, at the forefront of the political arena. Liberal and
conservative policy-makers alike have suggested various measures for reducing domestic
greenhouse gas emissions, namely, by reducing our use of fossil fuels in favor of alternative
energy sources. Although recent regulatory proposals have been unsuccessful (see below), I
think that there is a regulatory framework which can effectively reduce the emissions of
greenhouse gases - specifically, carbon dioxide - and simultaneously catalyze the alternative
energy industry (which will have the effect of further reducing greenhouse gas emissions).
What measures have been proposed to control carbon dioxide emissions? Are there some
already in place?
In June 2009, Democrats in the U.S. House of Representatives had passed a bill
implementing a national cap-and-trade program. However, that bill ultimately died in the
Senate.7 In December 2010, the Obama administration again tried to push through alternative
carbon controls, this time using the EPA and the Clean Air Act (CAA) as its vehicle.8 However,
the so-called “back door” carbon controls, as Republicans referred to it, was eventually shot
down as well with the passing of the Energy Tax Prevention Act.9 [I’m confused – Obama
signed this law?] In short, there is presently no national system, including cap-and-trade, for
controlling carbon emissions in place within the United States.
However, there is a national cap-and-trade system for sulfur dioxide emissions - known
as the Acid Rain Program - which, until recently, had a single, national trading system.10 In
2011, the trading program was divided into four separate regional trading programs.11 Another
example of a cap-and-trade program in the United States - and one dealing with carbon dioxide is the regionally based Regional Greenhouse Gas Initiative (RGGI). The RGGI is “a cooperative
effort by ten Northeast and Mid-Atlantic states to limit greenhouse gas emissions. RGGI is the
first mandatory, market-based CO2 emissions reduction program in the United States.”12
Although the RGGI has its downsides (i.e., pricing every ton of carbon), it has also successfully
reduced carbon emissions.13 So while there is not a national carbon cap-and-trade program, nor
any plans for one (regulatory or otherwise), there are models for a national system. [what about
the European system?]
What are the options for controlling carbon emissions?
Congressional GOP Move to Stop EPA’s Cap and Trade Regulations, HUMAN EVENTS,
http://www.humanevents.com/article.php?id=42324.
8
Id.
9
EPA’s Cap and Trade Upheld, Thanks to Obama and Harry Reid, HUMAN EVENTS,
http://www.humanevents.com/article.php?id=42790.
10
Acid Rain Program, WIKIPEDIA, http://en.wikipedia.org/wiki/Acid_Rain_Program.
11
Id.
12
FRED BOSSELMAN, JOEL B. EISEN, JIM ROSSI, DAVID B. SPENCE AND JACQUELINE WEAVER, ENERGY, ECONOMICS,
AND THE ENVIRONMENT 802 (3rd. 2010).
13
Id. at 803.
7
Marc Rigsby
Energy Law
There are several types of incentive-based, policy options for controlling carbon dioxide
emissions, including tax programs and various iterations of cap-and-trade programs.14 Pricebased incentives refers to taxes on emissions, which “would raise the cost of emitting greenhouse
gases, thereby encouraging households and firms to cut their emissions as long as the cost of
doing so was less than the tax. That approach would set an upper limit on the cost of emissions
reductions (at the level of the tax) but would not ensure than any particular emissions target was
met.”15 On the other side, a quantity-based economic incentive system, such as cap-and-trade,
would set an overall limit on the level of greenhouse gas emissions but leave the decisions of
where and how the necessary reductions should take place to households and firms.16 Under that
approach, policymakers would establish an overall cap on emissions but allow regulated firms to
trade rights to those emissions, called allowances. Trading allowances would permit firms that
could reduce their emissions more cheaply to sell their excess allowances to firms that faced
higher costs to reduce their emissions. Unlike a tax, there is a definite upper limit on the amount
of emissions. Perhaps similar to a tax, however, is that the cost of reducing emissions could rise
and fall depending on the economic and environmental climate, including “fluctuations in energy
markets, the weather, and the technologies available for reducing emissions.”17
What is the best system? [how define best?]
Comparing a tax program with a cap-and-trade program, it is obvious that there are tradeoffs to both. A tax program would certainly put an increased cost on carbon emissions, and
therefore force firms to reduce their carbon-yielding production. However, the amount by which
carbon emissions are reduced would not be completely certain because there is not a set cap.
Instead, firms would produce as long as the costs of doing so were less than the tax and they
would have the ability to produce beyond the desired threshold should they decide to absorb
further costs. So, while carbon reductions would certainly be realized, the exact size of the
reduction would be somewhat uncertain. On the plus side, a tax programs would be relatively
straightforward - taxes are universally understood and could, theoretically, be adopted and put
into effect quickly. A cap-and-trade model also has its advantages and disadvantages.
A cap-and-trade program would more successfully set an upper limit on carbon
emissions, because each year the government would decide on a precise cap. Of course, the
carbon emitting firms could always exceed the cap, but that is unlikely because they would have
to pay a fine. Since they are already paying to emit, they would be hard-pressed to pay even
more. Firms could certainly trade allowances back and forth and decide on their individual
carbon emissions, but the aggregate level would be controlled and could more effectively be
lowered to the desired level. One of the common criticisms of cap-and-trade programs is that
they are difficult to understand and would likely be difficult to implement. [to whom would
apply?] Although ordinarily it might take a while to put the system in place, successful cap-andtrade programs already exist throughout the country. With models like the U.S. Acid Rain
Policy Options for Reducing CO2 Emissions, CONGRESSIONAL BUDGET OFFICE (2008) located at
http://www.cbo.gov/ftpdocs/89xx/doc8934/02-12-Carbon.pdf.
15
Uncertainty in Analyzing Climate Change: Policy Implications, CONGRESSIONAL BUDGET OFFICE (2005) located
at http://www.cbo.gov/ftpdocs/60xx/doc6061/01-24-ClimateChange.pdf.
16
Id.
17
Policy Options, supra note 14.
14
Marc Rigsby
Energy Law
Program and the RGGI, the infrastructures for pollutant monitoring, allowance distribution, and
the like are already in place and may serve as models for a national system.
What are the variations of a cap-and-trade program?
There are several design decisions that must be considered in implementing a cap-andtrade program, for example, whether to implement the system upstream or downstream, how to
allocate allowances (or permits), and if a “safety valve” and/or “circuit breaker” should be a part
of the system.18 Let’s first look at the downstream/upstream distinction. Downstream refers to
the traditional approach of capping carbon emissions at the end-user level: at the factories where
fossil fuels are actually combusted.19 [and at businesses and houses that use natural gas?]
Upstream refers to where carbon is essentially entering the economy, “when fossil fuels are
imported or produced domestically.”20 [but what incentive is there upstream to become more
carbon efficient?] The table below summarizes the advantages and disadvantages of both
approaches.
Downstream
Would require
Ease of
Implementation monitoring and
regulating more entities,
could be prohibitively
expensive
Upstream
Although carbon is ultimately emitted by
hundreds of millions of sources, it enters the
economy through a relatively small number
of fossil fuel suppliers
Could cap virtually all fossil fuel based
carbon emissions in the U.S. while
minimizing government’s administrative
costs and the private sector’s reporting costs
Carbon-Target
Certainty
CostEffectiveness
A system that was not
extremely costly could
cap only a subset of
carbon emissions, while
not limiting emissions
from sources outside the
cap
A comprehensive
downstream trading
program would entail
very high administrative
costs
Could ensure economy-wide emission target
would be met because it would cover
virtually all sources of emissions
Would limit fossil fuel production, leading to
higher prices for those fuels and for energyintensive goods and services. The higher
prices would give the entire economy
incentives to reduce carbon emissions
Id.
An Evaluation of Cap-and-Trade Programs for Reducing U.S. Carbon Emissions, CONGRESSIONAL BUDGET
OFFICE (2001) located at http://www.cbo.gov/ftpdocs/28xx/doc2876/CapTrade.pdf.
20
Id.
18
19
Marc Rigsby
Energy Law
21
Another design decision is how to effectively allocate allowances. There are two primary
options for the allocation of carbon dioxide allowances. The government can give away
allowances, or they can auction off the allowances. Furthermore, if they are given out it must be
decided on what basis they are given out, for example, based on historical carbon emissions,
anticipated carbon emissions, etc.22 By auctioning off carbon allowances, policymakers could
partially offset the so-called tax by using the revenues of sold carbon permits to lower some of
the existing taxes. The money raised from auctions could also be funneled towards investments
in alternative energy sources. This is one benefit to using an auction system. However, a capand-trade program is inherently regressive. [was this true for the sulfur program?] With a capand-trade system the relative price of energy-intensive goods will rise, and as a result the relative
income of energy-intensive users will fall. In particular, less wealthy firms will spend a larger
proportion of their income on purchasing carbon permits from other firms. If the auction system
was used, it would only worsen the situation and make the effective regressive tax of carbon
permits even steeper for these less wealthy firms. If, however, the permits were given away then
it would help mitigate the regressive nature of carbon permits. [what about allocating to energyintensive users – a wash?]
The final design question in a cap-and-trade program is whether or not a hybrid feature,
such as a “safety valve” or “circuit breaker,” should be used.23 A cap-and-trade program allows
for the trading of allowances, thus creating a market for these “goods.” The price of these goods,
like the goods in any other market, are subject to the whims of supply and demand. As the
demand for carbon allowances increases, or as the supply decreases, the price will inevitably
rise. With a “safety valve,” the government essentially sets a price ceiling on allowances. 24 If
the price of allowances reaches a particular height, then the government will increase the supply
of allowances (even if it means exceeding the cap) in order to maintain the price level. The
“safety valve” makes sure that carbon allowances do not become prohibitively expensive, and it
ensures continued economic growth.
A “circuit breaker” operates a little bit differently. With any cap-and-trade system, the
government will gradually lower the overall cap of carbon emissions. When the cap is lowered,
the supply of allowances decreases and, consequently, the price of an allowance may increase as
a result. In some instances, the cap (or, supply of carbon allowances) may be lowered too fast
and cause the resulting price to become prohibitively expensive. With a “circuit breaker,” the
government again sets a trigger price. However, rather than flooding the market with allowances
to maintain that trigger price, when the market price of an allowance hits the trigger price the
government simply freezes the carbon cap level. By stalling any further reductions in the overall
cap, the government allows demand to catch up with supply, and waits for the price to drop. The
price may temporarily stay above the trigger price, but ultimately it will go back down as firms
adjust their practices (and emissions). When the allowance price returns to a level safely below
the trigger price, the government will resume reducing the carbon cap.
Id.
Policy Options, supra note 14.
23 Policy Options, supra note 14.
24 Id.
21
22
Marc Rigsby
Energy Law
What system should we use in the United States?
I think that the U.S. should implement a national [downstream?] cap-and-trade program
for controlling carbon emissions. I am aware of its potential economic effects - the price of
energy will increase, and that will, in turn, trickle down and be passed on to businesses at every
level, as well as consumers. However, the negative economic effects would only occur in the
short-run. In the long-run, not only would the country (and world) be better off because of our
reduced carbon emissions - which could help curb global warming - but I think our economy
would be better off as well. There are a few reasons I believe this is the case. First, by forcing
firms to reduce their carbon emissions, we are forcing them to operate more efficiently. A more
efficient firm saves money. Second, and more importantly, by forcing firms to reduce their
carbon emissions (and thus increasing the price of fossil fuels) we are simultaneously
encouraging the use alternative energy sources. This will have the effect of catalyzing the
alternative energy industry, because wind energy, solar energy, geothermal energy, and every
other “alternative” type of energy will become more attractive. Alternative energy sources
represent a huge industry whose growth can help boost employment and the economy.
I also have an opinion on the design decisions that we should utilize. I think that the U.S.
should cap carbon going upstream, because it appears far simpler, and because the psychological
effect of knowing our fossil fuel inputs are being limited should further spur development in
alternative energy. [what is being traded?] I think allowances should be auctioned, because
although it might help the exacerbate the regressive nature of the carbon “tax,” the profits
generated can, again, help fund alternative energy sources and potentially offset government
taxes in other areas. Finally, from a policy standpoint I prefer the “circuit breaker” to the “safety
valve,” because the latter seems like a system that could be abused as firms demand more
permits and drive up their price until the government is forced to flood the market with more
permits, which is counter-productive.
How should we implement it?
This is essentially a question of legislation versus regulation. I mentioned earlier that
Obama tried to pass a bill [he let it die in the Senate after three Senators, including Lindsay
Graham, were willing to support it] through Congress which would have implemented a carbon
cap-and-trade system. The bill ultimately failed. The EPA subsequently tried to control carbon
emissions via direct regulation under the CAA. Thus far it has been blocked from doing so. But
what is the better approach? The downsides to regulation are numerous: “Regulation by the EPA
requires plant-by-plant determinations. Numerous industries would be caught in the regulatory
web. Levels of control technology would have to be set in individual rulemaking proceedings
for specific industries that would be time consuming and contentious. One unstated
assumption...is that litigation - perhaps slowing progress for years - would inevitably follow.”25
Not everyone shares the view that legislation is preferable. Jim Rogers, CEO of Duke
Energy, said that “‘some in his industry may be happier with the EPA stepping in where
Congress fails.’ In this vein, the EPA is the devil you know, and not a fully empowered devil at
that. It can only impose technology controls established in rulemaking proceedings as [best
25
ENERGY, ECONOMICS, AND THE ENVIRONMENT, supra note 12 at 802.
Marc Rigsby
Energy Law
available control technology.”26 [but this is neither tax nor cap-and-trade] However, even if
regulation was the preferred option we do not even know whether the EPA could actually
regulate carbon emissions under the CAA. In Massachusetts v. EPA, 549 U.S. 497 (2007), the
Supreme Court ultimately held that the EPA had the statutory authority to regulate GHG (i.e.,
carbon) emissions under the CAA. Massachusetts, however, dealt exclusively with regulating
emissions from mobile sources (i.e., automobiles). Shortly after the Massachusetts case, and still
during the Bush era, a similar question arose in In re Deseret Power Electric Cooperative.
Specifically, the question was whether the EPA could regulate carbon emissions of stationary
sources. Ultimately, the question was not really answered, but the case prompted the Obama
administration to look into the matter. The EPA has since proposed various rules relating to
carbon emissions. There are some rules in operation, but those pertain primarily to the reporting
and monitoring of carbon emissions. The EPA cannot yet actually control carbon emissions
from stationary sources - the proposed rules were blocked, as I mentioned earlier, by the Energy
Tax Prevention Act. Regardless, even if the EPA could regulate carbon emissions, they could
not do so in the form of a nation-wide cap-and-trade system. [could EPA create a cap-and-trade
reg?]
I reiterate my defense of a cap-and-trade system, and I believe that we should implement
it through legislation. [what about politics of “cap and tax”?] Legislation will, first and
foremost, allow an actual cap-and-trade system, and it will be relatively faster and relatively
more efficient than any regulation. Finally, if legislation was passed it would be much more
pervasive, and would essentially be immune from challenge - unlike regulation by the EPA,
which would require more individualized control of carbon emissions, and which could have
each of its decisions questioned, causing great delays and inefficiencies. A cap-and-trade
program, if executed well, would not only work in the United States, but I think it would also
greatly enhance the country’s economy.
26
Id.