Two new comment letters on state energy and climate policy

Earlier this December Michael Wara and I finished a pair of comment letters on two critical California policy processes.

The first letter (see here) concerns the proposed expansion of CAISO's wholesale electricity market to include PacifiCorp and potentially other western utilities. While regionalization could better facilitate integration of renewable energy resources, it also raises a set of legal and governance challenges because California takes a decidedly different approach to energy and climate policy than its neighbors in the Intermountain West. Michael and I have participated in one particular process in which CAISO and CARB have discussed how to better account for greenhouse gas emissions in a regional market (past comment letters here and here). Because California is the only western jurisdiction to price the carbon emissions associated with power imports, out-of-state utilities have an incentive to preferentially send their low-carbon resources to California while keeping high-emitting resources for themselves. As a result, it is possible that high-carbon out-of-state resources turn on to serve new California load, but via a regional electricity market low-carbon resources are deemed delivered to California—an automatic kind of resource shuffling that produces the false appearance of low emissions on California's books. 

Earlier in CAISO's process, Michael and I had raised concerns that CARB's preferred way of accounting for these resource shuffling impacts would raise significant legal risks under the dormant commerce clause and Federal Power Act. (That this is the first process in which CARB has publicly recognized the potential for resource shuffling, despite intentionally gutting their rules on this issue a few years back is ironic—but that's another story.) After additional discussion, CAISO eventually selected a different approach, one that Michael and I believe will do a good job of accurately identifying the marginal power plant that is dispatched to serve California load and accounting for those greenhouse gas emissions. It's refreshing to see regulators tackle technically complex issues in service of reaching a workable, pro-climate outcome. While greenhouse gas accounting is only one of several issues to resolve—notably, there are additional governance challenges and the lack of post-2020 legal authority to price carbon, without which no regional market can accommodate state climate policy—we are grateful that CAISO has been so responsive to stakeholder feedback. 

The second letter (see here) addresses a Discussion Draft of CARB's 2030 Scoping Plan. The 2030 Scoping Plan is part of a process to determine how California will reach a bold new target established by SB 32, which requires statewide greenhouse gas emissions to fall 40% below 1990 levels by 2030. Hitting the 2030 target will require annual emission reductions in the next decade that are approximately ten times as steep as those needed to get to our much more modest 2020 target. So it should go without saying that careful analysis is needed to develop a robust implementation strategy, especially under the incoming Trump Administration. 

What CARB has so far put forward falls well short of that mark. On several key dimensions, CARB not only fails to satisfy the best possible analytical standards, but occasionally ignores basic scientific methods. For example, in order to develop a strategy to reach a deep reduction target some fifteen years in the future, it is necessary to have some sense of what the business-as-usual trajectory will be. Over that kind of time period, the future is very uncertain. Yet CARB has not been willing to engage in any kind uncertainty analysis. Instead, the regulator claims to know with precision what the future will look like both with and without its preferred (but largely unspecified) policy interventions. CARB also insists on using quantitative models that don't include macroeconomic feedback or carbon pricing—a curious choice for analyzing a deep climate mitigation target that the agency proposes to reach in part via carbon pricing policies.

On top of that, CARB's clear preference to maintain its flawed cap-and-trade program would, by the regulator's own calculations, lead to an emissions trajectory that misses SB 32's target. Because cap-and-trade allows regulated entities to bank extra allowances not needed in any given year, the program is designed to encourage companies to reduce emissions early and save those extra allowances for later—enabling companies to comply with the cap-and-trade program requirements while emitting significantly more emissions than is allowed under SB 32 in 2030. The figure below shows CARB's preferred implementation plan in green: in this scenario, emissions fall lower in the late 2010s but remain relatively high, ultimately missing the 2030 target by a wide margin.

Source: Figure III-3 in CARB's 2030 Scoping Plan Discussion Draft

Source: Figure III-3 in CARB's 2030 Scoping Plan Discussion Draft

Worse still, CARB continues to take an unreasonable approach to considering the potential role of carbon taxes. It's been obvious for years that the regulator has been opposed to carbon taxes on ideological grounds, though the precise reasoning has never been clear. Ultimately, where the legislature has granted the agency discretion to choose between competing instruments, it's the agency's business to act on its well-reasoned preferences. Problem is, CARB is now citing climate denier websites to attack British Columbia's carbon tax in order to support CARB's preference for cap-and-trade.

Yes, that's right: the nation's leading climate regulator—presumably through careless neglect—is now relying on right-wing blogs to make its case. As Michael and I wrote in our most recent comment letter: 

Lastly, we were surprised to find that one of the references CARB relies on to establish its criticism of British Columbia’s carbon tax—a blog called “The American Thinker”—is a reliable source of articles that dispute the scientific consensus on climate change [see footnote 98 on page 97 of CARB's Discussion Draft]. Recent headlines include “Climate Change: Where is the Science?” and “Trump and the Climate Change Clown Show.” One imagines that the blog’s publishers never expected to be cited favorably in a key California climate policy planning document; certainly we never expected a moment like this.

Frankly, the American Thinker incident does not reflect well on the sincerity of the scoping plan process. We encourage CARB to consider an explicit retraction. We also hope that in the future, CARB will be more selective in the sources on which it relies, particularly when criticizing the policies of other jurisdictions with which it collaborates on climate policy.

I hope that CARB will aim for a much higher standard in future drafts of the 2030 scoping plan, and not just in its footnotes. The regulator needs to take a much more balanced and well-supported approach to comparing cap-and-trade and carbon taxes, expand its modeling to include models that can address carbon pricing and macroeconomic feedback, and develop a rigorous uncertainty analysis. Meanwhile, we should all pay more attention to what the legislature does in 2017 because even CARB's preferred plan will require new legislative authority. 

New publication in the Energy Law Journal

My former UC Berkeley student Andy Coghlan and I have just published an article in the new issue of the Energy Bar Association's Energy Law Journal.

Our paper analyzes how the California state constitution constraints the future of carbon pricing in state climate policy. We find that extending the carbon market's authority after 2020 while retaining collection of revenue from government-run allowance auctions likely requires a 2/3 legislative supermajority under California's Proposition 26. Simple majority legislative strategies may be possible, but present both novel legal risks and significant policy consequences, such as precluding the collection of government revenue via 100% free allocation of allowances. 

In addition to speaking to the live issue of the role of carbon pricing in California's post-2020 climate policy strategy—see this new comment letter from me and Michael Wara on the California Air Resources Board's 2030 scoping plan process—our paper highlights how carbon pricing is critical to the future of western electricity markets.

As Michael and I have pointed out repeatedly (see here and here), plans to expand California's wholesale electricity market (CAISO) depend on California employing a state-level carbon price to ensure that only low-carbon resources are dispatched to serve California customers. That approach is consistent with the way CAISO operates its current Energy Imbalance Market (EIM), which applies California's secondary carbon market price to out-of-state power plants that wish to sell to California customers.

That basic market design is set to continue in any expanded CAISO energy markets. After several rounds of public comment, CAISO has prepared a "straw proposal" for how the EIM and an expanded CAISO energy market would operate. As with the EIM, the expanded energy market would apply California's state-level carbon price to out-of-state resources that are deemed to be dispatched to serve California customers. 

Whether and how to expand CAISO's energy markets is a complicated subject, but one thing should be clear: California needs to have the legal authority to impose a carbon price on imported electricity in order to make this market design concept work. In my view, however, that authority almost certainly expires at the end of 2020 without legislative re-authorization—see a comment letter from me and Michael Wara here for a full analysis.

If California wants to expand CAISO's energy markets, state policymakers will first need to extend carbon pricing authority beyond 2020. Absent a carbon price, there is no way to ensure that a regional electricity market including states whose energy and climate policy priorities could not be more different will not undermine California's policy goals. And as Andy and I describe in detail in our new paper, achieving that post-2020 carbon pricing authority likely requires a 2/3 legislative supermajority. 

Thanks to ELJ Editor-in-Chief Bob Fleishman for the opportunity to publish with ELJ; to  ELJ Articles Editor Kevin Poloncarz for his comprehensive and thoughtful feedback; and to the student editors at the University of Tulsa College of Law for their excellent assistance.  

New comment letter on CAISO regionalization

Michael Wara and I just submitted a comment letter to CAISO and CARB, both of which have put forward proposals for how to modify operation of the interstate Energy Imbalance Market (EIM) and, potentially, to apply these models to full regionalization of the CAISO energy markets.

Source: CAISO

Source: CAISO

On the process side, we continue to be concerned that the pace of CAISO expansion discussions is overly ambitious given the lack of clear state authority to price carbon after 2020—in order to maintain its climate leadership, California will need to secure that authority before committing to a regional energy market. We also recommend that CAISO and CARB separate discussion of pre-2020 EIM operational reforms from the post-2020 regional energy market design process, since the carbon price trajectory in California and across the west is likely to be much higher in the post-2020 period. We will likely see additional carbon pricing regimes in the West if the D.C. Circuit upholds the Clean Power Plan; any regional market design will need to accommodate the possibility of multiple carbon pricing regimes. 

In addition to these procedural issues, Michael and I also address two legal aspects of the new market design proposals. We believe that the next round of market mechanisms need to explicitly address the dormant commerce clause risks of differential attribution of GHG emissions from in-state and out-of-state resources. CARB's proposal would shift away from the source-specific attribution found in the EIM today and apply different GHG attribution rules to in-state and out-of-state resources; both proposals would apply different GHG accounting to out-of-state resources with bilateral contracts with California load-serving entities, compared to merchant resources that do not have bilateral contracts. Similarly, these different attribution methods raise potential non-discrimination issues under the Federal Power Act. 

We are finally getting to the point where CAISO and CARB are articulating specific mechanisms for regional electricity market integration. Thanks to both entities for the hard work their staff put into developing descriptions, numerical examples, and for the continued commitment to cooperating on the regional GHG implications of energy market design. This is important technical work—now it's time to harmonize the legal and economic discussions. 

Three new comment letters on California climate policy

Yesterday Michael Wara and I submitted a pair of comment letters to CARB regarding its proposal to extend the cap-and-trade system beyond 2020. We split our comments into a letter that addresses CARB's legal authority to develop this regulation and a set of substantive policy considerations regarding the proposal's details. Unfortunately, our view is that CARB likely lacks the necessary authority to act because the authorizing statute (AB 32) only provides this authority through 2020. On the policy side, CARB has also made a number of assumptions regarding the stringency of the post-2020 caps that may frustrate California's ability to reach its 2030 target by placing an overly aggressive share of the burden on difficult to regulate "uncapped" sectors. CARB will discuss its proposal at a Board Meeting this Thursday in Sacramento. 

Today I finished up a related comment letter to the California Independent System Operator (CAISO). CAISO is proposing to expand its wholesale electricity market to include some of California's neighbors. The proposal implicitly assumes that California maintain a post-2020 price on carbon, without which a wholesale market cannot distinguish between high- and low-GHG resources. Because the future of California's approach to carbon pricing is very much up in the air at the moment, I revisit the concerns expressed in the legal comment letter Michael and I sent to CARB. My comment letter to CAISO also addresses the need for additional detail on the precise market design details since the legal and net GHG implications of CAISO regionalization will depend on these parameters. 

Let's just say it's been a busy week in state climate policy.

Washington's proposed Clean Air Rule

In an earlier post, I provided some background on climate policy developments in the State of Washington, where the Department of Ecology withdrew a proposed cap-and-trade regulation in February and promised a revision over the summer. As expected, the Department then issued a proposed Clean Air Rule in late May and provided an opportunity for public comment. 

Consistent with the Department's earlier thinking on climate policy, the proposed rule contemplates a significant role for in-state compliance via allowances from external emissions trading markets. While the new proposal doesn't mention other linked markets by name, it would set up a process whereby the Department of Ecology could approve external emission trading markets' allowances for compliance with the Clean Air Rule. The accompanying cost-benefit analysis makes clear that one of the Department's compliance scenarios assumes that allowances could be purchased from the California-Québec market, which is currently oversupplied

Based on the concerns outlined in my earlier post, I wrote a short comment letter addressing the environmental risks associated with enabling in-state emitters in Washington to comply with the proposed rule by purchasing allowances from California's oversupplied carbon market.

That said, the proposed link to California isn't the only problem with this rule. It also contemplates broad use of voluntary carbon offset protocols as well as renewable energy certificates (RECs), both of which set a low bar for compliance standards. Since other stakeholders are already concerned about these issues, however, I decided to focus on recent developments in California's market—most of which are poorly understood outside of California and in any case occurred after the Department of Ecology put out its proposed rule.

At the same time, there's an important connection between voluntary offsets, RECs, and my concerns with linking to oversupplied markets. In many ways, the excess permits available from an oversupplied system are analogous to low-quality carbon offsets: when a regulator allows a company to purchase an oversupplied market's allowance (or a low-quality offset), that purchase doesn't cause net emissions to fall on a one-for-one basis. In the case of a low-quality carbon offset, the lack of environmental quality means that the "real" emission reductions are less than the face value of the credit because the offset rules are too lax; in the case of an oversupplied market, the "real" emission reduction is less than the face value of the allowance because market demand is too lax relative to supply. In both cases, in-state emitters hold an instrument that allows them to emit more at home because the instrument counts as a reduction abroad; and in both cases that reduction abroad isn't worth 100% of its stated value. 

Washington's proposed Clean Air Rule offers a useful reminder of the institutional constraints on market-based climate policy. Economic intuition suggests that the more compliance options are available—and the greater their geographic scope—the lower overall compliance costs will be. But the governance challenges can be enormous. 

As my colleague Michael Wara pointed out in his own comment (no link available), the proposed rule would either enable a high volume of low quality offsets or require the Department of Ecology to become an offsets regulator, hiring full time staff and vetting technically complex offset protocols. Similarly, if the state wants to make sure that the use of RECs is robust and additional, it will need to track RECs markets across the western U.S.

My point is that linking carbon markets raises similar challenges, as I've argued elsewhere. One has to monitor the integrity of linked markets in order to be confident that the full range of compliance instruments is equivalent to in-state reductions. If that task can be done well and cheaply, it's a great idea. But if a regulator lacks the capacity, budget, or will to perform these duties on ongoing basis, then perhaps the risks of linking are greater than the benefits

New paper on California's carbon market

Andy Coghlan and I have a new article out in The Electricity Journal on recent developments in California's carbon market. In the quarterly auction this past May, 90% of allowances failed to find buyers. As a result, the joint California-Québec auction failed to collect over $880M, $550M of which was due to be delivered to California's greenhouse gas reduction fund (GGRF).

There will be significant consequences if Q3 (Aug) and Q4 (Nov) auctions follow the pattern observed in Q1 (Feb) and Q2 (May). As Andy and I discuss in our piece, the fundamental drivers of the May auction results include persistent market design issues and a lack of current legal authority to extend the market after 2020. This suggests that the market's problems are unlikely to be resolved anytime soon. 

Given the importance of carbon market revenue to the political economy of California's climate policy, Andy and I hope that readers will find our article a useful resource for putting the May auction in context. Thanks to the journal's editor, Rich Cohen, for expediting its publication.