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.