Lecture 26

Climate Change II: Carbon Pricing

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

November 8, 2024

Understanding Carbon Offsets

What Are Carbon Offset Credits?

  • Definition: Transferable instruments certified to represent the reduction of one metric ton of CO₂ or CO₂ equivalent (CO₂e).

  • Mechanism:

    • Investment in Projects: Funding emission-reducing projects that are additional to what would occur naturally.

  • Usage: Entities purchase offsets to reduce their net emissions where allowed.

What Are Carbon Offsets?

  • Voluntary Markets:
    • Individuals: Airline passengers may choose to offset the carbon emissions from their flights by purchasing offsets.
    • Organizations: Companies aiming for net-zero emissions can buy offsets to compensate for emissions they cannot eliminate.
  • Compliance Markets:
    • Cap-and-Trade Programs: Firms can use certified offsets to meet legal requirements.
    • Carbon Tax Programs: In some cases, offsets can reduce the level of taxable emissions by subtracting certified reductions from actual emissions.

Uncertainty-Decreasing Hybrid Carbon Pricing Designs

Uncertainty-Decreasing Hybrid Carbon Pricing Designs

  • Emissions Trading Programs
    • Aim to achieve a specific emissions target.
    • Prices in allowance markets adjust to meet this goal.
    • Uncertainty: Future price uncertainty but more emissions certainty.
  • Carbon Tax Programs
    • Impose a specific set of prices over time.
    • Market reactions determine resulting emissions.
    • Uncertainty: Price certainty but emissions uncertainty.

Uncertainty-Decreasing Hybrid Carbon Pricing Designs

Reducing Uncertainty

  • Goal: Reduce both price and emissions uncertainty without undermining policy effectiveness.
  • Potential benefits:
    • Increased likelihood of environmental groups and businesses finding common ground.
    • Enhanced political support for carbon pricing.

Emissions Trading Program Hybrids

  • Price Uncertainty Concerns:
    1. Prices falling below expectations undermining future incentives.
    2. Prices rising higher than expected, undermining political support.

Emissions Trading Program Hybrids

Price Floor: Minimum Auction Price

  • Purpose: Prevent auction prices from falling below expected levels.
  • Mechanism:
    • Administratively determined minimum price, rising annually.
    • Example: Regional Greenhouse Gas Initiative (RGGI)’s minimum reserve price increases by 2.5% annually.
  • Limitations:
    • Doesn’t address the surplus of allowances leading to low prices.
    • Future auctions may still face low prices due to surplus.

Emissions Trading Program Hybrids

Emissions Containment Reserve (ECR)

  • Purpose: Address allowance surplus and prevent low prices.
  • Components:
    1. Prespecified trigger price.
    2. Prespecified number of allowances to withhold.
  • Operation:
    • If auction prices breach the trigger price, allowances are withheld.
    • Example: RGGI withholds up to 10% of allowances if prices fall below $6 (2021 trigger price).

Emissions Trading Program Hybrids

Cost Containment Reserve (CCR)

  • Purpose: Prevent prices from rising to politically unacceptable levels.
  • Versions:
    • Soft Collar:
      • Prespecified allowances added when prices exceed a trigger price.
      • CCR is replenished annually.
      • Example: RGGI’s CCR trigger price was $13 in 2021.
    • Hard Collar:
      • No limits on allowances added to keep prices from rising above the ceiling.
      • Provides more price certainty but less emissions certainty.

Carbon Tax Hybrids

  • Main Concern: Achieving emissions goals despite uncertainties in forecasting.
  • Strategies:
    1. Complementary Policies: Augment the carbon tax to further reduce emissions.
    2. Adjustment Mechanisms: Adjust the carbon tax rate to meet emissions goals as conditions change.

Carbon Tax Hybrids

Implementing Complementary Policies

  • Approaches:
    1. Introduce additional regulatory policies if the carbon tax falls short.
      • Challenges: Difficult to fine-tune and undo regulations.
    2. Use additional tax revenue from excess emissions to purchase carbon offsets.
      • Government acts as the purchaser, ensuring quality and negotiating prices.

Carbon Tax Hybrids

Adjustment Mechanisms in Carbon Taxes

  • Discretionary Adjustments:
    • Prespecified triggering conditions.
    • Responses crafted when triggers are breached.
    • Example: A five-year review process to update carbon tax rate.
  • Automatic Adjustments:
    • Both triggering conditions and adjustments are prespecified.
    • Tax rates adjust automatically based on emissions relative to benchmarks.
    • Example: Adjusting tax rates if cumulative emissions exceed benchmarks.

Carbon Tax Hybrids

Adjustment Mechanisms in Carbon Taxes

  • We do not have the real-world example of these adjustment mechanisms in Carbon Taxes.
  • Modeling Result: Flexible carbon tax programs can significantly reduce emissions uncertainty.
  • Potential benefits:
    • Reducing excessive emissions outcomes.
    • Narrowing the range of expected emissions.
    • Increasing the probability of meeting specific emissions targets.

Providing Context: A Brief Look at Four Illustrative Carbon Pricing Programs

Four Illustrative Carbon Pricing Programs

1. Canadian National Carbon Pricing Program

  • Flexibility: Provinces can design their own systems or use the federal system.
  • Federal Pricing System:
    • Fuel charge on fossil fuels.
    • Output-Based Pricing System (OBPS) for large industrial facilities.
  • Carbon Price: $65 CAD per tonne CO2e, increasing to $170 by 2030.
  • OBPS Details:
    • Emission standards based on sector averages.
    • Facilities exceeding standards pay charges; those below earn credits.

Four Illustrative Carbon Pricing Programs

2. European Union Emissions Trading Scheme (E.U. ETS)

  • Scope: Covers 45% of E.U.’s GHG emissions.
  • Mechanism:
    • Cap-and-trade system with decreasing cap over time.
    • Allowances are auctioned; revenue returned to member states.
  • Market Stability Reserve (MSR):
    • Adjusts supply of allowances to stabilize the market.
  • Carbon Border Adjustment Mechanism (CBAM):
    • Importers report embedded emissions and surrender certificates.

Four Illustrative Carbon Pricing Programs

3. China’s Emissions Trading System

  • Design: Output-based standards targeting emissions intensity.
  • Scope:
    • Initially covers large firms in the electricity sector.
    • Plans to include seven additional sectors.
  • Allowance Allocation:
    • Free allocation based on benchmarks.
    • Multiple standards reduce regional disparities.
  • Cost-Effectiveness:
    • Less cost-effective than traditional ETS but yields significant net benefits.

Four Illustrative Carbon Pricing Programs

4. Washington State Climate Commitment Act

  • Emissions Trading Program starting in 2023.
  • Coverage:
    • Industrial facilities, fuel suppliers, electricity generators, and more.
  • Mechanism:
    • Cap-and-invest program with decreasing allowances.
    • Includes price floor and ceiling.
  • Offsets:
    • Up to 5% of obligations can be met with offsets.
  • Revenue Use:
    • Funds directed toward clean energy, transportation, and climate justice initiatives.

Output-Based Carbon Pricing Systems

  • Comparison to Traditional ETS:
    • Implicitly subsidize output.
    • Less cost-effective due to output incentives.
  • Empirical Findings:
    • China’s system costs about 47% more than conventional ETS.
    • Environmental benefits outweigh the higher costs.

Policy Design and the Just Transition

Understanding the Just Transition

  • Definition: A framework ensuring that the shift to a low-carbon economy is fair and inclusive.
  • Goals:
    • Protect vulnerable communities from disproportionate burdens.
    • Provide opportunities for economic and social advancement.
  • Key Components:
    • Equity in environmental benefits and economic opportunities.
    • Support for workers and communities affected by the transition.

Importance of a Just Transition

  • Ethical Considerations:
    • Moral responsibility to avoid exacerbating social inequalities.
  • Social Stability:
    • Preventing resistance to climate policies by addressing concerns of affected groups.
  • Sustainable Outcomes:
    • Long-term success of climate policies depends on public support and fairness.

Climate Damages and Vulnerable Populations

  • Disproportionate Impacts:
    • Lower-income households spend a higher percentage of income on essentials affected by climate change (e.g., food, energy).
    • Geographical vulnerabilities: Certain regions are more prone to climate-related disasters.
  • Global Inequities:
    • Developing countries contribute least to emissions but face the most severe consequences.

Regressive Nature of Carbon Pricing Without Mitigation

  • Energy Expenditures:
    • Carbon pricing increases the cost of fossil fuels.
    • Low-income households are more affected due to higher energy cost shares.
  • Economic Burden:
    • Without interventions, carbon taxes can consume a larger portion of low-income budgets.
  • Public Perception:
    • Regressive impacts can lead to opposition against carbon pricing policies.

Designing Progressive Carbon Pricing Policies

  • Revenue Recycling:
    • Returning carbon tax revenues to households can offset increased costs.
    • Methods:
      • Lump-sum rebates or dividends.
      • Tax credits targeted at low-income households.
  • Targeted Support Programs:
    • Energy assistance programs.
    • Job training and education initiatives in green sectors.

Breakdown of Revenue Allocation in 2017-2018

  • Climate Initiatives: 41.27%
    • Direct investment in climate-related projects.
    • Supports renewable energy, energy efficiency, and emission reduction programs.
  • General Budget: 38.31%
    • Funds are integrated into the general government budget.
    • Used for various public expenditures without specific earmarking.

Breakdown of Revenue Allocation in 2017-2018

  • Economic Development: 11.71%
    • Investments in economic diversification and support for transitioning industries.
    • Funds infrastructure projects and innovation in green technologies.
  • Tax Cuts: 5.59%
    • Reduction of other taxes to alleviate economic impacts.
    • Can benefit businesses and households financially.
  • Direct Transfers: 2.67%
    • Lump-sum payments or rebates to households.
    • Aimed at mitigating regressive effects on low-income groups.

Addressing Just Labor Transitions

  • Support for Affected Workers:
    • Retraining programs for workers in fossil fuel industries.
    • Unemployment benefits and job placement services.
  • Economic Diversification:
    • Investing in alternative industries in regions dependent on fossil fuels.
  • Community Development:
    • Grants and investments to revitalize affected communities.

Conclusion

  • Integrating Equity into Climate Policy:
    • Essential for the effectiveness and acceptance of climate initiatives.
  • Balancing Environmental and Social Goals:
    • Policies must reduce emissions while promoting social justice.
  • Moving Forward:
    • Continuous assessment and adjustment to ensure a fair transition.