Carbon Cap-and-Trade Makes Money Out of Thin Air

Mirant's coal-fired Dickerson plant, on the Potomac River in Montgomery County, Maryland.

Curling up with the summary of the 2010 federal budget isn’t exactly cozy Saturday morning reading, but today I took a crack at it. While there are several items of note (including the drastically reduced usage of the word “terrorism” compared with the last several editions), one budget item in particular caught my attention: climate revenue.

As far as I can discern without actually calling up a human being to ask, the “climate revenue” line item refers to money that is expected to be generated by a proposal to implement a nationwide carbon cap-and-trade system. Note: for those of you who click on the link, sorry about the tiny print, but the reference is on page 3 of the table. Blame the Government Printing Office!

The kicker: it’s expected to haul in $646 billion over the first decade of its existence. This is a brand-new, novel source of revenue, something never before seen in a federal government budget. The idea quite literally is to make money out of vapors.

The national plan consists of other elements designed to reduce the country’s carbon output–notably, forms of “carbon sequestration”, where CO2 is injected through various means into subterranean reservoirs, coal mine seams, and under-ocean saline reservoirs.  The U.S. Energy Department even has a searchable function for descriptions of ongoing sequestration research projects in your own home state! But the cap-and-trade idea is the crown jewel in the Obama administration’s efforts to effect change on emissions impacts.

The idea is pretty simple: CO2 emitters are allowed a certain tonnage of emissions (a “cap”) after which they must buy credits to account for the excess. Producers of CO2, say a coal-fired power plant, buy credits at a rate determined through an auction. The power plant can then freely “use” its credits, each of which corresponds to one ton of emitted carbon dioxide. If the power plant exceeds its allocation of credits, it can be fined, or have restrictions placed on the number of credits it can buy in subsequent years (leading to compounded fines.)

Trading comes into play when companies with extra credits–this might include companies which have voluntarily reduced emissions or implemented new, cleaner technologies–swap or sell them to bigger producers in need of more credits to cover their emission volumes. Over time, both the cap and available credits are reduced. With fewer credits to go around, companies have a real economic incentive to work to reduce emissions. Check out a couple of cute illustrations by the jolly folks at the U.S. Environmental Protection Agency in its “cap-and-trade primer“.

Meanwhile, all the money generated through these carbon credit “auctions” goes back into government coffers, and is used to fund energy technology research, home weatherization, power grid modernization, or offset resulting electric rate increases.  A study (hefty PDF here) by researchers at the University of Maryland’s Center for Integrative Environmental Research suggests that the average consumer’s power bill shouldn’t increase for several reasons. Higher hourly rates will lead to lower demand for power, and a state’s re-investment of its auction revenue into energy efficiency programs will reduce the overall amount of energy required. A little mind-bending, but there it is.

Now, there already exists what amounts to a pilot cap-and-trade program: the Regional Greenhouse Gas Initiative (RGGI), a collection of Northeast and Mid-Atlantic states working together on a regional emissions goal. Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont held the first auctions of their credit allocations last year: The Washington Post reported in a Sept. 30, 2008 story that the first auction raised nearly $40 million for the member states.

Maryland’s laws mandate the state use auction revenue to:

…support energy efficiency, directly mitigate electricity ratepayer impacts, promote renewable or non-carbon emitting energy technologies, stimulate or reward investment in the development of innovative carbon emissions abatement technologies with significant carbon reduction potential, and administer these regulations. (Maryland State Carbon Trading Regulations)

The second RGGI auction in mid-December was slightly more successful, raising $106.5 million. The third auction is slated for March 18, 2009.

RGGI member states’ CO2 emitters paid, on average, around $3 per carbon-ton unit for each credit. The federal program, by comparison, intends to start carbon credit prices at around $15 per ton. Experts say the goal of $646 billion is not unreasonable: see this Feb. 26, 2009 story by Reuters for more. RGGI’s critics said it set its emission cap too high and its credit prices too low, but the cooperative said it was done that way intentionally to ease participants into the credit-buying process. (Similar cap-and-trade methods were employed to phase out leaded gasoline in 1973 and CFCs in the 1990s, for example.)

Compliance rules for each state went into effect on Jan. 1, 2009. I researched Maryland’s rules for participation in RGGI to get an idea of how it will work there, since it’s the nearest participating state to Virginia.

The initial annual allocation of carbon credits RGGI is doling out totals 188.1 million tons, and Maryland’s 2009-2014 chunk of that equals 37.5 million tons. Every year after 2014, each state’s credit allocation will be reduced by 2.5%. In Maryland, any coal, oil or gas power plant with a capacity of 25 megawatts or more is required to participate, and must buy credits. In Maryland, that affects 16 plants, which can swap, sell, or save credits for future years if they don’t use everything in one calendar year. There are also a number of exemption rules, allowing producers extra flexibility for contributing to other mitigation programs, such as marshland and forest restoration. By participating in the RGGI, Maryland aims to reduce its emissions to pre-2006 levels by 90% in the year 2050.

The federal goals, by contrast, are laid out in the relevant 2010 budget section:

After enactment of the Budget, the Administration will work expeditiously with key stakeholders and the Congress to develop an economy-wide emissions reduction program to reduce greenhouse gas emissions approximately 14 percent below 2005 levels by 2020, and approximately 83 percent below 2005 levels by 2050.

Final thought: I wonder if there are any estimates of the job creation associated with research and development for carbon sequestration, scrubbing technologies, and other mitigation technologies? This is only one sector!

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