Although the U.S. Supreme Court made news recently with its unprecedented order to stay Obama Administration’s Clean Power Plan (CPP), the Environmental Protection Agency (EPA) has expressed strong confidence that the CPP will be eventually upheld.
Assuming the EPA is correct, the question of what the best way for states to implement the CPP is remains. According to a recent paper by William Hogan, a professor at Harvard Kennedy School, imposing an “explicit price on carbon” is essential to achieving the CPP’s dual goals of environmental protection and market efficiency. Hogan explores a number of approaches to implementing the CPP, evaluating each policy’s strengths and shortcomings.
Among all policies available, Hogan believes that a national carbon tax would be the best but least practical option. For one, a national tax would be the best option because the influence of carbon emissions is not regional but global. A national carbon tax in relation to ones at the state level can better reflect the global costs of carbon emissions. Second, a tax is cost-effective because it would represent how much society would have paid for the damages caused by excessive carbon emissions. Third, it is simple and efficient because all regulators need to do is incorporate the tax into the final price of electricity generation and let the market work on its own.
However, Hogan argues that a national carbon tax is unlikely under the state-by-state implementation in the CPP. The CPP is not really a directive plan, but a flexible framework to reduce carbon emissions and combat global warming. It calls for each state to figure out what to do and submit an implementation plan to the EPA for approval. If a state fails to comply with its own plan, the EPA can step in and impose a federal plan on the state.
Hogan believes that the “imaginable” way to implement a national tax under the CPP would be for states to cooperate and bring the same carbon tax plans to Regional Transmission Organizations (RTOs), independent organizations authorized by the Federal Energy Regulatory Commission to develop rules and administer interstate electricity transmission. But in reality, even the EPA cannot determine a common cost of carbon emissions. According to the EPA’s data, the carbon prices in different states range from $0 to $26 per unit. What is worse, Hogan notices that the EPA does not provide the underlying details of economic models used by the agency to calculate these carbon prices.
If a national carbon tax cannot be adopted, Hogan recommends a “cap-and-trade approach” as an alternative. Under this approach, the RTOs would set a cap of carbon emissions by issuing a certain amount of emission permits and allow individual entities to trade them. Then the market would set a price for the permits which represents the cost of carbon. However, Hogan worries that setting a cap at the very beginning would result in uncertain permit prices which ultimately may not reflect the full carbon cost that should have been taken into account. To avoid such uncertainty, Hogan suggests the RTOs set a floor and a ceiling on the permit price.
Hogan also introduces three options under the CPP for controlling individual operations to reduce carbon emissions. By “restricted offers,” the RTOs can limit the operation of a generating plant to a certain time slot in each day. “Self-scheduling,” a self-regulating form of restricted offers, asks individual operators to provide a daily operating schedule. “Cumulative constrained dispatch,” a longer time-frame version of restricted offers or self-scheduling, gives operators flexibility as long as their average carbon emissions do not exceed a specified amount each year.
These three CPP implementation approaches, however, generate even more uncertainty than a carbon cap. As Hogan illustrates in his discussion of cumulative constrained dispatch, individual operators will decide the exact prices of their products; meanwhile, regulators have no incentive to adjust prices as long as operators meet emission restrictions. Also, RTOs cannot easily monitor the behavior of individual operators, according to Hogan.
Hogan at last expresses concern with implementation options focusing solely on environmental costs and limiting carbon emissions at the cost of business profitability. Hogan warns that methods like subsidies, procurement mandates, and environmental dispatch, which function outside the market, would be detrimental to market efficiency and could even lead to a “collapse” of the current electricity market.