California is in the process of implementing a broad portfolio of policies and regulations aimed at reducing greenhouse gas emissions. This paper summarizes the initiatives likely to impact the electricity generating sector. We present calculations showing that there is a substantial risk that two of the most prominent policies could simply result in a reshuffling, on paper, of the electricity generating resources within the West that are dedicated to serving California. This reshuffling is different from the conventional leakage problem as it involves no physical changes to the way electricity is generated across regulated and unregulated regions, but is instead driven by a contractual reshuffling of who buys power from whom. The problem is similar to an ineffective consumer boycott. The problem is still present but less severe if more Western states adopt carbon limitations. We also show that some of the least market-based initiatives, the renewable portfolio standards (RPS), are likely to have the biggest near-term impact on the carbon-intensity of electricity generation in the West. Thus the scale of RPS programs may be limiting the potential role of non-renewable options in reducing carbon emissions from the electricity sector.

1.0 Introduction

When it comes to global climate change, California has been much in the news lately. A series of ambitious policy announcements focused on reducing emissions of greenhouse gases have drawn attention to California's efforts to combat climate change. California assembly bill 32 (AB 32), in many ways the capstone piece of legislation, calls for an overall reduction in greenhouse gas emissions to 1990 levels by 2020. While the details of implementing AB 32 are still being worked out, market mechanisms such as cap-and-trade are being seriously considered. At the same time, several other policies are designed to reduce carbon emissions through more interventionist regulations, aimed, for instance, at altering electricity fuel choice, household energy use, and automotive emissions.

In this paper, we demonstrate how a market-based cap-and-trade policy, when applied only to California, could have very little effect on carbon emissions from the electricity sector. Others have identified the conventional leakage problem, where regulation of one region can cause economic activity to move to the unregulated region (see, e.g., Fowlie
2007). We show that in the electricity industry, California companies could achieve their 1990 emissions levels by contracting to buy power from different sources. Essentially, there is enough existing low-carbon electricity in the west to meet all of California's projected demand in 2020 by simply reshuffling contracts. Unlike with leakage, the reshuffling could be achieved without any change in the carbon output from electricity generation. The problem is analogous to an ineffective consumer boycott. Further, if the electricity sector is allowed to trade with other sectors, it is likely that electric companies could generate excess allowances by reshuffling, limiting the ability of a cap and trade system to reduce emissions in other sectors of the economy.

Real reductions in carbon emissions seem most likely to be achieved by other, more interventionist, command-and-control policies, such as the renewable portfolio standard (RPS), which requires electric utilities to procure a certain fraction of their power from sources powered by renewable fuels. Our results point to the inherent policy questions a small jurisdiction like California must face: Is the goal to truly reduce greenhouse gas emissions, and not just cause the sources to change location? Or is the goal to produce a regulatory policy that could be scaled up to a national level, and provide a framework for economically efficient reductions if the policy were more widely adopted? This question is particularly relevant in the setting we consider as the goals are contradictory. In other words, market-based mechanisms appear unlikely to reduce carbon emissions from the electricity sector when applied to California alone. The RPS, while likely to reduce carbon emissions, will only exacerbate the extent to which a cap-and-trade policy can be undermined.

While our paper focuses on California policies and their impacts on the electricity sector, market-based and command-and-control policies coexist in other contexts. It is important to understand how the command-and-control policies are likely to interact with more market-based policies and elaborate on circumstances in which one can undermine the
effectiveness of the other. For example, fuel efficiency and low-carbon fuel standards are designed to reduce the carbon-intensity of transportation, and they would interact with any cap-and-trade initiative that included the transportation sector. Similarly, existing cap-and-trade markets, such as the Acid Rain Program for sulfur dioxide or the NOx Budget Program for nitrous oxides, coexist with New Source Review, a command-and-control program that requires new or substantially retrofitted stationary sources to install pollution control equipment. With conventional pollutants such as sulfur dioxide or nitrous oxides, command-and-control regulations may be valued because they impose an upper-bound on the pollution emitted by any one source. This argument is irrelevant in the case of carbon.

In some sense, the discussions that are unfolding in California represent, on a smaller scale, the same debates on the best ways to formulate international greenhouse gas policies. Just as California must consider both the direct and indirect impacts of its regulations, as well as its ability to influence its neighbors and Federal policy, individual nations must address the same issues on the international stage. The crux of the issue is over the actual goals of such policies: to achieve maximum reductions locally, or to encourage maximum participation outside of the local region?

One such debate has concerned the merits of a "narrow but deep" vs. "shallow but broad" sets of emissions reduction goals (see, e.g., Aldy, Barrett and Stavins, 2003). Some policies focus on an ambitious (e.g. deep) set of reductions applied to a small (e.g. narrow) set of jurisdictions. The Kyoto Protocol has been characterized as narrow but deep, and California's goals, which call for deeper reductions in a much smaller
jurisdiction must be considered even more so.

One of the criticisms of the narrow but deep strategy is that the ultimate goal, a reduction in global concentrations of greenhouse gasses (GHG), is too easily circumvented. Policies aimed at promoting alternative, "low-carbon" energy sources, will, if successful, also drive down prices of conventional fuel sources, thereby increasing their consumption,
at least in areas not participating the efforts.1 More directly, efforts to curtail emissions from specific industries could result in leakage, as those industries migrate to locations outside of the regulatory regime.

The proponents of the shallow but broad strategy argue that without widespread participation, the leakage issues will overwhelm the best efforts of the participating countries and eventually undermine efforts everywhere. On an international scale, the broad diversity of governance structures and regulatory institutions amongst countries raises additional challenges. It is generally thought that by making the reduction targets more modest, participation will be much more attractive to a much larger set of jurisdictions.

The direct applicability of such arguments to California's situation depends upon the industry that is the subject of regulation. Transportation services are by definition local, and cannot be exported to other regions, short of an exodus of the people doing the traveling. Industries that produce goods that are costly to transport, such as cement, are also less likely to migrate. The electricity industry, however, represents the opposite extreme.

At first glance, one might expect that the electricity industry may not be much of a migration risk either. Power plants are not easy to move, are quite costly, and experience useful lifetimes over 50 years. However, California has always been a large importer of electricity, and the electricity it does import tends to be among the most carbon intensive. Thus California's regulations do not need to lead to an exodus of power plants in order to be undermined - such an exodus has already occurred. Instead these regulations may simply lead to a re-arrangement of which plants sell power to Californians and which ones sell power elsewhere.

In this paper we focus on 3 overlapping policies that directly impact the electricity sector in California, assembly bill 32 (AB 32) and senate bill 1368 (SB 1368), which limit greenhouse gas emissions, and California's renewable portfolio standard (RPS), articulated in senate bill 1078. The important difference between these policies is that the RPS cannot be achieved with imports from pre-existing sources of renewable power from outside of California, since there was such little pre-existing capacity, while it appears that the goals of AB 32 and SB 1368 can be. In other words, the goals of the RPS are binding even if sources are expanded to the entire western U.S., while the GHG policies are not.

One unfortunate implication of this is that the RPS may be one of the less efficient means of achieving GHG emissions reductions. Unlike a more flexible carbon cap, it does not reward generation from non-renewable sources of low carbon power, and rewards energy conservation only very weakly. Yet the RPS, and other initiatives that are even more narrowly targeted, are likely to be the main drivers amongst these policies at least in the near term.

3.0 Implications for California

Our examination of California's position in the western electricity market indicates that there are significant limits to the state's ability to unilaterally impact carbon emissions from the electricity sector. Two of the main policy tools under consideration are source-specific regulations of plant emissions and a cap-and-trade system for trading carbon emission credits. Our analysis indicates that either option could lead to an outcome of "exporting" California's emissions, at least on paper. The net impact of carbon emissions from electricity generation sources would be minimal. If California were truly going it alone in its quest to limit GHG emissions, it appears that more direct regulatory interventions, such as directly funding power plants with low carbon emissions, will be necessary to have an impact on overall emissions.

The outlook for a cap-and-trade system brightens somewhat if it is extended in scope to include Washington, Oregon, Arizona, and New Mexico. Even a producer-based standard applied to these five states would require the closure of major coal-producing facilities for compliance. For the overall impact to be significant, however, these plants need to be replaced by something cleaner, instead of just by a coal plant located outside of the five states. A load-based standard would likely have more impact, but even with a cap-and-trade system encompassing these five states, the biggest driver for change remains the renewable portfolio standards.

These results highlight an important question. What is California actually trying to achieve with its GHG emissions policies? Are California's goals truly limited to forcing down the carbon footprint from activities within the state, as the various legislative initiatives articulate? If so, one must keep in mind that the net carbon equivalent reductions from California's policies, even if it achieves all its goals without circumvention would amount to less than 200 MMTCE economy-wide, while China's emissions are forecasted to rise by several thousand MMTCE by 2015.22

Given this sobering fact, it becomes clear that these initiatives are pointless unless they help to induce change beyond California. The question therefore becomes, what attributes would make California's policies most likely to have an impact beyond the state's borders? There are at least two potential answers to this question. First, California's actions may influence the adoption of GHG regulations elsewhere, and second, California's policies may influence the specific technologies used to reduce GHG emissions elsewhere.

There is already quite a bit of momentum for GHG regulations outside of California. There is a reasonable argument to make that the specific policies adopted by California do not matter that much in terms of influencing other jurisdictions, simply the fact that California is trying to do something on this issue could help spur other jurisdictions to action. Under this form of the "leading by example" argument, the specifics of the
example may not matter much.

Still, it is worth considering that the goal of reaching 1990 emissions levels by 2020, at least in the five western states might be achievable through relatively conventional means

- widespread substitution of natural gas for coal production along with continued expansion of wind and other renewable sources. Unfortunately, these means are likely insufficient to meet the more ambitious targets necessary to achieve stability in global concentration of CO2. Nor is it likely that deploying further financial resources to these conventional technologies would lead to the kind of "game-changing" innovations that may be necessary for dramatic reductions below 1990 levels. It is very possible that most of the great efficiencies to be had from wind and natural gas production have already been captured.

In light of this argument, truly expanding the impact of California's policies to a global level may require innovation in transformational technologies. Developing countries may only be persuaded to adopt clean technologies if they are demonstrated to actually be less expensive than conventional ones. This argues for focusing a GHG policy more on high-risk, high-return technologies that could truly transform the global energy picture.

While the renewable portfolio standards encourage investment in new, low carbon technologies, they are input-based standards and provide no incentives for investment in other potentially important low carbon electricity generation technologies, such as geological carbon sequestration. This highlights the conventional problem with targeted subsidies-by picking technologies, policymakers may be overlooking other technologies that could be more attractive.

Returning to the question of influencing policy within the United States, it is important to remember that, while a cap-and-trade program on a local level (where "local" could even be as large as the west coast) may be ineffectual, it is a much more appealing tool when applied on a national level. One could think of California's current policy efforts as an attempt to design a regulatory policy and infrastructure that could be readily scalable to the national level. Viewed from this perspective, the question of whether GHG policies have an immediate impact on Californian's behavior is not of central importance. After all, even if we hit California's own targets, this amounts to a relatively small drop in the global carbon bucket. What is important is developing a policy that is sensible if applied to the nation and beyond.

 

Web link: http://www.ucei.berkeley.edu/PDF/csemwp166.pdf

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