Carbon trading in the Northeast: The Regional Greenhouse Gas Initiative

The Regional Greenhouse Gas Initiative  (RGGI, pronounced “Reggie” for short) holds its next auction on March 11th.  I’m going to devote this post (and possibly the next one) to what RGGI is, the economic theory behind it,  and what it means for the state of Maine. (A little caveat is in order here: like all my blog posts,  this one is meant to educate and entertain,  but it is not meant as a rigorous economic analysis. I do this in my free time,  after all.  ☺)

RGGI is a multi-state carbon-trading exchange. Pollution trading markets have been in existence for decades, most notably (at least here in the US) the sulfur dioxide market that was established in 1995 and existed in its original form until 2011, when it morphed into a few different programs. But that’s another blog post for another day.

Carbon dioxide trading programs (or greenhouse gas trading programs more generally) have been around since 2005, when the first phase of the European Union’s Emissions Trading System was created under the Kyoto Protocol.

The general idea is that some central authority sets a “cap” on the amount of pollutants (usually measured in tons) that an entity such as a state or a country can emit in a given year. Then, the units that are subject to the cap (usually a subset of firms or companies that emit carbon dioxide) look at the going price per ton of emissions, compare that to the cost of abating a ton of emissions, and then decide whether to engage in abatement or to buy “permits,” each allowing them to emit one unit of emissions.  Theoretically, at least, if the price of a ton of carbon is set high enough, more firms will engage in pollution reduction.

As you can imagine,  the questions surrounding the development of a new market like this are complex,  fascinating to me and other economists, and mind numbing to the general public. I’ll spare you the details.  Fortunately,  RGGI is well-established,  so for our purposes they don’t matter anyway.

According to its website, RGGI is “a cooperative effort among the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont to cap and reduce CO2 emissions from the power sector.” (http://www.rggi.org/)  Although there are plenty of other entities that emit CO2 (most notably transportation, production of metal and mineral products such as steel, iron, and cement, and the manufacture  of chemicals), the power generating industry is the largest single source of CO2 emissions in the US at 38%. (Transportation is not far behind, though, at 32%.)

In this case,  RGGI sets a “cap” on emissions for the entire multi-state area.  Regulated companies (power utilities with a generating capacity over 25 megawatts) are required to keep permits equal to their emissions. Permits are auctioned off on a quarterly basis, and the proceeds go to programs to increase energy efficiency and “accelerate the deployment of renewable energy technologies.” 

They also allow “offsets,” which is an interesting story in itself.  Offsets allow firms to invest in greenhouse gas reduction activities in order to get a “credit”. Once they apply that credit,  they may not need to buy as many emission permits as they would have.   There’s a lot of controversy about whether credits are actually effective or not,  but I’ll go into that in a later blog post.

So,  is RGGI effective? Turns out that’s a really difficult question to answer. “Effective” could mean, “does RGGI cost less than reducing the same amount of emissions with traditional regulation (command and control) would?” Or, “has it reduced emissions more than in the absence of regulations?”  There are many different ways of asking – and answering – that question.

Let’s start with the cost. There’s no easy way to compare the cost of the program with the cost of traditional “command and control” regulations. (Many people might say that the program is very expensive – which it is – but the relevant question is not how much the program costs, but how much it costs relative to the alternative.)  The problem with traditional regulation, as many economists see it,  is that command and control regulations aren’t flexible. They say something like,  “Thou shalt not emit more than X tons per day,” never mind how expensive it may be for the firm to comply.  Theoretically,  this sort of permit system should be cheaper,  but there’s really no easy way to know.  And, the media is touting the fact that RGGI states managed to reduce greenhouse gasses 20% faster than non-RGGI states, while still increasing their economies.  (Again,  the true test is: how fast would those economies have grown under an alternative regulatory scheme?  But those counter-factuals are difficult to prove.)

What about emissions reduction? Well, under the  EPA’s recently proposed carbon dioxide guidelines, the nine states that make up RGGI would only have to reduce their emissions collectively by 38% by 2030 (from a 2005 baseline), whereas RGGI claims that the collaborative has already exceeded that goal. 

So,  if seems as if RGGI is a success,  at least,  insofar as its own stated goals. There are other criteria by which to measure success as well: equity (meaning,  who bears the costs and who rapid the benefits,  and are they distributed equally), actual effectiveness (as measured by “is it enough to do what needs to be done?”), and perhaps whether it is successful at providing incentives to change behavior as well.

My next blog post will focus on these issues,  at least,  as much as I can.  Stay tuned!