Mitigating Greenhouse Gas Emissions in the Northeast and Mid-Atlantic Transportation Sector: A Cap-and-Invest Approach

II.      The Cap-and-Invest Model

Cap-and-trade programs generally operate as follows.[13] The government sets an overall emissions target¾the cap¾and determines which facilities will be covered. Emission allowances, each generally equal to one ton of emissions, are periodically auctioned or distributed without cost—or both— to covered facilities.[14] The total number of allowances is equivalent to the cap number, which decreases over time.[15] A market is created in which covered facilities may purchase or sell allowances from other covered facilities. Covered facilities are required to hold enough allowances to cover their emissions at the end of a compliance period, which may range from one to three years.[16] If a facility lacks sufficient allowances, it will be assessed a monetary penalty in addition to having to purchase enough allowances to cover the shortfall.

This market-based approach provides covered facilities three options: (1) they may reduce their emissions to meet the number of allowances they purchase or receive; (2) they may purchase additional allowances on the market and emit more; or (3) they may reduce their emissions below the allowances they hold and sell the remainder on the market.[17] The advantage of cap-and-trade programs is that facilities that can reduce their emissions more cost-effectively will do so, while those that face higher emissions reduction costs will purchase additional allowances at auction or on the market.[18] Accordingly, cap-and-trade schemes provide firms with flexibility to design cost-effective, tailored emissions plans, and the regulator achieves its policy objective by means of the overall emissions cap.[19] “Cap-and-invest” refers to cap-and-trade programs that invest their proceeds into other policy initiatives intended to address the pollutant or its effects.

a.      RGGI

RGGI is the first market-based regulatory program in the United States designed to reduce GHG emissions.[20] It 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 electricity generation sector.[21] RGGI is composed of individual CO₂ budget trading programs implemented in each participating state. Through independent regulations, each state’s CO₂ budget trading program limits emissions of CO₂ from electric power plants with the capacity to generate 25 megawatts or more (some 164 facilities), issues CO₂ allowances, and establishes participation in regional CO₂ allowance auctions.[22]

RGGI began with discussions among the governors of seven New England and mid-Atlantic states, which led to a 2005 Memorandum of Understanding that outlined the program.[23] In 2008, the RGGI states issued a Model Rule that participating states could use as guidance to establish and implement their individual programs.[24] RGGI’s designers expected the initial program might be expanded in the future by covering other emission sources, sectors, GHGs, or states.[25] CO₂ emissions from covered facilities in RGGI states account for approximately 20 percent of GHG emissions in the region.[26]

At the end of each three-year compliance period, covered facilities must surrender one allowance for each ton of CO₂ emissions generated during the period.[27] Covered facilities are permitted to bank an unlimited number of emission allowances for future use.[28] Over 90 percent of allowances are distributed through periodic auctions, and a reserve price sets a price floor for allowances.[29] RGGI employs a “cost containment reserve” that allows for additional allowances to be auctioned if certain price thresholds are met.[30] In limited circumstances, covered facilities may also submit offsets, which are measurable reductions, avoidances, or sequestrations of emissions from non-covered sources, in lieu of emission allowances.[31] The RGGI states agreed that each would use at least 25 percent of its individual auction proceeds “for a consumer benefit or strategic energy purpose.”[32]

Whether or not RGGI has been successful is the subject of debate. As designed, it applies only to CO₂ and only to emissions from some 164 power plants with the capacity to generate twenty-five megawatts or more.[33] Since CO₂ accounts for only 20 percent of total GHG emissions in the RGGI states, and electricity generation accounts a fraction of total CO₂ emissions, RGGI’s potential is limited.[34] The Congressional Research Service has thus described the initiative’s contribution to global GHG reductions to be “arguably negligible.”[35] In addition, RGGI significantly overestimated emissions from member states for its first compliance period and set an initial emissions cap that was actually above realized emissions levels.[36] This limited participation in the program and allowed participating facilities to bank substantial amounts of unused allowances.  After the 2012 program review, RGGI lowered the cap by 45 percent between 2014 and 2020.[37] And after the most recent review in 2016, RGGI lowered the cap by an additional 30 percent between 2020 and 2030.[38]  The extent to which these adjustments will hasten CO₂ emissions reductions remains to be seen.

RGGI member states invest the proceeds from allowance auctions in a variety of consumer benefit programs at scale.[39] In October 2017, RGGI, Inc. (the corporate entity that administers RGGI) released a report that tracks the investment of RGGI auction proceeds in 2015 and the benefits of these investments throughout the region.[40] The report estimates that “[t]he lifetime effects of these investments are projected to save 28 million MMBtu of fossil fuel energy and 9 million MWh of electricity, avoiding the release of 5.3 million short tons [4.8 million metric tons] of carbon pollution.”[41] The report also notes that “RGGI investments in 2015 are estimated to return $2.31 billion in lifetime energy bill savings to more than 161,000 households and 6,000 businesses which participated in programs funded by RGGI investments, and to 1.5 million households and over 37,000 businesses which received direct bill assistance.”[42] RGGI states have discretion as to how they invest RGGI proceeds.

The report breaks down these investments into four categories.  Energy efficiency makes up 64 percent of investments. Funded programs are expected to return $1.3 billion in lifetime energy bill savings to over 141,000 participating households and 5,700 regional businesses.[43] Clean and renewable energy makes up 16 percent of investments, and investments in these technologies are expected to return $785.8 million in lifetime energy bill savings to 19,600 participating households and 122 regional businesses.[44] Greenhouse gas abatement makes up 4 percent of investments and are expected to avoid the release of 636,000 short tons of CO₂.[45] Finally, direct bill assistance makes up 10 percent of investments accounting for $40.4 million in bill credits and assistance to consumers.[46] One independent report notes that, while RGGI states each have their own unique auction revenue investment programs, “[o]verall, greater than 60 percent of proceeds are invested to improve end-use energy efficiency and to accelerate the deployment of renewable energy technologies,”[47] which far exceeds the 25 percent investment “for a consumer benefit or strategic energy purpose” required by the Model Rule.

b.      California’s Cap-and-Invest Program

In 2006, California enacted its landmark climate change law, the Global Warming Solutions Act, also known as AB (“assembly bill”) 32.[48] The statute established an aggressive goal of reducing GHG emissions to 1990 levels by 2020, and an 80 percent reduction from 1990 levels by 2050, across multiple sectors of the state’s economy.[49] AB 32 directed the California Air Resources Board (CARB), the state’s air pollution regulator, to implement a cap-and-trade program, which went into effect in 2013.[50]

According to CARB, the program, which covers approximately 450 entities, “sets a statewide limit on sources responsible for 85 percent of California’s greenhouse gas emissions, and establishes a price signal needed to drive long-term investment in cleaner fuels and more efficient use of energy.”[51] It is “designed to provide covered entities the flexibility to seek out and implement the lowest-cost options to reduce emissions.”[52] The 2013 cap was set at about 2 percent below the emissions level forecast for 2012, declines an additional 2 percent in 2014, and declines 3 percent annually from 2015 to 2020.[53]

Unlike RGGI, California’s program distributes free allocations of emission allowances earlier in the program, but those allocations decrease over time as the program transitions to an auction process.[54] The allocation for most industrial sectors is set at approximately 90 percent of average emissions and is updated annually based on each facility’s production.[55] Electrical distribution and natural gas facilities receive free allowances on the condition that the value of allowances must be used to benefit ratepayers and achieve GHG emission reductions.[56] The allocation for electrical distribution utilities is set at about 90 percent of average emissions, and for natural gas utilities, is based on natural gas supplied in 2011 to non-covered entities.[57] The program includes cost containment measures and allows for the banking of allowances, has a three-year compliance period with an annual obligation to surrender 30 percent of their previous year’s emissions, and allows for offsets of up to 8 percent of a facility’s compliance obligation.[58] AB 32 also employs a substantial penalty mechanism for facilities that fail to meet their compliance obligations: “If the compliance deadline is missed or there is a shortfall, four allowances must be provided for every ton of emissions that was not covered in time.”[59]

California’s cap-and-trade program became linked with Québec’s cap-and-trade system on January 1, 2014 and became linked with Ontario’s cap-and-trade program on January 1, 2018.[60] All allowances issued by the California, Québec, and Ontario programs before and after the linkage can be used for compliance interchangeably across jurisdictions.[61] The three jurisdictions also hold joint allowance auctions.

On January 1, 2015, suppliers of transportation fuels, including gasoline and diesel fuel, became covered under the program.[62] A fuel supplier is defined as “a supplier of petroleum products, a supplier of biomass-derived transportation fuels, a supplier of natural gas including operators of interstate and intrastate pipelines, a supplier of liquefied natural gas, or a supplier of liquefied petroleum gas.”[63] All fuel suppliers that deliver or import 10,000 metric tons or more of annual CO₂ equivalent emissions are subject to a reporting requirement, but only suppliers that reach a 25,000 metric ton threshold are covered by the cap-and-trade program.[64]

Proceeds from the allowance auctions are deposited in the state’s Greenhouse Gas Reduction Fund and are appropriated by the state legislature for “investing in projects that reduce carbon pollution in California, including investments to benefit disadvantaged communities, recycling, and sustainable transit.”[65] As of 2017, some $3.4 billion had been appropriated to state agencies implementing GHG emission reduction programs and projects, collectively referred to as the California Climate Investments.[66] Of that amount, $1.2 billion has been expended on projects “expected to reduce GHG emissions by over 15 million metric tons of carbon dioxide equivalent.”[67]

III.     Applying a Cap-and-Invest Approach to Northeast and Mid-Atlantic Transportation Sector

Under business-as-usual trends, carbon emissions in RGGI states will be 23 percent below the 1990 baseline in 2030.[68] These states must achieve much deeper emissions reductions across multiple economic sectors in order to achieve their “greenhouse gas emission reduction targets for 2030 that range from 35 to 45 percent, centered around a 40 percent reduction from 1990 levels.”[69] Since transportation represents the largest share of GHG emissions in the RGGI states, that sector should be a primary focus of policymakers’ attention.

One study finds that the levels of emissions reductions necessary to meet the GHG reduction goals of the states in the region could be accomplished “through a suite of clean transportation policies” including financial incentives for the purchase of clean vehicles, such as electric and hybrid light-duty vehicles and natural gas powered heavy-duty vehicles; investments in public transit expansion including bus rapid transit, light rail, and heavy rail; promotion of compact land use; investment in bicycle infrastructure; support for travel demand management strategies; investment in system operations efficiency technologies; and investment in infrastructure to support rail and short-sea freight shipping.[70]

One potential mechanism for achieving the levels of reductions necessary for the RGGI states to meet their targets “would be to implement a transportation pricing policy, which could both achieve GHG reductions and generate proceeds that could be used to fund clean and resilient transportation solutions.”[71] For example, “carbon-content-based fees, mileage-based user fees, and motor-fuel taxes” could “generate an average of $1.5 billion to $6 billion annually in the region.”[72] A mid-range pricing policy that generated approximately $3 billion annually “would create a price signal that would promote alternatives to single-occupancy vehicle travel and result in modest additional emission reductions. It would also raise a cumulative $41 billion to $46 billion for the region during 2015-2030.”[73] Proceeds from such a pricing policy would offset projected declines from existing state and federal gasoline taxes and could be used to fund other clean transportation initiatives.[74]

A hypothetical regional cap-and-invest program for vehicle emissions might be structured as follows. Member states would establish a mandatory regional cap on GHG emissions from the combustion of fossil transportation fuels calculated using volumetric fuel data and fuel emission factors available from the Environmental Protection Agency.[75] The cap would decline over time. States would auction allowances equal to the cap and establish an entity like RGGI, Inc. to administer the program, auction platform, and allowance market.[76] Regulated entities would achieve compliance by purchasing allowances at auction or from other market participants, and possibly with offsets earned from reductions in other aspects of their operations.[77] As with RGGI, individual member states would commit to invest a percentage of their auction proceeds into other initiatives aimed at reducing GHG emissions, including from transportation, and could retain the discretion to decide individually how to allocate those funds.[78]

Because power plants are stationary and relatively few in number, their GHG emissions can be regulated directly, i.e., at the stack. Vehicles, however, are mobile and far more numerous. To regulate the emissions from every fossil fuel powered vehicle directly, i.e., at the tailpipe, would entail a substantial and possibly prohibitive administrative burden, and would likely be politically unpalatable. The logical approach is to regulate transportation emissions indirectly by focusing on transportation fuel. Determining which types of fuels and which entities in the fuel supply chain to cover under the cap-and-invest program will be critical.

Transportation fuels that could be covered include, among others, gasoline, on-road and off-road diesels, aviation fuels, natural gas, propane/butane, and marine fuels.[79] Considering both the volume of each type of fuel consumed and the comparative emissions resulting from its consumption, the program should cover, at a minimum, gasoline and on-road diesel, which account for approximately 85 percent of carbon emissions from transportation in the region.[80] Other fuels may make up too small a portion of total emissions to justify the additional technical and regulatory burden of covering them.[81] In addition, because all states in the region currently require reporting on gasoline and on-road diesel, the most straightforward approach would be to regulate those fuels. Covering other fuels would require at least some states that do not already require reporting of these fuels to establish new reporting requirements.[82]

Another key design choice is the point of regulation. The question here is which entities within the transportation fuel supply chain should be subject to the regulatory obligation to hold sufficient allowances. Because all states in the region have existing reporting and enforcement mechanisms for gasoline and on-road diesel (and many also tax off-road diesel and aviation fuel), one option would be to regulate existing state points of taxation for these fuels.[83] However, state points of taxation are not uniform throughout the region. They can include many different types of entities in the supply chain and in some states the point of taxation is different for different fuels.[84] State regulations also differ with respect to what actions by covered entities trigger the reporting requirement.[85] Many states have points of regulation low in the supply chain, such as entities that purchase fuel from the terminal rack and distribute it to retailers.[86] Thus, while using existing state points of taxation to regulate transportation fuels would make use of existing state regulatory mechanisms, it would also require regulating over one thousand entities across the region, many of which are smaller distributors.[87]

Another possible point of regulation would be one that is as far upstream as possible, i.e., entities that refine fuel in the region for use in the region, and those that import fuel into the region for use in the region.[88] This would include refineries, and for fuels refined outside the region, the first importers into the region.[89] Eight refineries in the region and an unknown number of first importers, including foreign suppliers and suppliers from U.S. states outside the region, would be subject to regulation.[90] This option would require reporting of the destination of all fuel produced in or that enters the region to ensure that a fuel to be used outside the region is not inadvertently covered.[91] While the Energy Information Administration (EIA) and the Environmental Protection Agency generally require destination data from refiners and importers into the U.S. and from interstate suppliers, the agencies do not publicly disclose this data.[92] Thus, regulating refiners and importers would likely cover many fewer entities as compared to existing state points of taxation, most of which would be large petroleum companies.[93] However, because only three states in the region have refineries within their borders, and because importers are not systematically tracked throughout the region, accounting for fuels that are transported through states to prevent double-counting would likely require the establishment of new regional reporting requirements that would include points of origin and destination.[94]

A third possible point of regulation would be entities known as prime suppliers, defined by the EIA as “suppliers who produce, import, or transport product across state boundaries and local marketing areas and sell to local distributors, local retailers, or end-users.”[95] For the region, this includes approximately 30 refiners, other producers of finished fuel, interstate resellers and retailers, and importers.[96] EIA requires these entities to report the amount of fuel, including gasoline, diesel, and aviation fuel, sold or transferred for end use by state on a monthly basis.[97] Although EIA does not publicly provide disaggregated prime supplier data because of statutory privacy restrictions, organizations may enter into data-sharing arrangements with EIA to obtain individual prime supplier data.[98] Thus, while the prime supplier group would include a larger number of regulated entities than importers and refiners, it would provide a consistent definition of a point of regulation already understood by the regulated entities.[99] Regulating prime suppliers, most of which are higher in the supply chain than existing state points of taxation, would also relieve most smaller entities of compliance obligations.[100]

IV.    Conclusion

States in states in New England and the mid-Atlantic region must make much deeper emissions reductions in the transportation sector in order to meet their overall GHG emission reduction targets. Recognizing this reality, representatives from Connecticut, Delaware, Maryland, Massachusetts, New York, Rhode Island, Vermont, and Washington, D.C., at the 2017 Conference of the Parties to the United Nations Framework Convention on Climate Change, signed a joint statement affirming their commitment to reducing GHG emissions from the transportation sector. In that statement, they identified “market-based carbon mitigation strategies” as potential pathways to achieving needed emissions reductions.[101]

Despite its early struggles, the cap-and-invest approach to mitigating emissions in the northeast and mid-Atlantic electricity generation sector has achieved, at a minimum, some emissions reductions, substantial investment in other GHG mitigation efforts, and overall net benefits within the region. California has achieved substantial GHG emissions reductions across multiple sectors, including transportation, and has invested substantial sums in a suite of other green programs. These examples demonstrate the potential of using a cap-and-invest approach to accomplish environmentally and economically sound policy objectives, both within the RGGI region and in the context of transportation. If properly structured, such an approach could achieve significant emissions reductions in the region and raise substantial funds for other GHG mitigation and climate change adaptation initiatives.

How would a cap-and-invest approach to transportation emissions be structured? The fundamental aspects of RGGI and California’s cap-and-invest program are similar in most respects. California occupies a unique position in federal regulation of automobile emissions and had the benefit of constructing a program applicable only to itself, although its program is now linked with programs in other jurisdictions. RGGI already covers much of the Northeast and mid-Atlantic region, could be expanded to include other sectors of those states’ economies, including transportation, and could be linked with the California-Québec-Ontario cap-and-invest system to create a larger and more efficient allowance market.

Owing to the practical differences between directly regulating emissions from power plants and indirectly regulating transportation emissions by fuel type and supply chain point, the mechanics of using a cap-and-invest approach to mitigate transportation emissions, especially across jurisdictions, poses some potentially challenging design issues. The program should cover, at a minimum, gasoline and on-road diesel. Identifying the appropriate point of regulation will require policymakers to consider a host of technical, administrative, and policy issues. Existing state points of taxation are numerous and vary by jurisdiction and by fuel type within jurisdictions. Upstream refiners and importers are far fewer in number but regulating these entities would likely require the development of new regional reporting mechanisms that might make this option administratively undesirable. While the prime suppliers group is larger in number than refiners and importers, regulating prime suppliers would provide a consistent state-based definition of a point of regulation already understood by the regulated entities, and would not subject most smaller entities to compliance obligations.

Copyright 2018 James D. Flynn. All rights reserved.