Regulating Carbon Intensity
Market-Driven Compliance in a Nutshell
(Note — March 16, 2022. This article is under revision to change the performance standard from tonnes allowed per $million of sales to tonnes allowed per $million of value added. The change will eliminate double allocating emissions along a value chain. For example, the value of a good at the end of a value chain includes the sales values of all upstream inputs. Allocating allowable emissions based on total sales at each stage as originally proposed will grant the same emissions to both the upstream and downstream producers since the same value is reflected in both upstream and downstream sales figures. Additional research on value added data is underway to present value added rather than total sales examples. There is no projected completion date at this time. The conceptual basis of Market Driven Compliance, however, is unchanged, and this article provides an adequate basis for understanding the concept and its intellectual foundation.)
This article is a summary introduction to my four other articles on carbon policy. Links to further reading in those articles will be found at the end of this piece.
Carbon conversation currently exists in a carbon pricing echo chamber. Discussion is limited to a tax or auctioned cap and trade. Pricing carbon, however, has it exactly backwards, imputing value to the wrong thing, emissions. By paying a tax or bidding at an auction, polluters can buy indulgences authorizing harmful behavior. Collected when there is no abatement, a carbon tax or auction fee does little more than manipulate consumers whose responsibility for pollution is, at most, tangential.
What’s needed is a policy valuing emission reductions — one rewarding abatement rather than only punishing emissions. Also, if we want to minimize carbon intensity in our economy, carbon intensity can and should be regulated directly. EPA’s averaging, banking and trading (“ABT”) approach, in use for transportation fuels (see these Code of Federal Regulations Subparts: 40 CFR Part 80, Subparts H, I, L and O), uses a true market to address both positive reward for abatement and direct regulation of carbon intensity . ABT can regulate carbon with a universal performance standard apportioning a cap equitably based on a polluter’s importance to the economy. With a universal standard, credits for better-than-standard performance can be traded between all regulated sectors. All of this might be possible under Clean Air Act §111 without new legislation. Nothing in §111 prohibits using one performance standard for all categories.
This piece describes the mechanics and structure of Market-Driven Compliance (“MDC”) to generate curiosity about how to make it happen. The reader is asked to suppress any impulse to reject MDC simply because it does not resonate in the carbon pricing echo chamber. Links to further reading on MDC mechanics and structure, on the flaws of carbon pricing, and on the intellectual reason for a property-based carbon policy are provided at the end of this paper. Here are the how, who, what, where, and when of MDC. “Why” is described in one of the links at the end of this paper.
How
MDC is an emission reduction trading scheme modeled after EPA’s ABT programs using an intensity-based performance standard. MDC does not allow the government to distribute emission allotments by auction or otherwise. Rather, the government’s role is limited to three basic functions.
First, the government sets a universal performance standard for sources and a national cap for emissions. If the average polluter meets the standard, the national cap will be met. Second, the government enforces the standard and ensures necessary information meets quality standards. Third, the government moderates a market where tonnes not emitted or TNE credits created by over compliance are traded and, also, maintains a registry of banked TNE balances. The government does not allocate emissions to individual sources. The economy does that.
The performance standard limits annual emissions to a specified number of tonnes for every million dollars of receipts, i.e., sales. There will not be one standard for electricity generators, another for steel mills, and yet another for cement plants. If the economy purchases more steel than gasoline, steel mills will be granted more of the cap than refineries. The sum of emissions from all sources must honor the cap. TNE trading allows the least expensive means of abatement to be shared across the entire economy while still defending the cap.
The devil of any public policy is always in the details, but the fundamentals of MDC are easily understood. In EPA’s Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990–2018, the chart opening this article tracks U.S. GHG intensity relative to 1990 in terms of emissions per capita and emissions per dollar of GDP.
If tonnes per GDP dollar can measure GHG performance for an entire economy, a similarly broad performance standard can regulate individual sources in that economy. The table below shows 2017 GHG emissions for an assortment of industries, their 2017 receipts, their implied intensities and efficiencies, and composite data for the group. A full-blown program would cover many more sectors, but this sampling illustrates the concept.
The average emission intensity for these twelve sectors is 3,100 MT per million dollars of receipts. To reduce emissions by 10 percent, the performance standard would be 90 percent of 3,100 or 2,790 MT/$ million. In this example, Pulp and Paper Manufacturing sources would be allowed emissions of 520 MMT based on multiplying the performance standard times annual receipts (2,790 x 186,245).
Since the sector emits only 25 MMT, pulp and paper sources could bank or sell 495 MMT of TNE. Even if all available TNE were sold, however, total emissions would still be 416 MMT short of a 10% reduction.
Those 416 MMT would be supplied from actual reductions or verified GHG sinks. All that matters is that net combined annual emissions do not exceed the cap. What we do know is emission reductions will be accomplished at the lowest possible overall cost to both polluters and consumers.
TNE should not expire unlike Renewable Fuel Standard RINs or gasoline benzene and sulfur credits. Limiting their lifespan guarantees TNE will be used, something not to be encouraged. As TNE age, however, their value will increase, and the probability of their use will decrease with time.
Leakage and border adjustments must be addressed. MDC will apply the performance standard to import receipts. Compliance will be determined from emissions at the point of manufacture. All obligated parties, domestic and foreign, may opt to report emissions using an MT/$million “allowable” emission rate. The optional allowable would be a high percentile intensity as reported by the relevant sector.
Exports. To put them on an equal footing in international trade, existing exporters will develop a pre-MDC baseline intensity. The government will issue to these exporters TNE in the amount of their export receipts multiplied by the difference between their baseline intensity and the greater of the performance standard or their compliance reporting intensity. New sources could receive an imputed baseline indexed to baselines approved for the same industrial sector.
Exporters paying indirect compliance costs through higher utility and other bills present a problem. I do not have a suggestion to preserve their international competitive position. Unlike a carbon tax rebate, however, which compensates only for taxes paid and not for abatement costs, MDC’s approach does address exporters’ direct abatement costs.
Who
The policy should start by regulating emission sources currently subject to EPA’s Greenhouse Gas Reporting Program (“GHGRP”) contained in the Code of Federal Regulations. GHGRP may need to be expanded to cover agriculture and activities removing carbon from the atmosphere.
What
All GHG emissions now covered by GHGRP will be regulated.
Where
The policy will apply to all regulated goods or products sold in the U.S.
When
ASAP. As obvious as this is, “as soon as possible” or “as soon as practical” depends on one’s definition of possibility and practicality. Using Section 111 of the Clean Air Act will be the quickest route. Unlike the Clean Power Plan, MDC does not require states to order load shifting between facilities. Rather, MDC applies directly to “inside the fence” emissions with the option to acquire offsetting offsite reductions. If EPA believes CPP is legal, then, too, is MDC.
The legal basis for the TNE trading scheme may be questioned. However, CPP and the ABT transportation fuel programs include trading provisions. Perhaps, that legal foundation will work for MDC.
Conclusion. The government may set the MDC cap, but only the economy apportions that cap among individual sources. MDC’s TNE market incentive allows high abatement cost sources to benefit from others’ low abatement costs. Domestic production is protected from less regulated imports, and exports are defended in international trade.
The first article linked below touches on MDC’s historical and philosophical basis, on implied subsidies and economic rents, on costs compared to a carbon tax, on equalizing the carbon footprint of consumer spending, on the concept and historical role of property in allocating resources and, perhaps, a few other things.
Whither Carbon Policy? — The Case for a Conservative Approach
A Tax-Free Carbon Policy — All-Sector, No-Auction Market for Reducing Carbon
Seven Reasons Taxing Carbon Won’t Fly (and shouldn’t) — Actually, upon reflection, 6½.
