Roger Caiazza
One of my pragmatic interests is market-based pollution control programs. As part of New York’s budget process Governor Kathy Hochul announced a plan to use a market-based program to raise funds for Climate Leadership & Community Protection Act (Climate Act) implementation. It has been touted as a solution for funding and compliance requirements because other market-based programs have been successful. Even though it has drawn widespread support I think the faith in the mechanism is mis-placed because the numbers do not add up.
Climate Act Background
The Climate Act established a New York “Net Zero” target (85% reduction and 15% offset of emissions) by 2050. The Climate Action Council is responsible for preparing the Scoping Plan that outlines how to “achieve the State’s bold clean energy and climate agenda.” In brief, that plan is to electrify everything possible and power the electric gride with zero-emissions generating resources by 2040. The Integration Analysis prepared by the New York State Energy Research and Development Authority (NYSERDA) and its consultants quantifies the impact of the electrification strategies. That material was used to write a Draft Scoping Plan that was released for public comment at the end of 2021 and approved on December 19, 2022.
The Climate Action Council (Council) has identified the need for a comprehensive policy that supports the achievement of the requirements and goals of the Climate Act, including ensuring that the Climate Act’s emission limits are met . A well-designed policy would support clean technology market development and send a consistent market signal across all economic sectors that yields the necessary emission reductions as individuals and businesses make decisions that reduce their emissions. It would provide an additional source of funding, alongside federal programs, and other funding sources, to implement policies identified in this Scoping Plan, particularly policies that require State investment or State funding of incentive programs, including investments to benefit Disadvantaged Communities. Equity should be integrated into the design of any economywide strategy, prioritizing air quality improvement in Disadvantaged Communities and accounting for costs realized by low- and moderate income (LMI) New Yorkers. Pursuant to the Climate Act, a policy would be designed to mitigate emissions leakage. Finally, an economywide strategy would be implemented as a complement to, not as a replacement for, other strategies in the Scoping Plan. A well-designed economywide program will bring about change in the market and promote equity in a way that does not unduly burden New Yorkers or with the global economy.
Hochul’s address stated that “New York’s Cap-and-Invest Program will draw from the experience of similar, successful programs across the country and worldwide that have yielded sizable emissions reductions while catalyzing the clean energy economy.” Subsequently other legislators have jumped on the bandwagon and offered legislation to modify the Hochul proposal. My problem is that the perception that these programs have yielded sizable emission reductions while providing funds needed for the transition are misplaced.
Emissions Market Program Background
The concept of emission markets is relatively simple. EPA explains that:
Emissions trading programs have two key components: a limit (or cap) on pollution, and tradable allowances equal to the limit that authorize allowance holders to emit a specific quantity (e.g., one ton) of the pollutant. This limit ensures that the environmental goal is met and the tradable allowances provide flexibility for individual emissions sources to set their own compliance path. Because allowances can be bought and sold in an allowance market, these programs are often referred to as “market-based”.
This is a fine overview but the details are what is important for New York’s plan. I have been following these programs since 1993 because I was responsible for submitting compliance reports from that point until my retirement in 2010. New York State has embraced this approach and I was involved in the stakeholder process associated with multiple rule-makings. Finally I have been tracking the performance of the Regional Greenhouse Gas Initiative (RGGI). All of my findings are based on observations of the inner workings of these programs.
A recent book Making Climate Policy Work comes to many of the same conclusions and raises concerns similar to mine based on economic theory. The description of the book states:
For decades, the world’s governments have struggled to move from talk to action on climate. Many now hope that growing public concern will lead to greater policy ambition, but the most widely promoted strategy to address the climate crisis – the use of market-based programs – hasn’t been working and isn’t ready to scale.
Danny Cullenward and David Victor show how the politics of creating and maintaining market-based policies render them ineffective nearly everywhere they have been applied. Reforms can help around the margins, but markets’ problems are structural and won’t disappear with increasing demand for climate solutions. Facing that reality requires relying more heavily on smart regulation and industrial policy – government-led strategies – to catalyze the transformation that markets promise, but rarely deliver.
The authors recognize the enormity of the challenge to transform industry and energy use on the scale necessary for deep decarbonization. They write that the “requirements for profound industrial change are difficult to initiate, sustain, and run to completion.” Because this is hard, they call for “realism about solutions.” Cullenward and Victor recommend clear thinking and strategy as opposed to “Efforts spent tilting at ephemeral, magical policy solutions waste scarce resources that should instead be invested in things that work.” The goal of their book is to explain how market-oriented climate policies have fallen far short and how they might be modified so that they work. If you are interested in more information about emission markets I recommend this book.
General Market-Based Program Concerns
I submitted comments on the Draft Scoping Plan chapter on a market-based approach for the transition plan based on my observations of similar programs. The EPA Acid Rain Program was a cap-and-trade control program that enabled affected sources to meet their compliance options efficiently. Affected sources could purchase allowances from a facility that had more cost-efficient control options to meet the overall cap. EPA notes that the program “has helped deliver annual SO2 reductions of over 93% and annual NOX emissions reductions of over 87%” since the start of the program. The costs have been far lower than expected in no small part because the affected sources figured out how to use fuel switching to coal with lower sulfur content. The success of the Acid Rain program led to similar programs for NOx both nationally, regionally, and limited to just New York State.
Despite the fact that these programs provided significant emission reductions at a lower cost to the affected sources the environmental community felt it was somehow unfair that some facilities made money selling allowances that had been given to them for free. That ignores the fact that those facilities selling the allowances made investments to get lower emissions. The idea that the polluters had to be made to pay led to cap-and-invest programs where the allowances are mostly available through an auction. The Regional Greenhouse Gas Initiative (RGGI) is a good example of that approach.
On the face of it, RGGI appears to provide emission reductions while also raising revenues so that model appeals to legislators. However, my observations of RGGI indicate that the theory of this approach is not matched by reality. Even though the CO2 emissions in the RGGI states have gone down substantially that was mostly because the effected sources switched from coal and residual oil to natural gas with lower CO2 emissions. The investments made with the auction proceeds that were supposed to fund emission reductions were only responsible for ~15% of the observed reductions. The accumulated total of the annual reductions from RGGI investments is 3,658,696 tons through December 31, 2020. The sum of the RGGI investments is $2,991,215,917 over that time frame. The cost per ton reduced $818 exceeds the societal cost of carbon so they are not justified by those societal benefits. Emission reductions in the future are going to have to rely on investments of the RGGI auction proceeds but at those high cost per ton reduced rates the costs may be too high for public acceptance.
One major difference between controlling CO2 and other pollutants is that there are no cost-effective control technologies that can be added to existing sources to reduce emissions. Combine that with the fact that CO2 emissions are directly related to energy production, the result is that after fuel switching the primary way to reduce emissions is to reduce operations. Consequently, CO2 emission reductions require replacement energy production that can displace existing production. If existing generation is not displaced with zero-emissions resources then energy production must be capped.
New York Numbers
The first numbers consideration is the cap itself. EPA explains that “The cap is intended to protect public health and the environment and to sustain that protection into the future, regardless of growth in the sector.” For the Acid Rain Program the cap was originally intended to reduce emissions by 50% but later was tightened down. In the NOx cap and trade programs the caps were set based on a technological evaluation of the control technology available to affected sources. The industry – agency issues with those caps centered on whether the agency estimates for additional control levels were reasonable. Importantly, the SO2 and NOx caps were based on the feasibility of affected source characteristics and were not binding in and of themselves.
On the other hand the CO2 cap in RGGI and the New York cap-and-invest caps are not based on feasibility. I define a binding cap as one chosen arbitrarily without any feasibility evaluation. In 2030 New York GHG emissions must be 40% lower than the 1990 baseline but this is an arbitrary target mandated by the Climate Act. The state’s Scoping Plan for this transition did not include an analysis to see if this target was feasible so I think this will be risky.
The following graph lists NY GHG emissions by sector from 1990 to 2030. The data from 1990 to 2020 is from the New York 2022 GHG emission inventory. Electric sector emissions are available through 2022 and I used those with estimates based on recent averages to project emissions for the other sectors in 2021 and 2022. The emissions shown for 2023-2030 simply represent the straight-line interpolation between the 2022 emissions and the 2030 emission limits consistent with the state’s Climate Act mandate that 2030 emissions must be 40% less than the 1990 baseline emissions.
I estimate that meeting the 2030 emissions limit will require a 4.5% annual decrease from each sector from 2023 to 2030. That is an unprecedented reduction trajectory. Those percentages translate to annual reductions of 2.73 million metric tons of CO2e (MMT) for the electricity sector, 0.97 MMT for agriculture, 5.32 MMT for buildings, 1.59 MMT for industry, 4.89 MMT for transportation, and 1.88 MMT for the waste sector.
The Climate Act has exemptions for certain sectors. All components in the agriculture sector are not required to meet the 40% mandate and energy-intensive and trade exposed industries also get some sort of a pass. Even a cursory examination of the data in the graph suggests that the presumption that a binding cap will necessarily ensure compliance is magical thinking. The historical trend in electricity sector emission reductions appear similar to the trend necessary to meet the 2030 target but the historical trend was caused by fuel switching and there are no more reductions to be had in that regard. In order to reduce electricity sector emissions the energy output will have to be displaced with wind and solar. Waste sector emissions have been more or less constant since 1990. An entirely new technology has to be implemented in the next seven years to get a 4.5% per year reduction in emissions. Transportation can only reduce emissions if the transition to zero-emissions vehicles accelerates a lot. When I point out that there has been no feasibility analysis I am concerned because the Scoping Plan did not analyze whether the necessary technologies are likely to be available and deployed as needed and there was no consideration of what if questions. At the top of that list is “what if the technology rollout is delayed?”
It is beyond the scope of this analysis to consider potential control strategies for every sector. I did investigate one proposed strategy for the building sector transition that was included in Hochul’s proposal. Part VI-B:, Decarbonize New York’s Buildings states:
Building electrification and related upgrades improve interior comfort, reduce exposure to air pollution, and support local jobs. But right now, only about 20,000 New York homes install modern heat pumps for heating and cooling each year. While New York is making progress through programs like NYS Clean Heat, more must be done to cut emissions in our buildings.
To accelerate green buildings in New York, Governor Hochul is setting an unprecedented commitment of a minimum 1 million electrified homes and up to 1 million electrification-ready homes by 2030, and ensuring that more than 800,000 of these homes will be low- to moderate-income households. This target will be anchored by a robust legislative and policy agenda, including: raising the current rate of electrification of approximately 20,000 homes per year more than tenfold by the end of the decade.
I evaluated this component of the plan and the emissions reductions that could be expected for comparison to the annual 5.32 million metric ton of CO2e reduction required to meet the binding cap. Instead of using the confusing and poorly documented Scoping Plan estimates of residential energy use I used the New York State Energy Research & Development Authority Patterns and Trends document. Appendix B, Table B-1 lists the average household consumption by fuel type. I calculated the GHG emissions (CO2, CH4, and N2O) for direct emissions and New York’s required upstream emissions for each fuel type to get an estimate of residential electrification impacts on emissions.
I assumed that the two million homes initiative would convert 250,000 homes per year (two million divided by eight years). I apportioned the type of fuels used by the observed number of residences using each fuel type in the Scoping Plan. In other words, for this analysis, I maximized the potential emission reductions by eliminating the average fuel use in Table B-1 to zero. I found that these conversions would reduce GHG emissions by 1.3 million metric tons of CO2e per year. The Building sector has to reduce emissions 5.32 million metric tons of CO2e per year so the two million home initiative will only reduce emissions 25% of the amount needed when it gets cranked up from 20,000 homes to 250,000 homes per year.
I also took a shot at the costs. I assumed that the two million homes would be converted over to electricity for heating, cooking, hot water, and clothes dryers. I calculated the differential cost between replacement of existing fossil-fired technology with heat pumps and included $6,500 for upgrades to the electric service. Following the Scoping Plan recommendations, I also accounted for improved building shells. I estimate that the average cost to electrify a single residence is $42,777 all in. Multiplying that cost by 250,000 homes per year gives $10.7 billion per year in residential electrification costs for one quarter of the reductions needed. If the building shell is not upgraded the average price increase drops to $24,750 and the total annual cost drops to $6.2 billion per year. Even if you assume that my cost estimate is 25% high and the building shell is not included the costs are $4.6 billion per year.
Another thing to consider is the costs per ton for emission reductions in the buildings sector. In the best case, not including building shells and 25% below my estimates, the cost is $3,500 per ton reduced. That is on the order of 28 times higher than the New York value of carbon which is $126 per ton in 2023.
Discussion
One of the talking points of the Scoping Plan was that emissions from the Buildings Sector was the largest source of emissions in New York. However, the difficulty getting reductions from the sector was not discussed. There are two ramifications of that overlooked challenge.
In the first place the cap and invest binding cap has set an ambitious emissions reduction trajectory of 4.5% reductions per year to ensure compliance with the 2030 Climate Act mandated cap equivalent to a 40% GHG emission reduction from the 1990 baseline. That equates to 5.3 million metric tons per year. I estimate that electrifying 250,000 homes per year that are currently burning fossil fuels will only reduce emissions 1.3 million metric tons per year or one quarter of the amount needed.
Where are the rest of the building sector emission reductions going to come from? The lack of specificity in the Scoping Plan documentation precludes an easy response to that question. There is another aspect of this even if there is some sort of technology available for the remaining reductions required. The current NY rate of electrification is 20,000 homes per year and Hochul’s two million homes per year program will increase that by more than ten times someday. The trained labor and supporting infrastructure necessary is simply not available at this time. Providing training for staff takes time and money and companies have to invest more time and money in the infrastructure to do the work. It is impossible to go from 20,000 to 250,000 homes per year overnight.
The theory of a market-based carbon emissions reduction program is that the higher cost of the fossil fuels with the allowance adder will incentivize innovation to get the most cost efficient solution. Even if someone were to develop a magical solution that dropped the costs to electrify an order of magnitude, there just are not that many emissions from an individual residence available. As a result, the cost per ton reduced will still be well in excess of the New York Value of Carbon, $471 per ton reduced vs. $126 per ton in 2023. If the costs to make these reductions exceed the societal benefit of the reductions then the reductions are not cost-effective.
The second ramification is equally troubling. It is not clear at this time exactly how the program will be rolled out. The state will put allowances up for auction annually equal to the reduction trajectory amounts needed to meet the 2030 emission limits. I am guessing that the providers who supply fossil fuel to the building sectors will be responsible for building sector compliance. They will purchase allowances for each quantity of fuel purchased. If they purchase fuel and have insufficient allowances to cover that energy then they cannot sell the fuel.
I don’t think the advocates for a binding CO2 cap really understand that limiting the number of allowances also places a limit on fuel use. In theory scarcity will drive the prices up incentivizing innovation for lower carbon solutions but the ultimate compliance strategy is to simply not burn fossil fuels. If the emission reduction control strategies are developed slower than the arbitrary compliance trajectory then there will be an inevitable artificial shortage of fuel. If a power plant has insufficient allowances, it cannot run and provide energy when needed. When the fuel providers don’t have enough allowances, then they will have to limit how much fuel aka energy they can provide to homes and other users. Given that the trajectory is so ambitious and the options to make reductions appear to be so limited I don’t see any way this will not result in artificial fuel shortages.
Even if there are sufficient allowances the artificial scarcity will drive up prices. One of the great unknowns of the Hochul proposal is the revenue target. A feature of most cap and invest programs are limits to constrain the auction price. However, the market price has no such limits. The impacts of a binding cap on costs is another unknown with likely bad consequences.
Conclusion
New York policy makers have glommed on to Cap and Invest because they think it is a solution that will easily provide revenues and compliance certainty. Unfortunately, that presumption is based on poor understanding of market-based emissions programs. The reality is that successful programs used emissions reduction strategies that are not available in the quantity or quality necessary for New York. Presuming that past performance would be indicative of future reduction success and establishing an arbitrary emissions targe that is incompatible with realistic emission reduction trajectories is not going to end well because the numbers simply do not add up.
—————————————————————————————————————————————
Roger Caiazza blogs on New York energy and environmental issues at Pragmatic Environmentalist of New York. More details on the Climate Leadership & Community Protection Act are available here and an inventory of nearly 300 articles about the Climate Act is also available. He has also addressed cap and invest programs and RGGI in other articles. This represents his opinion and not the opinion of any of his previous employers or any other company with which he has been associated.
Related
