Auction Recommended for California’s Allocation of Emission Allowances

by | Oct 10, 2009

CO2architectureRegulation of greenhouse gas emissions in the electricity sector under a cap-and-trade system in California poses significant policy questions about how to allocate tradable emission allowances, according to a new report by Resources for the Future. The study suggests that the most cost-effective approach to implementing a cap-and-trade program is to use an auction for the allocation of emission allowances, and involving states throughout the western region would make it significantly more effective.

The Report, Allowance Allocation in a CO2 Emissions Cap-and-Trade Program for the Electricity Sector in California (PDF), addresses the options for regulation of California’s electricity sector within the context of an economywide cap-and-trade program in the state, and potentially the western region or the nation, which would likely cover roughly 83 percent of emissions.

In December 2008, the California Air Resources Board released a proposed framework for the California Global Warming Solutions Act (AB32), which was adopted in 2006, that outlines roles for a collection of regulations, voluntary measures, and other policies to reduce CO2 emissions, said Resources for the Future.

The plan also proposes a role for cap-and-trade, coupled with the opportunity for emitters to buy, sell, or bank the opportunity to emit up to the level of the cap, said Resources for the Future.

The details of the cap-and-trade program and exactly how it will relate to the other measures and policies is a decision that will be made over the next few years, according to Resources for the Future.

The report uses simulation modeling for the electricity sector to examine different approaches to allocation under a cap-and-trade program in California, and how it will impact pricing and the performance of the regional electricity markets.

The research cites the opportunity for emission reductions in California to be offset by emission increases in neighboring regions that supply electricity to the state. The amount of emission leakage (i.e. an increase in CO2 emissions outside of California as a result of the program) varies with the regulatory design of the program, according to the report.

One finding shows that roughly one-quarter of the emission reductions targeted for 2020 in a CO2 cap-and-trade policy in the California electricity market would be lost through emissions leakage with an allowance auction, and under a load-based approach to allocation, the percentage of emission reductions lost through emissions leakage would rise to 45 percent.

Researchers say if the state ignores emissions associated with imported power (an approach that would not comply with AB32), emissions leakage would approach 100 percent.

The study also finds that imposing a western regional CO2 emissions cap on the electricity sector would address the emissions leakage problem.

Researchers say it also would lower the cost to California electricity consumers and at a substantially lower marginal cost for CO2 emissions reduction than a cap-and-trade policy limited to California.

In addition, they say allocating allowances to local distribution companies in the broader western region will reduce the increase in electricity price, but will increase allowance price by nearly 30 percent compared to an auction.

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