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First Glimpse: PennFuture analyzes draft of DEP's cap-and-invest program

On February 13th, the Pennsylvania Department of Environmental Protection (DEP) will be presenting the first draft of the regulatory language for a “CO2 Budget Trading Program” to the Air Quality Technical Advisory Committee (AQTAC), a positive next step in a long 18 to 24 month regulatory process. The draft provides some key details—and questions—on the Governor’s intention to create a state cap-and-trade program to cut electricity sector carbon emission.

How does Cap-and-Invest Work?

Cap-and-invest is a longstanding carbon reduction tool with a very straightforward concept: the state sets a carbon limit for an industry that declines over time and provides annual “allowances” to carbon polluters. 

In the case of Pennsylvania, the Governor intends to enact a cap-and-invest program for power plants with a capacity over 25 megawatts (MW). Power plant owners must obtain allowances for each ton of pollution they emit in any given year. As the carbon cap decreases, the cost of allowances will increase and polluters will be incentivized to invest in lower-carbon technologies. For those generators that continue to emit, the costs of pollution will be better reflected in the wholesale price of the energy they sell.

Economically, this is the “polluter pays” principle in action—rather than subsidizing the cost of pollution for dirty plants, we will monetize the costs of that pollution and let the market make better-informed choices about what power to buy.  The proceeds from power plant owners buying allowances would be invested back into efforts to reduce air and carbon pollution.  

When this rule goes into effect in Pennsylvania, the DEP will issue a specific number of allowances, each one representing one ton of CO2 emissions. To emit carbon pollution, power plants will need to obtain sufficient allowances. For example, a reasonably modern natural gas plant will require about one allowance for every two and a half megawatt hours (MWh) of generation. Coal plants, which produce significantly more carbon pollution, will need around twice as many allowances per MWh. Of course, carbon free generation like nuclear, wind, and solar won’t need any allowances at all. 

What Choices will Polluters Have?

Given a choice, carbon polluters would want to keep the status quo where they get to dump pollution in the air for free. While this proposal closes that particular candy store, companies still have a number of options to make compliance easier and less costly.

Pollution Prevention: Investing in efficiency improvements or changing their operations so they emit less pollution. When pollution is no longer free such changes will be more cost-effective.

Permit Conditions: Power plant units supplying electricity to industrial facilities that don’t send a significant amount of power to the grid or other facilities may be able to make minor changes to their operating permits and be exempt from the program entirely.

Offsets: Power plant units may also be able to reduce their need for allowances by offsetting their pollution with verifiable reductions from other projects. This could be capturing landfill methane, sequestering carbon through reforestation, avoiding methane through better agricultural practices, or—and this is particularly important in Pennsylvania—plugging abandoned oil and gas wells.

Where do Companies get Allowances?

Ultimately, many electricity generators are going to need to obtain at least some allowances and, for that, the proposed rule sets up an auction program.

An auction program could be developed in several different ways, but the draft doesn’t specify which would be prefered. Pennsylvania could provide a  “clearing price” auction where participants submit sealed bids for the number of allowances they want and the price they will pay, and everyone pays the price in the lowest winning bid. It could also create a “pay-as-bid” auction where all the winners pay what they bid. Or, it could be a multi-round auction where participants can adjust their bidding strategy between rounds. The mechanics may differ, but the goal is to discover what the market thinks is a fair price for allowances rather than a “command and control” system where the DEP sets the price entirely on its own.

While DEP can run the auction entirely on its own, it also has the option of joining a multi-state market—like RGGI—if it determines that there is an appropriate market to join and the benefits outweigh the costs. It is expected they will. Economies of scale with a bigger market will reduce our share of the administrative and support costs, a multi-state market can lessen concerns about cross-border effects, and large markets can even lower the cost of compliance for participants. This is where RGGI comes into play. If we do join a multistate market, RGGI is the logical choice.

Features of DEP’s Proposal

Guardrails Around Allowance Prices: Preventing price shocks for consumers is always an important concern and spikes in fossil generation caused by severe weather could cause problems. Like all of the RGGI states, DEP proposes to mitigate this concern with a cost containment reserve (CCR). The CCR will make additional allowances available to keep costs down if the auction price is higher than a specified trigger price. On the other hand, unexpected retirements of polluting plants could make demand for allowances drop sharply. While lowering emissions is a good thing, a sharp fall in prices may make the program less effective at incentivising further emissions reductions. For that reason, DEP is proposing an emissions containment reserve (ECR). Similar to the CCR, the ECR would withhold allowances if the cost of reductions is much lower than expected.

Free Allowances for Waste Coal: The proposal also uses free allowances as a policy tool. The draft program proposes to give away free allowances to further subsidize waste coal generators’ continued pollution. Waste coal proponents claim that they are providing an environmental service by cleaning up abandoned waste coal piles that are polluting our land and water. While burning these coal piles is one way of removing them, this proposal doesn’t require the DEP to first determine that burning the coal is the best option available, it doesn’t attempt to prioritize removal of the most problematic waste piles first, and it doesn’t require any analysis to ensure the benefits these plants provide to justify the value of all the subsidies they are getting. This is a detail of the draft proposal that needs further attention by DEP moving forward. 

Improvements DEP Should Consider

Planning for retirement of waste coal generation: If subsidies for waste coal remain part of the plan, more work should be done to plan for their eventual retirement. Currently, the proposed rule says that when sufficient waste coal retires for the set-aside to be reduced or eliminated, the allowances return to the auction pool. Because waste coal produces significantly more carbon pollution per megawatt-hour than the likely alternatives, this will add unneeded allowances to the market, depressing allowance prices, and making our carbon targets harder to reach. A better choice would be to retire these allowances from the auction pool entirely. If any allowances are returned to the auction pool, they should be discounted to reflect the fact replacement generation will likely be much cleaner.

Protecting Voluntary Purchases of Renewable Energy: One set-aside DEP should consider adding to the draft rule is for voluntary purchases of renewable energy. Having a cap on carbon emissions is vital, but unless we are careful, a cap can also backfire and act as a carbon floor.  If households or businesses choose to purchase clean renewable generation to fight air pollution and climate change, they want to ensure that they are getting real emissions reductions. As the rule is written, however, a voluntary purchase of clean generation leaves more room under the cap for others to buy more dirty power. DEP could fix this problem by keeping a pool of credits out of the auction and retire them for each ton of emissions avoided when individuals or businesses choose to buy clean renewable generation. Without this addition, the only way an individual could ensure they were making a difference is to not only buy clean energy but also buying the allowances. Making clean-energy consumers pay twice is the exact opposite of the polluter pays principle.

What Happens Next?

This is one of the most important regulatory actions we have seen during the current administration, and DEP’s proposal is a good start, but there are still opportunities to make it better. For the next few months DEP will present their ideas and get input from various advisory committees before formally proposing the rule this summer. After that, the public will have the opportunity to send in written comments and testify at hearings.

PennFuture will be following this closely throughout the rulemaking process, so be sure to stay tuned into our blogs for the most recent updates. 

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