Cleaner Cheaper Smarter: Recommendations from the U.S PIRG Education Fund

The Case for Auctioning Pollution Allowances in a Global Warming Cap-and-Trade Program

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U.S PIRG Education Fund: Cleaner, Cheaper, Smarter - The Case for Auctioning Pollution Allowances in a Global Warming Cap-and-Trade Program.
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Executive Summary:
Global warming poses a profound threat to America's future. Science suggests that, to avoid the most dangerous impacts of global warming, America and the world must take immediate action to reduce emissions of global warming pollutants. In the United States, that means halting the growth in global warming emissions now, reducing emissions by at least 15 to 20 percent by 2020, and achieving reductions of at least 80 percent by mid-century.

There are many policy tools that can be used at the state, regional and federal level to reduce emissions of global warming pollution. Among the most powerful of those tools are enforceable, science-based caps on global warming pollution. In some cases, emission caps have been paired with a mechanism that allows for the trading of pollution allowances. This combined policy approach is called “cap-and-trade.”

Under a cap-and-trade system, policymakers establish an overall cap on global warming emissions from all or part of the economy. Polluters must hold permits, called “allowances,” for every unit of pollution they emit, with the total number of allowances limited by the cap. Polluters are then free to buy, sell or trade allowances as they see fit.

The structure of a cap-and-trade program is critical to its success. One of the most important decisions policy-makers must make when designing a cap-and-trade system is how to distribute allowances. Allowances can be given away for free to polluters or other entities, sold at an auction, or distributed through a combination of the two methods.

Auctioning all allowances under a capand- trade program is fair, reduces the societal cost of achieving emission reductions compared to giving allowances to polluters for free, and promotes a transition to a clean energy economy. For those reasons, allowances should be auctioned in any global warming cap-and-trade program.

Auctioning allowances is fair.
• The air is a commonly held resource, to be managed for the benefit of the public. As a result, it is fair to require polluters to pay the public for the use of that resource and to hold them responsible for the costs their pollution imposes on society. Giving away pollution allowances absolves polluters of Executive Summary 6 Cleaner, Cheaper, Smarter that responsibility and even provides some polluters with a new opportunity to profit. Auctioning allowances, on the other hand, ensures that all polluters pay based on the amount of pollution they release.
• Auctioning allowances removes the potential for favoritism and market distortion in the distribution of free allowances.

Auctioning allowances enables emission reductions to be achieved at lower cost to society than if allowances are given away to polluters.
• Studies have estimated that auctioning allowances can reduce the societal cost of achieving a given level of emission reductions through cap-and-trade by as much as half.
• Auctioning allowances prevents polluters from gaining “windfall” profits as a result of cap-and-trade.

•When allowances—which are items of monetary value—are given to polluters for free, it can allow polluters to benefit financially without having to take any action to reduce their emissions.
•Europe's emission trading system, which includes free distribution of the vast majority of allowances, has resulted in power plant owners receiving billions of dollars in windfall profits from the pollution program. In the United Kingdom alone, windfall profits from emission trading have been estimated at nearly $2 billion. These profits come directly from the pocketbooks of consumers.

Auctioning allowances encourages a transition to clean energy sources.
• Giving allowances away to polluters for free based on their historic emissions (often called “grandfathering”) rewards owners of highly polluting facilities and discourages innovation. Auctioning allowances treats all emitters —dirty and clean facilities, and existing and new facilities—equally, placing them on a level playing field and sending economic signals that encourage cleaner sources of energy.
• Auctioning allowances can also generate revenue to support clean energy technologies. Studies suggest that combining a cap-and-trade program with aggressive efforts to develop clean energy technologies can allow for greater emission reductions to be achieved at lower cost.

Auctioning allowances provides important public benefits.
• Auctioning allowances will create millions or billions of dollars a year in revenue (depending on the size and scope of the cap-and-trade program) that can be used for a variety of public purposes. Among those purposes are:

•Investments in energy efficiency, which can reduce the total cost of achieving emission reductions. An analysis of an upcoming regional cap-and-trade program in the Northeast showed that increasing energy efficiency while imposing a carbon cap can actually lead to lower energy bills for consumers.
•Investments in clean energy research and development, as well as the deployment of renewable energy technologies. Research and development and early market support are necessary to ensure that renewable energy can play an important role in achieving the large reductions in global warming pollution that will be needed in the coming decades to prevent dangerous global warming.
•Reducing the cost of the program to consumers by returning a portion of auction revenues in the form of an annual rebate.

Policy-makers, environmentalists, businesses and consumer advocates are increasingly supporting auctions as a fairer and less expensive way to reduce global warming emissions under capand- trade.
• In the Northeast, where 10 states have agreed to reduce global warming pollution from power plants through the Regional Greenhouse Gas Initiative, all of the states have committed to auctioning a significant share of allowances. At least four states have committed to auctioning 100 percent of pollution allowances, while the others are still deciding on their approach.
• The federal Safe Climate Act, introduced by Rep. Henry Waxman (CA) and now cosponsored by more than 135 Representatives, calls for the use of auctions as the primary way to distribute allowances.
• The U.S. Climate Action Partnership —a coalition of major U.S.-based businesses and several environmental organizations—supports free distribution of a “significant share” of allowances initially, but states that “free allocations to the private sector should be phased out over a reasonable period of time.”
• The National Commission on Energy Policy, which originally advocated giving away nearly all allowances to polluters for free, recently urged that no more than 50 percent of allowances be allocated for free at the outset of the program, with free allocations to be gradually replaced by auctions.

Any global warming cap-and-trade program should include auctioning 100 percent of emission allowances, with the revenue from those auctions used to encourage a transition to a clean energy economy and to compensate consumers for the cost of the program.