Clean Energy Jobs comment: auction the allowances

This posts concerns HB 2020, the so-called “Clean Energy Jobs” bill, the cap-and-trade legislation currently under consideration in Oregon’s legislature.

There is just a handful of key parameters in any cap-and-trade system. I won’t review them because others have done this exceptionally well already, especially Sightline with its Cap and Trade 101 series from way back in 2009. I will focus here on one that combines big equity and efficiency considerations: the extent to which allowances are given away for free or auctioned.

At first blush, this question seems like an open one. To summarize:

Should we maximize revenues from allowances? Or should we allow compliance entities – especially in sectors that are emissions-intensive, trade-exposed, or both – time and cash to make the transition?

This framing sounds kind of reasonable; after all, we generally don’t want to expect unreasonable things of sectors that must make difficult changes as we move toward a low-carbon economy.

Unfortunately, the logic is unsound. Giving away allowances is a bad idea for at least three reasons.

  1. It is inefficient.
  2. It is unfair.
  3. It weakens other climate action by starving complementary measures and investments of money. This is both unfair and inefficient. (Side note: It is risky if the cap is set too high.)

Each of these is slightly tricky so let’s go through them, and then return to consider all of them with the big picture – society’s goals for this policy – in mind. And in case you want to skip there, I close with suggestions for cushioning the blow to emissions-intensive industries and facilitating their admittedly painful transition.

First, distributing allowances for free is inefficient. Giving away (rather than auctioning) allowances will shield firms and sectors from a price on carbon, which is the main mechanism for using market forces to ensure a speedy and efficient reduction in emissions. Without exposure to a carbon price, firms lack the incentive to innovate, invest, and operate differently so we move toward a low-carbon economy.

The main (faulty) counter-argument from economists is that, no, the firms still have the incentive to reduce emissions and sell their allowances to others who need them for compliance. After all, getting allowances for free doesn’t mean you can’t pursue cost-effective emissions reductions anyway and pocket the proceeds from selling your unused allowances to anyone else. Theoretically, this is possible, but ask yourself if you believe it: firms in emissions-intensive industries are going to choose difficult choices – new techniques, new technologies – over the easy path of…just buying time with freely distributed allowances? Give me a break.

If you don’t believe the economists, you might move on to the main (faulty) counter-argument from industry groups: these industries have no choice but to emit because their carbon footprints are locked in. You want yard of cement? Then you need to generate a certain quantity of greenhouse gas emissions. You want a sheeted bale of air dry pulp? Same story. Other raw materials or intermediate goods, such as semi-conductors? Ditto. There’s no choice in the matter.

Except that there is. Or rather, there are many, many differences in technology, efficiency, and operating practices that provide a wide range of emissions intensities for these goods. Furthermore, we want companies to have every incentive to discover the lowest-carbon way of doing what they do. Indeed, that is precisely what’s happening in California, with a carbon price incentivizing industrial efficiency and technology measures to reduce emissions.

Perhaps more to the point, if a material or product or service involves a lot of emissions, we want it to cost more so the rest of the economy can feel the presence of carbon emissions and economize. The price of gasoline will rise because it should! How else will all of the businesses and consumers located “downstream” of the compliance entities get a “market signal” to use less, use more wisely, or seek alternatives? That market signal is essential to the efficiency of the program. (Again, skip to the end for some suggestions for re-investing auction proceeds in highly impacted sectors.)

HB 2020 mysteriously offers free allowances to a vast array of businesses (see the excerpted list from the bill text).

(a) Cement Manufacturing, code 327310.
(b) Other Crushed and Broken Stone Mining and Quarrying, code 212319.
(c) Frozen Fruit, Juice and Vegetable Manufacturing, code 311411.
(d) Frozen Specialty Food Manufacturing, code 311412.
(e) Dried and Dehydrated Food Manufacturing, code 311423.
(f) Iron and Steel Mills and Ferroalloy Manufacturing, code 331110.
(g) Other Basic Inorganic Chemical Manufacturing, code 325180.
(h) All Other Plastics Product Manufacturing, code 326199.
(i) Mineral Wool Manufacturing, code 327993.
(j) Polystyrene Foam Product Manufacturing, code 326140.
(k) Glass Container Manufacturing, code 327213.
(l) Ethyl Alcohol Manufacturing, code 325193.
(m) Reconstituted Wood Product Manufacturing, code 321219.
(n) Gypsum Product Manufacturing, code 327420.
(o) Pulp Mills, code 322110.
(p) Paper (Except Newsprint) Mills, code 322121.
(q) Paperboard Mills, code 322130.
(r) Semiconductor and Related Device Manufacturing, code 334413.

Excerpt from HB 2020, as introduced, p. 13.

Perhaps you believe all change has ceased in those sectors, and that they therefore must receive this special attention. But again, the strong evidence from California is that a carbon price will spark a quest for efficiency and technological innovation, and that quest will deliver emissions reductions.

(In a separate post, I will examine the question of “market shifting” or “leakage” – when trade-exposed sectors become less competitive by having to pay a price on carbon. This concern is legitimate, but it still does not require allowance give-aways.)

Second, distributing allowances for free is unfair. If you give away allowances, you’re taking revenue from someone, and in this case the “someone” is clearly everyone else.

This argument isn’t about efficiency. Rather, it’s about fairness, and perhaps politics. Oregonians – yes, just regular people – should be outraged at the idea of giving away the permission to pollute. We should be upset about the policy folly it represents, as described above, but we should also be just plain mad that instead of charging admission to the atmosphere, we’re going to give free access for the first ten years of the policy. That is simply unacceptable.

And by “we” I don’t mean just Oregon residents. I also mean Oregon businesses, because the emissions-intensive industries that get this preferential treatment are not most of our businesses. Business leaders should stand up and complain that this plan to give away allowances is a huge subsidy to a small slice of the state’s economy, while the rest of us foot the bill.

And while you’re still mad, let’s talk about how, third, the give-away of allowances weakens all other work by starving complementary measures and investments of money. In addition to a price signal to reshape the market– you know, that price on carbon that we will feel in proportion to the carbon footprint of each purchase – we also need to make a lot of public investments to fill in where the market won’t. California has done exactly that, using its allowance auction proceeds to fund transit, affordable housing, clean vehicle rebates, street trees, energy efficiency in buildings, and more.

Notably, there’s an irony in this particular danger: an allowance give-away buys some votes up front, but it compromises the long-term political appeal of the policy by undermining popular and policy-aligned programs and investments. If we give away too many allowances, we simply won’t have the funds to build the right infrastructure (such as transit) and to do things that markets notoriously fail at (such as affordable housing or energy efficiency). Those investments have two things in common: they move us toward a low-carbon economy, and overwhelmingly, people want them.

(In a separate post, I will cover the rural-urban fairness issues in cap-and-trade, including the extra driving that rural Oregonians have to do – and therefore the additional carbon cost they carry – compared to urban populations that have more transportation options.)

Notably, giving away allowances is risky if the cap isn’t set right. (This is really an extreme version of #3, immediately above.) In the event that the cap – another key parameter in a cap-and-trade system – is set too low in certain years, all other programs could end up with almost no revenue whatsoever. Think about it: if the cap is too high and allowances are plentiful, then they could actually end up being worth zero, or close to it. This dramatic outcome is unlikely in Oregon because not all allowances will be given away for free, but depressed allowance prices still hit revenues hard if we aren’t

California deals with this problem simply and straightforwardly by auctioning allowances and having a reserve price. (For the record, RGGI – not the most effective cap-and-trade system to date – dramatically high-balled its cap so there were too many total allowances, but at least it auctions allowances and uses a reserve price, so the system functions like a low carbon tax.) We can argue about whether a cap should be lower and the ensuing price should be higher, but there’s no question that auctioning delivers revenue – and give-aways don’t.

Finally, it is almost certainly good policy to assist emissions-intensive industries with the transition. Quickly, there are at least two ways to do that:

  • Provide preferential financing – loans, loan guarantees, buy-downs of point-spreads, etc. – to ensure that companies are not credit-constrained when they make investments in new technologies and new equipment to reduce their emissions. We know that building a low-carbon economy means mobilizing capital, so let’s help out.
  • Provide grants and other investments for R&D activities so innovators have the resources they need, and so more of the innovation happens here. We know that we don’t yet have all of the technology that a carbon price will incentivize, but we also know that innovation is a bumpy road. We can accelerate that journey.

The aforementioned research from California that showed a response to carbon pricing also uncovered some capital constraints in those industries. Again, this barrier is in fact an opportunity for a complementary policy to grease the skids of the market. Those strategies in tandem could allow us to keep our industries intact while helping them participating in the transition. But if we don’t auction allowances, we may not have enough money to lend that helping hand.

Write to me (joshuaskov@gmail.com) if you have another part of HB 2020 you’d like me to dig into.

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