from Energy, Security, and Climate and Energy Security and Climate Change Program

Why Letting Manufacturers Opt In to Cap-and-Trade Could Increase Emissions

July 14, 2010

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Senators from manufacturing states have been among the most skeptical of cap-and-trade legislation. One would expect, then, that they’d be thrilled by the prospect of utility-only cap-and-trade, which would explicitly exclude manufacturing facilities. But not so. Here’s E&E Daily this morning:

“Sen. Sherrod Brown (D-Ohio), meanwhile, stressed earlier this week that manufacturers must have the choice to opt in to a carbon pricing system and that he is working on legislation that would allow them to do that under a utility-only bill.”

Why, after resisting cap-and-trade, do manufacturers suddenly want in?

Utility-only cap-and-trade would, like economy-wide cap-and-trade, increase the cost of the electricity used by many manufacturers. Under previously proposed economy-wide schemes, many manufacturers would have received rebates equal to or greater than those increased costs. Under most plausible utility-only schemes, most energy-intensive manufacturers will receive substantially smaller rebates, and some (such as those who are in states where electricity prices are not heavily regulated) may receive nothing. Utility-only is thus not a free pass for manufacturers.

These manufacturers are looking for “opt-in” provisions that would help cover some of their increased electricity bills. Yes, by joining the cap-and-trade system, they would see their costs increase further (because they’d pay for their own direct pollution too). But they’re looking for a deal that more than pays them for that extra cost. Hence the sudden interest in being part of the system.

What does this all mean environmentally? An well-designed opt-in scheme would probably strengthen the headline target of a cap-and-trade bill. That’s because the cap would be increased only by a fraction of the emissions of any facility that decided to opt in. Imagine, for example, that a plant with 100,000 tons of annual emissions chose to join. The 2020 target would probably increase by only 83% of that, or 83,000 tons. That would force 17,000 tons of reductions under the cap, either at the manufacturing plant, or in the (already covered) utility sector.

That said, to the extent that an opt-in scheme preferentially attracts those plants with the easiest potential reductions (which the most likely outcome), those reductions might be meaningless (i.e. they might be reductions that would have occurred anyhow, even without cap-and-trade). Indeed it is very possible that some of the opt-ins would actually weaken the environmental result.

Imagine, for example, that the 100,000 ton plant expects its emissions to drop by 20,000 tons by 2020. It opts in to cap-and-trade and follows through with its plans. The utility-only cap is about 2 billion tons of CO2 in 2020. The opt-in expands that by 83,000 tons, to 2,000,083,000 tons. 80,000 tons of permits are used up by the manufacturing plant. That leaves 2,000,003,000 tons of permits for the utilities, which is more than they started with. As a result, the carbon price drops, and emissions are reduced by less than they would have been without the opt-in.

Will this sort of thing happen? It depends entirely on how any opt-in provisions are designed. I have been skeptical of claims that badly-designed cap-and-trade could increase emissions. (Perhaps hostile is a more accurate word than skeptical.) Those claims tend to ignore economics. But a badly designed opt-in scheme could be an exception. Legislators should be careful to ensure that it isn’t.