Does decarbonization mean de-coalification? Discussing carbon reduction policies

In September, the Energy Security and Climate Initiative (ESCI) at Brookings held the third meeting of its Coal Task Force (CTF), during which participants discussed the dynamics of three carbon policy instruments: performance standards, cap and trade, and a carbon tax. The dialogue revolved around lessons learned from implementing these policy mechanisms, especially as they relate to coal. This summary reflects the views of various participants in the discussion, who all spoke under Chatham House rule.

Performance standards

A performance standard is commonly viewed as a regulatory tool in which the government sets pollution limits at the plant or unit level (although conceptually it could also apply to larger aggregations of plants, including utility portfolio standards). In the United States, federal performance standards for new power plants began in 1971 as part of the Clean Air Act (CAA), initially applied via heat input standards (reductions targeted around pounds per million BTUs) and later at the unit level in pounds of pollutant per MWh of net electricity output. Over time, companies sought guidance on which technologies to use for compliance, leading to the adoption of technology-specific standards, specifying particular technologies to control specific pollutants. It soon became clear that companies needed more flexibility leading to the enactment of the successful acid rain trading program.

Performance standards can be very effective: The experience with SO₂ scrubbers and NOx systems suggests that CAA standards played a significant role in improving the performance of these technologies and reducing costs. The impact of the CAA is also illustrated by the rising number of SO₂ technology patents in the aftermath of the law’s implementation and subsequent amendments. Moreover, as a result of the program, since the 1990s emissions of pollutants have declined 50 percent even as coal use and electricity output have increased, compliance has surged, health benefits have skyrocketed and costs of compliance have been one-eighth of EPA’s original cost estimates. Nevertheless, there are also drawbacks to using performance standards, chiefly that they can spur higher costs than a more market-based solution, given limits on compliance flexibility. In addition, performance standards provide no incentive to improve emissions reductions beyond set targets.

Importantly, this policy tool has not forced coal plants to retire. In fact, only about 2 percent of the reduction in coal use has been owing to retiring existing facilities. Rather, emissions reductions have resulted from using higher quality coal, fuel switching from coal to gas, and the wide-scale deployment of flue gas desulfurization technology (scrubbers). Combined, these responses have reduced SO₂ emissions, but only coal to gas fuel switching has reduced the actual volume of coal consumed. Since 2008, declines in coal-fired electricity generation are due to federal (MATS) and state greenhouse gas (GHG) standards, as well as the abundant supply of cheap natural gas, renewable portfolio standards, and a recession. Consequently, it is difficult to attribute reduced coal consumption and emissions solely to federal standards.

The question is whether similar clean air standards such as finalized under the EPA’s Clean Power Plan (CPP) will work in the same way as standards governing SO₂ emissions have. There is no straightforward answer. On the one hand, the CPP contains a state-wide rate based option allowing states to use other resources of their choice, including coal. Cap and trade is also an option under the CPP, effectively allowing higher cost (emitting) plants to operate where they choose. On the other hand, the U.S. Energy Information Administration (EIA) projects that under all of its scenarios, coal use in the United States will decline as a result of these new rules.

Emissions trading

An emissions trading mechanism–cap and trade–establishes an emissions cap or limit and allows the trading of rights to emit. A carbon price emerges through the trading system. Our discussion on the emissions trading approach highlighted several examples of carbon emissions trading frameworks, summarizing views on how this policy mechanism has worked to date.

First, the European Emissions Trading Scheme (ETS) has resulted in fuel switching from coal to gas in the electric power sector, and fuel switching from oil to gas in the industrial and heating sectors. The Regional Greenhouse Gas Initiative (RGGI) governing nine states in the north eastern and mid-Atlantic region of the United States has achieved emissions reductions mostly from non-price components, e.g., enhanced energy efficiency. There has also been fuel switching from coal to gas but this has been mostly market driven, i.e., based on low natural gas prices in the wholesale power market. Major CO₂ emissions reductions have been achieved as a result, even though there has been carbon leakage to neighboring states. Finally, as the emissions trading policy in California has been in place only two years, there is limited data available to evaluate its results.

The evidence to date suggests that emissions trading in theory and practice are two different things. These schemes are not as effective as anticipated, i.e., they have failed to deliver the desired volumes of emissions reductions in CO₂. This may be because regulators are in the early learning stages of implementing this tool. Another conclusion is that it is hard to predict the price of allowances. Measures such as a floor price on allowance auctions may be necessary to ensure that the policies retain incentives to innovate and invest in low carbon technologies through economic downturns and other fluctuations. These programs also reveal some of the administrative challenges associated with tracking allowance trades.

In addition, the market design is subject to regulatory capture: emissions trading creates concentrated costs for a powerful few (major emitters) across various sectors, while providing dispersed benefits for the broader population. There is little counterweight to these powerful few, as they play a major role in the design of a cap and trade policy.

In sum, the experience with carbon trading schemes to date suggests that they may be effective in the long-term if they send appropriate pricing signals for long-term investment, but in the short-term their efficacy as policy tools is not as straightforward. Moreover, it seems that sector- and/or technology-specific complementary tools are necessary, allowing for more targeted benefits to “winners” and targeted costs for polluters. Three examples of such complementary tools are:

• Regulating the resource out of the market: Ontario has developed a policy to phase out coal;

• Buying off major polluters: Germany has placed existing lignite plants in a security reserve, essentially paying them to lie idle, but to maintain capacity for an emergency;

• Crowding out: Renewable energy support schemes to bring down the costs of technology, in support of carbon prices.

Carbon tax

A carbon tax sets the price of CO₂ and actual emissions levels emerge from this price signal.

In designing a carbon tax, there are key questions that need to be addressed upfront:

• What emissions are subject to the tax, and who will pay it?

• What will the tax rate be and how will it evolve over time?

• What will the revenue be used for? 

• What will be the impact of the tax on a country’s competitiveness and how will emissions leakages be addressed?

• Will the tax complement other taxes and policies or will it supplant these? 

• What impact will a tax have on the overall policy agenda, for example on other policy goals such as research & development, economic resiliency, etc.?

Research indicates that there are several potential advantages of a carbon tax over other policy instruments. First, it can generate a significant amount of revenue that can be used for broader macroeconomic objectives. To give an example, revenues could be used to help protect lower income households and/or lower corporate tax rates. This type of “tax swap” could have a salutary effect on growth helping to offset the burden of the tax. A carbon tax can thus provide a “double dividend”: emissions reductions and economic growth.

Second, the carbon tax is viewed as a more efficient instrument in comparison to other mechanisms: It sends similar price signals across sectors and over time allows for a predictable capital stock turnover. For example, it is estimated that in the U.S. a carbon tax applied to fewer than 2,500 entities could cover 85 percent of GHG emissions.

Evidence suggests that the revenue neutral carbon tax instituted in British Columbia has worked as intended. Emissions have decreased both in absolute terms and relative to emissions in other provinces, and the economy has grown, also in absolute terms and relative to other provinces. Carbon taxes in other places, such as Norway and Sweden, also appear to be effective. However, the carbon tax in Australia was poorly designed, both economically and politically, and was repealed.

Observations and conclusions

One area of general agreement in the discussion was that reducing carbon emissions is a far more difficult and complex environmental problem than reducing criteria pollutants like SO₂. Carbon is a global stock pollutant, with long-term effects, and is deeply embedded in global economic activity. By way of comparison, the annual value of acid rain permits is about $5 billion, whereas a CO₂ tax would have the equivalent allowance value of $100 billion. Despite the consensus on the science of climate change–and overwhelming agreement that some policy action is required to establish a price signal to limit carbon dioxide emissions–there is far less consensus on what policy mechanism to use.

During the course of our Task Force meeting, participants raised several issues concerning the three carbon reduction policies summarized above.

Leakage, international competitiveness, and impacts on economic growth

There seems to be consensus that, once a policy mechanism establishing a price on carbon is in place, there will be the potential for “leakage,” meaning that carbon intensive activities migrate to those areas that do not price carbon. In those areas without a carbon price, industries would have a competitive advantage. However, there are mechanisms and approaches available to address this outcome, were it to occur, including using revenue (from a cap and trade or carbon tax) to promote growth, implementing border carbon adjustments, and leveraging U.S. diplomatic action. The latter would involve incorporating the United States’ major trading partners in a carbon pricing scheme not only to counter leakage, but also to demonstrate U.S. commitment to reducing GHG emissions.

In addition, with regard to a carbon tax, competitiveness could be preserved by initially implementing a low, but credible tax, and then gradually increasing the tax level. The rationale is that even when a carbon tax starts low, if there is the expectation that it will rise, investors can make decisions based on future prices.

Domestically, the impacts of a carbon price may be more difficult to gauge. Research indicates that the broad impact of a carbon tax will increase electricity prices where they are lowest and reduce or flatten them where they are high. Thus, the overall impact would level out electricity prices out across the economy, though regional differences may remain because electricity generation portfolios vary across the nation. To give an example, the Midwest of the United States is coal intensive, and concerns were raised in our discussion over how to address those states that would be impacted the most. Even with the revenues from a carbon tax earmarked for “pro-growth” tax reform, there was some skepticism over how to avoid a “revenue allocation free-for-all.”

Several issues were raised about the impact of carbon pricing on economic growth. First, there was a question of whether use of revenues from a carbon tax to promote growth might increase economic activity, causing an increase in emissions and thus offsetting the purpose of the carbon tax in the first place. Research indicates that there is some “rebound effect,” that the “pro-growth” approach increases emissions in the 2 to 3 percent range, thus yielding only a minor offset in emissions reductions. Second, an important point was made concerning climate policies in general. Even though there may be a rebound effect, there is also a “spillover effect” whereby the development and deployment of clean technology spurs the use of similar technologies.

Complementarity

Several participants in the task force meeting stated that the experience to date with carbon reduction policies indicates that they need to be complemented with other non-carbon price mechanisms, at least in the short-term. To give an example, in the EU, absent a carbon price that incentivizes investments in low-carbon technologies, a variety of other instruments are used, such as a mandatory minimum share of renewables in the generation portfolio. However, there was some skepticism of this approach, especially with regard to the danger of creating vested interests around those complementary policy instruments (for example, tax credits for renewable energy).

The impact on coal and role of carbon capture and storage (CCS)

The experts presenting to the Task Force agreed that research to date largely indicates that carbon reduction policies, regardless of the type, will significantly and negatively impact coal. In the words of one participant, “de-carbonization means de-coalification.”

CCS may be an avenue for continued coal use, but its high cost remains a barrier to market penetration. However, if there is a consensus to reduce carbon emissions, non-renewable options should be on the table, including a major policy push for CCS. We have discussed this in detail in a recent policy brief on the status of CCS in the United States. There was some discussion of what this CCS policy approach would look like, and some argued in favor of a strong governmental role in research, development, and demonstration of technologies on a larger scale, as well as the need for a carbon price to create a market for CCS technology.

Finally, there was discussion concerning coal use in different geographic regions globally. There are concerns that focusing on the declining role of coal in the United States or wider OECD region fails to take into account the projected rising coal use in developing countries, especially in Asia. This projected expansion provides another important reason to further reduce the costs of CCS technologies and create markets for carbon. Not all participants agreed, however, and some called into question the massive build-out of coal-fired generation in emerging markets as suggested by others. This, including the financing of new coal-fired electricity plants, will be a topic of a future Task Force discussion.

Next steps for Brookings

ESCI’s Coal in the 21st Century project will continue to work on several of the issues raised in this discussion.

As previously mentioned, on October 16 we released an issue brief examining what kind of policy approach will be required in the U.S. to commercialize CCS in order for it to become part of a low-carbon portfolio. This brief was launched at a public event at Brookings, featuring remarks from Carnegie Mellon University’s Professor Edward Rubin and Sasha Mackler, vice president of Summit Carbon Capture.

In late November, ESCI will convene its next installment of the CTF and one of the topics under discussion will be the role, status and future of coal in emerging markets, with a focus on the external financing of coal-fired electricity projects.

Finally, ESCI is working on a policy brief that takes an in-depth look at the role that coal plays in the Indian electricity sector, which is expected to be released in early 2016.