Cap and Trade: Transatlantic Perspectives on Trading, Auctioning and Revenue Spending

Congress is currently considering the creation of a national cap and trade program to reduce greenhouse gas emissions in the United States. The American Clean Energy and Security Act (H.R. 2454), recently reported out of the House Energy and Commerce Committee, includes a cap and trade program where 15 percent of emissions allowances would be auctioned each year for the protection of low-income households. Most of the remaining allowances would be allocated (provided at no cost) in the first few years to a variety of entities, including the electricity sector, energy-intensive/trade-exposed industries, natural gas distribution companies, states (for investments in renewable energy and energy efficiency), groups that work to prevent tropical deforestation and to meet other stipulated public purposes, etc.

On June 15, the Environmental and Energy Study Institute (EESI) and Heinrich Boell Foundation held a briefing for Congressional staff on cap and trade programs and the auction of emissions allowances and revenue spending. This briefing examined the experience of the EU and the northeastern states participating in the Regional Greenhouse Gas Initiative (RGGI), both of which have already implemented cap and trade programs to reduce greenhouse gas emissions. Speakers discussed the distributional and efficiency consequences for taxpayers of auction and allocating emissions permits for various purposes. The Heinrich Boell Foundation also released a new report Cap and Invest: Why Auctioning Gains Prominence in the EU Emissions Trading Scheme at the briefing.

• The purpose of a carbon cap and trade program is to give everyone equal incentive to reduce emissions through a free market system.
• The more important policy decision is not whether to auction or freely allocate emission allowances, but rather how to distribute the value of allowances.
• Free allocation to utilities will not prevent energy price increases and can lead to windfall profits for the power sector.
• Rising energy rates place a disproportionate burden on lower-income families. Giving allowance value in lump sum to households has a greater benefit for low-income households while awards given to utilities tend to benefit high-income households.
• The value of allowances can be used for consumer protection in the form of utility rate relief or increased energy efficiency. Rate relief provides a short term benefit, but it muffles the price signal and can raise the overall cost of the program. Reducing consumer demand through greater energy efficiency lowers the cost of allowances because utilities can meet the carbon cap more easily.
• The market forces of a cap and trade program should spur competing utilities to invest in research and development for emission-reducing technologies.
• RGGI auctioned 85 percent of allowances at the onset of the program.
• RGGI requires at least 25 percent of the auction revenues to be allocated for “consumer benefit or strategic energy purposes.”
• In 2005, the EU ETS primarily used free allocation of allowances to historically high emitters (“grandfathering”), although Denmark, Ireland, Hungary, and Lithuania experimented with auctions. Eleven EU states began to implement auctioning in the second phase, including Germany. In 2008, its government generated $1.3 billion (933 million Euros) in revenue from auctioning 8.8 percent of emission allowances.
• EU ETS and RGGI found sealed-bid, uniform price auctions to be easier and more efficient than taking the highest bidder (“ascending bid auctions”). In a sealed-bid format, an auctioneer receives all bids simultaneously and compiles them to generate a demand curve, which is used to determine a clearing price that all winning bidders pay.
• Both RGGI and EU ETS use independent monitors to oversee allowance transactions, which minimizes price distortion from speculation.