PDF _ RL34502 - Emission Allowance Allocation in a Cap-and-Trade Program: Options and Considerations
2-Jun-2008; Jonathan L. Ramseur; 33 p.

Update: Previous Editions:
June 2, 2008

Abstract: When designing a cap-and-trade program, one of the more controversial and challenging questions for policymakers is how, to whom, and for what purpose to distribute the emission allowances. Regarding the method of distribution to covered sources, policymakers could (1) sell the allowances through an auction process, (2) allocate the allowances at no cost to covered sources, (3) provide allowances to noncovered sources who would, in turn, sell them to covered sources, or (4) use some combination of these methods. Although the emission allocation method would not affect the environmental integrity of the cap-and-trade program, the selected allocation strategy could have considerable consequences.

Using auctions as a distribution method could avoid certain concerns that are likely to occur if covered sources receive all (or most) of the allowances at no cost: (1) consumers in different electricity markets may face inequitable price increases; (2) a weak price signal for electricity may be sent in areas with the most carbonintensive fuel portfolios; and (3) no-cost allowances may overcompensate covered sources. In addition, auction revenues offer a unique opportunity to reduce the overall costs of the emissions program. Several economic studies indicate that if used in the most efficient manner, overall costs could be minimized by almost 50%.

A greenhouse gas (GHG) emission cap-and-trade program would create a valuable new commodity: the GHG emission allowance. EPA estimates that allowance value could potentially account — in aggregate — for tens or hundreds of billions of dollars each year. When distributing this value, policymakers would face a choice between minimizing the costs imposed on the entire economy, minimizing the expected burden on specific parties, or supporting a range of climate- or nonclimate- related policy objectives.

For example, Congress may consider providing transition assistance to carbonintensive industries. Studies have estimated profits could be maintained in the energy production and electricity generation sectors, if approximately 20% of allowances were provided to those sectors at no cost. Members may also consider allotting allowance value to consumers, particularly low-income households, who are expected to bear the majority of the compliance costs via higher energy prices. Another option would involve distributing the allowance value to support various objectives: technology development, energy efficiency improvements, biological sequestration, climate change adaptation efforts, or non climate-related purposes, such as deficit reduction. Of these objectives, technology advancement is arguably the most crucial in terms of mitigation. Moreover, deployment of new technologies could potentially lower the overall costs of the program.

Although many of the proposals in the 110th Congress (e.g., S. 2191, S. 1766, and S. 3036) would employ an auction to some degree, none of the bills specifies the design of the auction. Congress may want to consider including specific design elements in legislative text, particularly auction frequency and whether or not the auction should have a reserve price, and if so, at what level.

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Topics: Energy, Economics & Trade

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