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Emissions cap-and-trade program is working well in California

Stanford economist: 'What we've learned is that a cap-and-trade system will not kill the California economy'

The climate change debate may seem mostly to be about science, but it's really driven by dollars and cents — what will it take to reduce greenhouse gas emissions, and how much will that cost? Of all U.S. states, California has taken the most direct approach to settling those questions through a pioneering cap-and-trade program.

More than two years into the program — which aims to reduce the state's overall greenhouse gas emissions to 1990 levels by 2020 — it's working very well, but it may not be doing as much as its biggest fans say.

"We think we do have a good story to tell," says Mary D. Nichols, chairwoman of the California Air Resources Board, which administers cap-and-trade.

The program's quarterly auctions of emissions allowances have gone on largely without a hitch. The program has fit in, as was expected, with other emissions reduction programs implemented under AB 32, the state's landmark greenhouse gas legislation, including mandates for renewable fuels sources for electrical utilities and emissions standards for new cars and trucks.

It has done so without a measurable drag on economic growth. The program generated $969 million in revenue for the state through the end of 2014, and is expected to generate $2 billion a year or more in the future. The money must be spent on efforts to reduce carbon emissions.

"What we've learned is that a cap-and-trade system will not kill the California economy," says Stanford economist Lawrence H. Goulder, who advised the ARB on the program's design. "The economy has continued to flourish."

The state's greenhouse gas emissions have declined since cap-and-trade was introduced in 2013, but "the jury's really out on whether we've seen a lot of reductions caused by cap-and-trade," says James Bushnell, an energy economist at UC Davis who follows the program closely.

That's important, because finding the right incentives for industries and consumers to reduce their carbon footprint may be the key to fighting climate change. All the options, including cap-and-trade, direct caps, and a carbon tax, are controversial, though some are more politically palatable than others.

California's cap-and-trade experiment is being widely watched because it covers the broadest range of industries of any such program in North America in the largest state economy in the region. It's also, as the Legislative Analyst's Office declared in 2012, "one of the most wide-ranging and complex regulatory efforts in the history of the state." If cap-and-trade can work here, it could work anywhere.

"California has provided a very good signal to other states and the federal government that significant reductions can be achieved through a market-based system," Goulder says. One positive aspect of the state's lengthening experience is that it has "drained away some of the fear-mongering" about cap-and-trade, says Severin Borenstein, an energy expert at UC Berkeley's Haas School of Business. For example, the state's oil and gas industry, which last year unsuccessfully lobbied to defer the Jan. 1, 2015, deadline for imposing cap-and-trade rules on gasoline suppliers, predicted that the regulation would drive up gas prices by 16 to 76 cents per gallon.

Borenstein and other experts accurately put the increase at closer to nine to 10 cents, and argued that cap-and-trade would be meaningless if the largest source of greenhouse gases, transportation fuel, was left out of the program.

To meet 1990 level goals, emissions must be cut by almost 16% — from 507 million metric tons of carbon dioxide equivalent to 427 million. Every year, ARB hands out or auctions allowances covering that year's emission cap, which is reduced year by year as 2020 draws near. Factories and other sources of greenhouse gases can buy the allowances they need or sell any they don't need. ARB forbids speculators to hoard allowances — to avoid the sort of manipulation that fouled the state's electricity market during the deregulation era of 2000-01 — and sets a floor price, which will rise slightly every year, to signal that emissions have some real cost.

The goal is to prompt emitters to become more efficient users of energy. But the pressure is more of a nudge than a cudgel because of fears of imposing emissions limits so tight or costs so high that businesses would flee the state. "Although we were moving forward ahead of others, we weren't moving so far ahead that it became destabilizing to current businesses in California," Nichols observes.

Energy experts expect the auction price of allowances to stay close to the minimum through 2020, largely because the emission caps have turned out to be higher than what the state's covered industries are actually producing.

The state's other emissions mandates already have done much to bring emissions down. Another big factor was the recession: The state's greenhouse gas emissions fell 4.4% from 2008 to 2009, tracking the slowdown in economic activity, and didn't return to pre-crash levels until 2012, ARB statistics show.

"Current emissions are below what we would have seen even without the program," Bushnell says. "When we came out of the recession, everybody was a bit more efficient, and those efficiencies have persisted." Auction prices may begin to rise, however, if the state enacts more stringent targets for 2020-30, as Gov. Brown advocates.

A larger question, Borenstein says, is whether emissions regulations such as cap-and-trade do enough to drive technological change. "California produces 1% of world greenhouse gases," he says, "so it's not going to solve the problem on its own. Making a difference means developing new technologies that can be used in the developing world. If California meets our greenhouse gas goals by taking expensive measures no one else is willing to do, that's not doing it in a way that drives technology forward."

ARB's Nichols maintains that cap-and-trade is achieving that goal merely by establishing a predictable benchmark price for carbon emissions. Even at a modest $12 per ton, she says, "that's enough of a signal for industries to make dramatic investments in clean energy."

But it's also just one piece of a broad strategy to fight climate change. By itself, cap-and-trade doesn't answer the one most important question on climate change: Just how much are we willing to do to win the fight?

Michael Hiltzik's column appears every Sunday. Read his blog, the Economy Hub, every day at, reach him at, check out and follow @hiltzikm on Twitter.

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