The Northeast’s carbon trading system works quite well. It just doesn’t reduce much carbon.

The danger of climate change has been understood for decades, but the US still has no coherent national climate policy. That has left climate-friendly states to fend for themselves amidst an inconsistent patchwork of federal subsidies and regulations. It’s a daunting task given the scope and complexity of the problem.

One of the oldest and most enduring state efforts is the Regional Greenhouse Gas Initiative (RGGI, pronounced “reggie”), a carbon cap-and-trade system operating in nine Northeastern states: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont. (New Jersey was also involved, but dropped out in 2011 at the insistence of Gov. Chris Christie.)

RGGI is currently undergoing a thorough review and evaluation, which will shape its course from 2020 forward, so it’s a good time for everyone interested in state carbon policy to get to know the program and its considerable virtues and limitations. (There will, ahem, be no federal carbon policy for a while.)

For those just getting to know RGGI, there’s good news and bad news. The good news is that it’s working. A sane, bipartisan process yielded a smart policy framework with enduring and broadly shared social and economic benefits.

The bad news is that RGGI isn’t succeeding in the one way that counts most: reducing carbon. It has benefited from emission reductions in the Northeast, but it hasn’t really caused any, or at least not many. Whether it can serve as an instrument of meaningful decarbonization — and retain its integrity and popularity — largely remains to be seen.

The good news: RGGI defied political gravity to become a model policy

The positive news about RGGI is captured in this enthusiastic new report from strategic consultancy MJ Bradley & Associates.

Among other things, the report is a fascinating (at least to a carbon nerd like me) walk through RGGI’s history. It all goes back to April 2003, when New York Gov. George Pataki (a Republican!) sent a letter to his fellow Northeast governors, inviting them to join a regional effort to reduce carbon emissions.

What followed was a largely rational, multi-year, multi-stakeholder process that yielded agreement and action — a rare thing in the age of partisan politics.

During that process, two key decisions were made, design choices that have ensured the policy remains both effective and broadly popular. There are lessons here for federal policymakers (should their attention ever again turn to carbon).

Understanding those choices requires a little (only a little, I promise) background on how cap and trade and RGGI work.

First: RGGI is not an economy-wide system. It applies to fossil-fuel power plants of 25 MW or greater (just shy of 170 facilities).

MJB&A

RGGI states set a declining cap on the total greenhouse gases permitted from those facilities. The reporting cycle is in three year increments — every three years, each facility must report its total tons of carbon emissions and submit an equal number of emission allowances.

(I won’t bore you with the details on reporting and tracking, but they are remarkably transparent.)

Every quarter, the states (through the third-party organization they’ve set up) issue a number of allowances equal to the cap; as the cap declines, the number of allowances declines.

That brings us to the two key decisions.

1) Permit auctions: how carbon value is created

Every cap-and-trade system faces a key foundational decision. The government is issuing all the allowances — how should it distribute them?

At the time RGGI was being developed, the only cap-and-trade schemes running covered traditional pollutants (NOx and acid-rain particulates) and they had answered the question the same way: They gave the allowances away. Allowances were distributed to regulated entities based on their reported baseline emissions.

RGGI’s architects realized a few key things. First, by creating these allowances, the government was creating, in effect, a valuable currency.

Second, because the power plants regulated by RGGI were operating in restructured electricity markets — in which power generators compete on open wholesale markets — they were going to capture the extra carbon value in their wholesale price bids anyway. The price of allowances would be incorporated in the market. If they were also given allowances for free, the power generators would effectively be receiving windfall profits — extra money for nothing.

So instead, RGGI designers decided to auction the permits, once per quarter. They would require power generators to pay for allowances, but they would allow the market to set the price.

This choice had several virtues. First, it created a source of revenue for governments (more on that later). Second, it ensured that every ton of carbon cost the same and every system participant had the same information about cost. And third, it allowed regulators to put in a reserve price — a lower bound on prices, beneath which allowance value could not fall, which served, when needed, as a kind of de facto carbon tax.

The decision to auction caused considerable blowback among generators and some regulators, who were used to the old model, though big energy consumers supported it. But — skipping ahead! — it turns out that that the auctions have been so predictably and transparently administered that they have made believers out of many previous skeptics. They have run without a hitch for almost eight years now.

(The allowances are tradable on secondary markets — the “trade” part of cap and trade. They are also “bankable,” which means generators can buy extra and put some aside to cover possible spikes in future years.)

2) Program spending: how carbon value is distributed

The auctions were not a mandatory part of the program, but RGGI governments have overwhelmingly opted for them. It creates a nice little pot of money for them to spend. Before the auctions started, participating states agreed to spend at least 25 percent of the revenue on consumer-benefit programs — energy efficiency to reduce bills, financial supports, etc.

In practice, however, governments have spent far more than 25 percent of the money on consumer-benefit programs. The bulk of the money has gone to energy efficiency programs, with substantial chunks also going to community renewable energy and direct bill assistance.

Only two states, New York and New Jersey, have diverted RGGI funds to pay off state deficits. Both were roundly criticized by environmentalists.

The investment of RGGI auction funds — a cumulative $2.6 billion since the program started — has, according to multiple studies (see, e.g., here and here), produced enormous health and economic benefits. As Jackson Morris of NRDC summarizes, RGGI funds:

• Created 30,000 job-years (a job-year equals one year of full-time work);
• Saved consumers $618 million on energy bills, with billions more expected;
• Generated $2.9 billion in regional economic growth; and,
• Produced $5.7 billion in public health benefits.

This handy site breaks down the program’s benefits state-by-state.

RGGI’s experience along these lines is highly germane to the ongoing debate over what to do with the revenue produced by a carbon price (carbon tax or cap and trade). Some argue for using it to reduce other taxes. Some argue for returning it to citizens as dividends. Some argue for investing it in clean energy and environmental justice. (This argument divided Washington greens last year, leading to the failure of a carbon tax initiative.)

RGGI states are free to dispense with the revenue however they choose, but they have all opted for some mix of “energy efficiency measures; community-based renewable power projects; credits on customers’ bills; assistance to low-income customers to help pay their electricity bills; greenhouse-gas-reduction measures; and education and job training programs.” These are all visible benefits (unlike tax reductions) that activate particular constituencies (unlike dividends), leading to a more politically secure program.

In short: RGGI was developed through a relatively orderly process; it was smartly designed to fund needed clean energy efforts and build political resilience; it is generally popular among Northeast stakeholders.

That is the good news.

The bad news: RGGI isn’t reducing carbon emissions much, if at all

What RGGI does, it does well. But the sad truth is that it doesn’t do the main thing carbon policy is supposed to do. It raises money to fund good programs, but the relatively small carbon price it imposes on a relatively narrow slice of the economy does not, in and of itself, drive many (or possibly any) carbon reductions that wouldn’t have otherwise occurred.

As the MJB&A report notes, during the policy development process, a modeling exercise was run to assess the economic impacts of various design choices. It showed “generally within two-hundredths of 1 percent change in economic indicators.” It is not a knock on RGGI to say that a program with 0.02 percent impact on the economy is not going to spark a new industrial revolution.

The amount of carbon emissions covered by RGGI is relatively small. A 2016 report from the Congressional Research Service found that “the total CO2 emissions from the nine RGGI states account for approximately 7% of U.S. CO2 emissions” and “the CO2 emissions from covered entities in the RGGI states account for approximately 20% of all GHG emissions in the RGGI states.”

Twenty percent of 7 percent is 1.4 percent of US emissions — not nothing, but modest.

What’s more, while carbon emissions from the electricity sector in the Northeast have indeed been falling, there’s little evidence that RGGI had much to do with it. Instead, as happened across the country, coal was replaced by natural gas, while renewable energy and energy efficiency also grew. (Northeast states also got a big boost in hydro.)

(CRS)

When they first set the cap, regulators completely underestimated these trends. They capped emissions based on 2005 estimates of what 2009 emissions would be.

By the time 2009 rolled around, emissions were already well under the cap. They remained under the cap until 2014, when RGGI states agreed to reduce the cap by 45 percent, from 165 mtCO2 to 91 mtCO2, from whence it will decline by 2.5 percent each year between 2015 and 2020.

Here’s a chart showing the old and new caps alongside actual emissions:

(CRS)

The cap itself didn’t force any emission reductions between 2009 and 2014. It was way above actual emissions! The auction reserve price — “originally set at $1.86 per allowance for the first RGGI auction in 2008, increasing 2.5 percent annually, standing at $2.10 in 2016,” according to MJB&A — acted as a small carbon tax, but not one large enough to shape broader market dynamics.

CRS’s somewhat dismal conclusion is that “from a practical standpoint, the RGGI program’s contribution to directly reducing the global accumulation of GHG emissions in the atmosphere is arguably negligible.”

How RGGI could be a true success

It’s too soon to tell what the effect of the new, tighter cap will be. Auction prices did spike a bit at the end of 2015, but they have since returned to early 2014 levels. They will have to get pretty high to meaningfully accelerate what is already an ongoing trend of decarbonization in the power sector.

A cynic might say that RGGI is popular largely because it hasn’t had much in the way of teeth. So far, it has drafted behind, and benefited from, larger trends in the power sector. Allowance prices have been inoffensively low; most generators have benefited more than they’ve been hurt; state lawmakers like having the money to spend. Who’s to complain?

I’m not that cynical. RGGI does reflect genuinely good policy design. The auctions are fair and transparent. The spending has largely been in keeping with the spirit of the program. The way it addresses “leakage” (don’t ask) is not perfect, but it’s not terrible. Overall it’s a nice piece of work, a credit to all involved — relative to national politics, a friggin’ miracle of comity.

But it won’t be a true success until it starts to drive meaningful reductions in carbon emissions. There are three (complementary) ways it could do that.

One, it can grow, to include more states. That seems a dim prospect given the current condition of politics and Republican domination at the state level, but such efforts should never be abandoned. (Keep hope alive!)

Two, it can reduce the cap much faster. That would inevitably mean more political friction. It would drive allowance prices high and eventually force the stranding of assets, putting some power plants out of business before the end of their lifespans and raising (solvable, but real) concerns about reliability.

Three, it can expand beyond the power sector to cover other big carbon sources — the biggest targets being fossil fuels used in transportation and heating. This is the only real long-term solution, in my view, but it’s also the most difficult. It will increase the program’s administrative complexity and the amount of political resistance it faces.

RGGI is an effective, well-run program, but its popularity is, in a sense, evidence of its inadequacy. The urgency of the climate problem is such that any policy ambitious enough to seriously address it is going to cause some socioeconomic friction. There will be losers.

When RGGI has haters — that’s when we’ll know it’s working.

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