Roger Caiazza
Independent Researcher and Publisher,
Pragmatic Environmentalist of New York

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[Editor Comment: Roger offers a thoroughly professional perspective on the trendy subject of carbon pricing, which is theoretically brilliant but impractical.]

The Federal Energy Regulatory Commission (FERC) hosted a technical conference regarding Carbon Pricing in Organized Wholesale Electricity Markets on September 30, 2020.  I had an overview post published at the Watts Up With That blog.  This post addresses potential implications of the conference on New York policy.

I first became involved with pollution trading programs nearly 30 years ago and have been involved in the Regional Greenhouse Gas Initiative (RGGI) carbon pricing program since it was being developed in 2003.  I have been following the New York carbon pricing initiative since that began.  I understand the basis of the rationale for a carbon price and understand some of the complexities associated with implementing such a program.  I write about the issues related to the energy and environmental interface from the viewpoint of staff people who have to deal with implementing these programs.  This represents my opinion and not the opinion of any of my previous employers or any other company I have been associated with.

World Carbon Tax Map

Background

Carbon pricing is a climate policy approach that charges sources for the tons of carbon dioxide that they emit.  A Resources for the Future summary lists several attributes that they claim makes carbon pricing more attractive than other potential policies to reduce carbon dioxide emissions:

• Carbon pricing allows emitters to choose the most efficient method to reduce emissions.
• An economy-wide carbon price applies a uniform price on CO₂ emissions regardless of the source.
• A carbon price encourages individuals and businesses to reduce their carbon emissions more than conventional regulations.
• A carbon price creates a new revenue stream that can be used in a number of ways.

The problem is that there is a large gap between the elegant theory of carbon pricing and real world carbon pricing.  In theory applying a carbon price across the globe on all sectors could work as advertised but the reality of a carbon price for one sector in one limited area is that it is a regressive tax and a prescription for potential leakage and misapplied price signals.

• Proponents have convinced themselves that somehow this is different than a tax but, in my experience working with affected sources, any carbon price is treated just like a tax and very rarely is it used to offset other taxes. It is paid by all who consume electricity including those who can least afford it so it is a regressive tax.
• Pollution leakage refers to the situation where a pollution reduction policy simply moves the pollution around the globe rather than actually reducing it. Similarly, economic leakage is a problem where the increased costs inside the control area leads to business leaving for non-affected areas. There also is an economic leakage effect in electric systems where a carbon policy in one jurisdiction may affect the dispatch order and increase costs to consumers in another jurisdiction.
• The revenue stream from a carbon pricing stream could be very large. In the classical theory those revenues are re-distributed to offset other taxes so that the consumers come out whole.  In practice all or part of the revenues have usually been diverted away from direct consumer rebates to fund carbon reduction programs.
• If a carbon price is being used to fund reduction programs there is a fundamental problem. As CO2 is reduced revenues decrease and eventually either the carbon price has to increase to a very high level or the revenues used to fund reduction programs will insufficient.
• Market participants don’t behave as expected by economic market theory so the markets don’t necessarily behave as the economists think they should. As a result, all the modeling and laboratory testing results should be viewed cynically.
• The carbon price signal is inefficient. I think that the full cost for CO2 reduction options exceed the negative externality costs that are the rationale for the carbon price.
• The carbon price signal is indirect. Because there are no cost-effective add-on controls for CO2 reductions, affected sources need to switch to a lower emitting fuel or be replaced in whole or part by alternative generation.
• In order to replace firm, dispatchable capacity the total costs to make in-kind replacement with renewable wind and solar are high and often not included in carbon price planning.
• Often overlooked are the daunting problems of the implementation logistics of a pricing program.
• Finally, a real-world study by the Regulatory Analysis Project, Economic Benefits and Energy Savings through Low-Cost Carbon Management, raises additional relevant concerns about carbon pricing implementation. They basically conclude that if you want to reduce carbon emissions it is more effective to target your financing to get the biggest reduction bang for the buck than to set a carbon price.

The September conference was held in response to requests for a technical conference to address this topic.  According to FERC:

“The purpose of this conference is to discuss considerations related to state-adoption of mechanisms to price carbon dioxide emissions, commonly referred to as carbon pricing, in regions with Commission-jurisdictional organized wholesale electricity markets (i.e., regions with regional transmission organizations/independent system operators, or RTOs/ISOs). This conference will focus on carbon pricing approaches where a state (or group of states) sets an explicit carbon price, whether through a price-based or quantity-based approach, and how that carbon price intersects with RTO/ISO-administered markets, addressing both legal and technical issues.”

My other post described the three panel discussions at the conference:

• Legal Considerations for State-Adopted Carbon Pricing and RTO/ISO Markets,
• Overview of Carbon Pricing Mechanisms and Interactions with RTO/ISO Markets, and
• Considerations for Market Design.

Experts were invited to submit comments to FERC before the conference (available in the event details).  During the conference each expert gave an opening statement and then FERC Commissioners posed questions to the panelists.  There is an audio recording of the conference available and I added the approximate times of each speaker to a copy of the agenda here.

New York Participation

There were three panelists from New York.  Two panelists from the New York Independent System Operator (NYISO) participated. Richard Dewey, President & CEO, was a panelist on the Overview of Carbon Pricing Mechanisms and Interactions with RTO/ISO Markets panel and Rana Mukerji, Senior Vice President, Market Structures, was on the Considerations for Market Design panel.

If you recall the NYISO carbon pricing proposal it is not surprising that both their submittals and comments were more or less advertisements for their proposal and arguments supporting it.  Michael Mager, counsel to Multiple Intervenors, an association of approximately 60 of New York’s largest industrial, commercial, and institutional energy consumers, also participated in the Considerations for Market Design panel.

According to Dewey:

“The NYISO firmly believes that its Carbon Pricing Proposal is the best option to maintain efficient competitive wholesale electricity market outcomes and to provide New York State with a powerful tool to achieve the CLCPA requirements. Carbon pricing in the NYISO’s wholesale markets has the strong advantage of signaling where new resources should locate for the highest value to the system and consumers. Internalizing a state-determined social cost of carbon dioxide emissions in the NYISO’s energy market pricing would send a meaningful financial investment signal to developers that identifies efficient ways to address State-mandated carbon emission reductions while more efficiently incenting resources to locate and perform according to the needs of the system.”

Mukerji said “In June 2019, the NYISO presented a complete Carbon Pricing Proposal to its stakeholders after nearly two years of stakeholder discussion and design effort. Reflecting a meaningful state/regional-determined price of carbon dioxide emissions in our wholesale electricity markets will allow the co-optimization of energy and ancillary services to develop least-cost solutions that maintain competitive markets and reliable operation of the electric system, while more fully considering the direct economic implications of state and regional initiatives to promote efficient market outcomes.”

Mager was unique amongst the panelists in that he represented electric consumers.  He has been immersed in the NYISO carbon policy development process and noted that “the development of a draft carbon pricing proposal within the NYISO stakeholder process revealed a number of areas of concern for large energy consumers that warrant consideration”.  He brought up four concerns:

• The appropriate scope of a carbon pricing program, specifically the concern that NYISO’s single-sector, single regional transmission organization proposal would cause leakage;
• How the carbon price would be calculated and updated;
• How the carbon revenues would be treated; and
• Whether carbon pricing can be implemented in a manner that protects consumers from double payments.

The first three concerns were addressed above.  The fourth concern is an implementation issue related to the fact that consumers are already paying for programs to reduce carbon emissions and it is a concern that adding an electric system carbon price will mean consumers pay for that and the old programs too.

Carbon Pricing Theory

The comments submitted by Joseph Bowring, independent market monitor for PJM, represented the majority opinion of the participants: “a market approach to carbon is preferred to an inefficient technology or unit specific subsidy approach or inconsistent RPS rules that in some cases subsidize carbon emitting resources”.  While I don’t disagree with the sentiment, I want to point out that it also represents a bias of most of the participants who work with electric markets.  Namely, a carbon price simplifies their lives because they only have to deal with one carbon policy and not a whole host of rules and subsidies that often have unintended consequences to the electric system.

Nearly every panelist who participated recognized that the theory of a carbon price works best across all sectors and, in this case, across all jurisdictions covered by FERC.  One thing that was missing in the conference was a discussion of the cutoff point the between the likelihood of success for a national carbon price across all sectors and the reduced possibility of success for the much more likely single-sector price in limited jurisdictions.

I do want to call out one carbon theory comment.  Dr. Matthew White, Chief Economist (ISO New England), noted during his comments (starting at the 3:25:55 mark of the audio) that as an economist he supported carbon pricing because “it can be simple, transparent and cost effective”.  He went on to claim that the experience with the Acid Rain Program supported carbon pricing:

“To see this you don’t have to rely on economic theory you can look no further than our nation’s experience with the sulfur dioxide market and how that priced emissions over the last three decades. That program has effectively curbed our region’s acid rain problem as it did throughout much of the United States.  It has done so at far lower cost than policy makers anticipated and it presented no impediments to the nation’s electricity markets nor to my knowledge the system’s reliability.”

Unfortunately, Dr. White picked a poor example of a market-based program as a comparison to carbon pricing.  While there is no doubt that the Acid Rain Program (ARP) was responsible for massive reductions and did so at much lower than anticipated costs the key question is why did that occur.  There are cost-effective add on controls for SO2 and many facilities installed those controls but there aren’t any similar options for CO2.  One of the biggest unanticipated results of the ARP was fuel switching to coal with lower sulfur contents.

That was cost-effective because the railroads were de-regulated and it became economical to ship coal from Wyoming’s Power River Basin all over the country.  While fuel switching is a viable control option for CO2 the fact is that nearly all the coal and most of the residual oil generation in New York and New England has already switched so future reduction potential from fuel switching is small.  The supposition that the success of the ARP means that a carbon pricing scheme will be successful is not supported by the observed reasons for the ARP reductions.

Wolak Comments

I also want to highlight the comments submitted by Frank A. Wolak, Director, Program on Energy and Sustainable Development, at Stanford University as they relate to carbon pricing theory and New York policy.  He makes three points:

“First, carbon pricing is the “least cost” way to reduce the carbon content of an electricity sector, and of a national or global economy. Second, it is impossible to measure the carbon content of electricity imported into a regional wholesale electricity market from a neighboring control area. This fact has important implications for policies aimed at limiting GHG emissions leakage. Third, in an uncertain economic environment there is a difference between a carbon tax and a cap-and-trade market. This fact is increasingly relevant to regions with significant intermittent wind and solar generation resources.”

Frank A. Wolak

Wolak makes an interesting argument for the effectiveness of carbon pricing: “subsidizing green is a much more expensive way to reduce GHG emissions than taxing brown.” He explains that the subsidies used to build clean, green facilities ensure that they get built but does not guarantee emission reductions.  He points out that “the process of raising these revenues destroys economic value. Less of the product or service providing the subsidy is produced and consumed. The larger the subsidies paid, the greater the amount of economic value that must be destroyed to finance them.”

On the other hand, taxing emissions or “brown” makes it more expensive to produce GHG emissions.

“The resulting higher price of goods and services that contain GHG emissions provides strong incentives to find the cheapest, least greenhouse-gas-emitting replacement.”  He claims that “The case for carbon pricing is clear relative to policies that subsidize less GHG-emissions-intensive energy sources. In fact, many studies even find that these subsidy policies increase national or global GHG emissions.”

His second point is especially important relative to the NYISO carbon pricing proposal.  He uses the current situation in the California market to argue that it is impossible to estimate out-of-jurisdiction carbon emissions.  He explains: “Measuring the carbon content of electricity produced in California is straightforward. The GHG emissions of all in-state generation units are measured in real-time.

By contrast, with electricity imports, only the flows of energy into the state can be measured, not what color the electrons are—green, brown, or other shades in between.”   It turns out that trying to handle this has been “a source of never-ending debate among stakeholders”.  He concludes “The only definitive conclusion from this debate is that there is no right answer, except to have the geographic footprint of the carbon market be at least as large as the geographic footprint of the wholesale electricity market.” From what I have seen of the NYISO proposal for a New York only carbon price, it will engender the same amount of debate and lack of a right answer.

His third point concludes that carbon pricing is the least cost path to reduce GHG emissions and that “a carbon tax rather than a cap and trade market is likely to do this at a lower cost to consumers and less administrative burden in both the short and long term”.   In this context I agree but not for the underlying reasons he gives.  For the affected sources the reality is that carbon cap and trade markets are treated like a tax so all the administrative burdens just add to the cost.

From what I have seen many economists don’t realize that fossil-fired generators in de-regulated markets have very short-term outlooks and purchase allowances from a cap and trade program merely as a cost of doing business.  The future cost of carbon is not as important to their plans as economic theory would suggest and nobody is buying allowances as an investment strategy.

Conclusion

My ultimate problem with carbon pricing, in general, and the NYISO carbon pricing proposal, in particular, is that the reality of any carbon pricing scheme that can get implemented is nowhere near the global, all sector ideal.  Sadly no one at the conference offered a suggestion for a cutoff point that would ensure success in the range between the two extremes. As shown, there are a whole host of practical problems that have to be overcome for a carbon price to successfully reduce CO2 emissions, maintain affordability and preserve current reliability levels.  To date, NYISO has given short shrift to the practical concerns raised by Mr. Mager and myself.

Practice vs. Theory

There are vocal advocates for carbon pricing and their views were well represented at this conference.  I believe that those who support carbon pricing on theoretical economic grounds are overlooking or are unaware of the practical issues I have raised.  Most of the other supporters clearly have vested interests.  The electric system operators are simply looking for an easier way to deal with the admittedly ineffective and potentially dangerous to reliability policies currently in use.  Others smell a revenue stream and want to glom onto that money for their own interests.  As I have shown for NY that may not necessarily be the best thing for electric system consumers.

Mike Mager’s comments sums up the situation well:

“In conclusion, the debate about the pros and cons of carbon pricing cannot be divorced from the numerous underlying, implementation-type issues, the resolution of which may have significant impacts on consumers.”

Reposted, with permission, from the Pragmatic Environmentalist of New York blog by meteorologist Roger Caiazza.