Pennsylvania Legacies #202: Carbon Pricing 101 (repeat)

Josh Raulerson (00:01)
It is Friday, October 13th, 2023. I’m Josh Raulerson, and this is Pennsylvania Legacies, the podcast from the Pennsylvania Environmental Council. More than 18 months after officially joining the Regional Greenhouse Gas Initiative, Pennsylvania’s bid to begin selling carbon allowances on the RGGI carbon market is still in the hands of state courts. A decision could come at any time from either the Commonwealth Court, which is weighing challenges to Pennsylvania’s RGGI program, or from the State Supreme Court, which could overturn an injunction that blocked the Commonwealth from participating in the market back in 2022. That latter outcome, a Supreme Court ruling in RGGI’s favor, would essentially clear the way for full participation, unlocking billions in potential proceeds and even more in federal funding for the clean energy transition. A thumbs down from the lower court would put the decision to appeal in Governor Josh Shapiro’s hands. The Governor hasn’t said where he would land on that question, although his first budget proposal last spring did include hypothetical RGGI revenues.

Candidate Shapiro had pledged last year during the gubernatorial campaign that he would consult with key stakeholders on the matter, asking them to study Pennsylvania’s options for decarbonizing power generation and report back. Well, that report from the Governor’s RGGI Working Group arrived in September, following months of dialogue between industry, labor, environmental and consumer advocacy leaders. PEC had a seat at that table, where we helped make the case that RGGI participation would satisfy the Governor’s three-part test for energy policy, namely reducing greenhouse gas emissions, protecting consumers, and employing Pennsylvanians in the energy sector. While working group members didn’t necessarily see eye to eye on all the details of Pennsylvania’s existing RGGI program, the discussions did reveal a previously unseen level of agreement on both the need to cut emissions quickly and the benefits of a cap-and-invest model like RGGI. They also acknowledged that RGGI is effectively the only option for advancing Governor Shapiro’s decarbonization agenda in a timely manner.

Any viable alternative, the panel concluded, would take years to establish and might never pan out at all, whereas RGGI is already in place and ready to go, with a 15-year track record of success in states that have already joined. The only thing we need to begin realizing RGGI’s economic potential in Pennsylvania is a green light from the courts. The name of the game right now is Hurry-Up-and-Wait. So while we’re waiting, we thought what better time for a little refresher on what RGGI is, how it works, and why we think it’d be a game changer for Pennsylvania. We explored those questions several years ago in conversation with Franz Litz, a policy expert and one of the original architects of the Regional Greenhouse Gas Initiative. A lot has happened politically since we first published that interview, but it’s still a pretty solid primer on the mechanics and underlying principles of the RGGI model. So here it is, episode #108 from October, 2019. Enjoy.

Franz, welcome to Pennsylvania Legacies. Really excited to have you here.

Franz Litz: (03:15)
Thanks for having me, Josh. Great to be here.

Josh Raulerson: (03:18)
So I want to start with really basic stuff. A lot of Pennsylvanians are probably hearing this, this term, the Regional Greenhouse Gas Initiative for the first time, and maybe others have heard it, but are unfamiliar with what it actually means. So since you, I understand we’re kind of there at the beginning, why don’t we start at the beginning. Tell me what is RGGI, how did it kind of get off the ground and what’s the goal? Where’s it going?

Franz Litz (03:40)
Yeah, I, I was, with New York State when RGGI got off the ground originally, and it started with the Republican governor of New York reaching out to his counterparts across the northeast and mid-Atlantic and saying, Hey, let’s get together and do something about carbon pollution from power plants. And he was very interested in approaching it from a market-based vantage point. As you may know, these market-based instruments have long been the preference of economists and Republicans — really, those who, who look for ways to reduce pollution with great flexibility. So Governor Pataki, the Republican governor of New York, reached out to his counterparts. And in those early days, it was mostly Republican governors from the other states. It was about six of the nine were Republican, the other three were Democrats. We all came together around one table and designed a system that could get reductions of carbon pollution from power plants across the region in the most cost effective way.

Josh Raulerson (04:45)
Okay. So, so the most cost effective way, I’d like to drill down a little bit and get a better handle on what that actually means at the level of, of the mechanics of the RGGI model. Can you sort of break it down and explain how it’s different from other approaches that states have taken or have considered to regulate carbon? Whether we’re talking about this in, in a market context or something else.

Franz Litz (05:06)
So the first thing you do when you’re setting up a program like RGGI is you decide what sources of pollution you want to regulate. And in this case, the state said we’re, we want power plants to emit less pollution. And so power plants were the sources. And what we did is we asked ourselves the question, well, how much pollution is coming out of the power plants at the start of the program that became our baseline or our starting point for the program. And then we said, over time, we want that amount to decrease. And so we established a cap, a cap on emissions that began at current levels and declined in a relatively modest way over time. And the way that functions is the states set a cap and then they issue allowances. They’re called, they’re really like permits. One permit for every ton that’s permitted to come out of the smoke stacks of power plants, and then they sell those allowances.

Power plants have to buy them, and they’re not allowed to emit a ton of pollution without having one allowance to cover that ton of pollution. So the government is saying, we’re going limit the total amount of pollution that comes out of power plants,  but we’re going let those power plant owners decide which of them reduce their emissions and which of them buy allowances to cover their pollution. And so what the net effect is that the marketplace — and that’s why we call it a market-based mechanism — the marketplace decides where the cheapest reductions are, and that leads to the most cost effective result. And then over time, the cap gets lower and it just kind of ratchets down as we go.

So in the first year, you might issue enough allowances to, to equal the emissions where your, your starting point is, but over time, each year goes by, you’re, you’re issuing, in this case, selling fewer of those allowances. And so overall, the total number of tons that end up in the air goes down and down and down. And in the RGGI program, the emissions for the participating states is about 45 to 47% lower than it was in 2005. So the program has achieved and locked in some very significant emission reductions over the last 10, 11 years that it’s been in place.

Josh Raulerson (07:23)
So the rates that are set are, are not arbitrary. There’s a process, there’s a way that they’re determined. I’m assuming this happens at least to some degree at the state level. How much kind of autonomy do the states have in making those determinations? How do you actually decide where the cap is?

Franz Litz (07:40)
The RGGI states each have implemented a separate program that operates and stands on its own. And what they’ve said to each other is, we will accept each other’s allowances across state borders. In other words, we will let our power plants use in New York allowances that Massachusetts issued and vice versa. And across those states, they’ve linked their programs up and they’re linked by the mutual acceptance of each other’s allowances. Now, the way RGGI has worked, even though it is a set of separate independent programs that stand on their own, the states have come together, of course, and this was from the very beginning. They came together and said, how do we want design this program? And they developed what we call a model rule. It’s a like a model set of rules. Presumably, Pennsylvania would start with this model set of rules and, and look at it and say, which things do we like? Which things don’t we like? What can we live with, what can we not? And they’ll talk about any changes they’d like to make with the other states. But very early on the states, in developing that set of rules, they had to do a number of things. The first was to understand where the emissions were likely to go in the power sector without the program in place. And to understand that the states do computer modeling, they use a computer to simulate the electricity system. And by doing that analysis, they get a sense of what the cost will be when they impose different cap levels, different reductions in emissions over time. And after doing some of that analysis and getting comfortable with where they thought the cost would be, they then decided on the cap and they decided on how quickly the cap would decline over time.

And they also discussed amongst themselves ways to make sure that the cost of the program stays within expected bounds. And to achieve that result, they implemented a couple of features in the program. We, you know, we call it a price collar or cost containment mechanism. And essentially what the states are doing is they’re saying, if the price of these allowances goes higher than we expect, what we’ll do is we’ll, we’ll float some more allowances into the system. We’ll ease up on the supply constraint through what is called a cost containment reserve. And by adding a little bit of supply to the system, the cost is kept down. There’s also a converse mechanism, a, a countervailing force that if, if the cost ends up cheaper than the states thought, they’ve implemented what is called an emissions containment reserve. And essentially in that event, if it turns out that it was a lot cheaper to get these reductions than we thought, we could afford a deeper reduction than what the emissions containment reserve does, is it takes allowances out of the system and we get a, a quicker reduction over time. So what the states essentially have done is they’ve set the stringency of the program, how quickly the cap goes down with reference to some very sophisticated modeling, which has proved to be a very effective method over the past 10, 11 years of RGGI history. And they’ve also said, you know, in addition to understanding where we think the price would go, we’re also going to implement these two mechanisms that are gonna be designed to keep the price within a reasonable bound.

Josh Raulerson (11:05)
In some ways, Pennsylvania being a few years late to the party, so to speak, has the luxury of being able to look at what other states have done and how it has played out for them. What can you tell me along those lines? Like you were talking about the computer models. Have those proven to be pretty reliable? Is that reassuring to people that might otherwise have doubts? 

Franz Litz (11:22)
Yeah, the computer model that’s used by the RGGI states is a model that’s also used by EPA, it’s used by utilities in planning the system. So it’s, it’s a pretty well respected analytical tool that helps policymakers understand what the potential impacts are of a policy like RGGI. And it’s been used by the RGGI states from the very beginning. So RGGI got started back with a, with an MOU among the governors in December of 2005. It launched in 2009. And then every three or four years since the program launched, the states have gotten together to do what they call a program review. And that program review is a way for the states to come together around a table and say, how is our program design working? Are things progressing as we thought? And I think what we can say is the modeling tool that’s used is very conservative. It tends to, it tends to give the states policymakers and stakeholders a sense of a worst case scenario. Really, the costs that the model tend to project are higher than what has been actually happening in, in the real world. And, and that’s actually a really good thing for policymakers who tend to be conservative, conservative with a small C, they want to make sure they take measured steps. And indeed RGGI has been a pretty modest program over time. I think objectively we can say the carbon prices in the program have been quite low. Nevertheless, RGGI plus other factors in the electricity system have, uh, led to some pretty steep reductions. So as I mentioned, 45% below 2005 levels in the RGGI states, which, in case you’re wondering or your listeners are wondering, that’s about a 90% deeper reduction than seems to be happening in other states that don’t have the program in place. 

Josh Raulerson: (13:22)
So with that information, and again, being able to look at what the experience of the other states has been over the last 10 or 11 years, what, you know, inferences might we be able to draw about how this transition might play out in Pennsylvania, what would you anticipate over the next few years if Pennsylvania enters RGGI?

Franz Litz: (13:38)
So the good news for a state like Pennsylvania that is thinking about doing a program like RGGI and, and linking up to the RGGI states is there are a lot of trends in the sector itself that really lend themselves to an easy path ahead. For example, low natural gas prices that’s already working to shift us away from higher carbon resources and toward lower carbon resources. Renewables costs are decreasing, as we know in the market, which is, which is of course making it less expensive. And in some case, wholly cost competitive to have a zero cost, zero operating cost resource like solar or wind on the system. And so these other market forces are in play at the time to, I think, make it a very reasonable and positive trend for getting on board with a program like RGGI for Pennsylvania. So I guess what that comes down to is it should be fairly straightforward and relatively low cost.

Josh Raulerson (14:41)
So fairly low cost, fairly low risk in a lot of ways. What about the positives? People that are supportive of, of Pennsylvania entering RGGI will often cite there’s all these new revenues out there. That’s, that’s a way to kind of bring people along politically with the process. You know, certainly PEC is one of the groups that have been supportive of this move. And we like to say that this is money that can be used to promote innovation to, to sort of soften impacts on consumers. Like, you know, the energy cost that you mentioned. What are we actually talking about in terms of revenue? How much might we be looking at what could be done with that? What are other states doing, I guess, with the money they’re bringing in?

Franz Litz: (15:20)
Yeah, I’m glad you raised this. So RGGI works in really two chief ways. One is through the cap that I described, which locks in emissions across the sector. The other very important way that RGGI acts is, I mentioned that the allowances get sold. The states have come together, the RGGI states have come together and they designed and built an auction platform, which is something that already exists and Pennsylvania could utilize when it linked up with RGGI. And so every, every quarter they sell about a quarter of the allowances that are part of the cap for that year. And that generates revenue, if you want to get a sense of how much revenue. It’s, uh, the price has been hovering around $5 a ton, recently, and Pennsylvania will have a, would have a cap of ballpark, 75 million tons each year. So you could take 75 million times it by $5, and that’s roughly your annual revenues that could be generated through this kind of an approach in Pennsylvania. What the states in RGGI have used that money for, it varies a little bit across the states. It would be up to Pennsylvania to decide how they would spend that revenue. Some ways, just to give you a sense of what’s been going on in the other states, most of the states have used a lot of that money to invest it in energy efficiency measures. Energy efficiency is the cheapest. We like to say it’s the cheapest way to reduce emissions. And part of the reason why is when you use less electricity, you’re not paying for the electricity. And so by investing in energy efficiency, you, you have a kind of multiplier effect. You may invest a dollar, but you end up getting multiple dollars in back in benefit. So energy efficiency has been a chief investment. Some states have used it to invest in renewables, solar, some have invested it in ways to get more storage on the system, energy storage, which helps us better utilize variable resources like, solar and wind. And at least one state, Maryland, has used it to offset consumer impacts and they’ve used about half of their money to directly rebate to customers. So that gives you a sense of how that revenue has been used in other states.

Josh Raulerson: (17:42)
And certainly we would hope that however the revenue gets used, it’s in a way that furthers the, the larger goal of decarbonization. But at the end of the day, right, there’s really, it’s really up to the states. Is that right? I mean, they can kind of spend this money more or less however they want.

Franz Litz: (17:56)
It’s really up to the states how that those allowances are distributed and um, if they’re auctioned, how that money is used. Each state is, has sort of been given an ability to make that decision themselves.

Josh Raulerson: (18:11)
And we’ve been talking about this mostly in terms of how Pennsylvania might be affected by this change. Can we come at it from the other direction and talk about how Pennsylvania entering this market would affect the market? What’s the bigger picture? 

Franz Litz: (18:23)
Yeah, that’s a good question. Pennsylvania has an emissions from this sector on the order of 75 million tons a year. That’s about the same as all the other RGGI states combined presently. So Pennsylvania would roughly double the emissions in the program covered by the cap. And so Pennsylvania would be, you know, roughly half the program if, you know, measured in terms of emissions.

Josh Raulerson: (18:52)
And this helps the other states? Is that good for everybody?

Franz Litz: (18:55)
So I mentioned that when the states come together and talk about program design, they use a, a computer model to give them a sense of what would happen if they were to lower the cap more by X amount. Well, that same kind of an analytical exercise will need to be done as Pennsylvania develops its rule. I mean, if I were advising Pennsylvania, I would say use the same model as RGGI. They did use that model in connection with the climate action plan. So I suspect that is what they will do. And then the fact that they’re using that same analytical tool will make it easy for both Pennsylvania and the RGGI states to better understand what happens when you bring, you know, such a big state into the program. And using that tool, they can set Pennsylvania’s cap in a way that doesn’t upset the apple cart. And by that I mean not only in a way that makes sure that the price doesn’t go too high, but also that it doesn’t go too low. The RGGI states are interested in keeping the allowance price in roughly the same range where it is.

Josh Raulerson (19:55)
RGGI obviously centered on the northeastern states, and I understand there are similar kind of analogous programs happening in other parts of the country. And I’m just curious why is that, why is it that these markets tend to be clustered in geographic regions? Is this a technological thing? Is it, is it legal, political? Why is it that way? And then what are other carbon markets in other parts of the country doing? How do they compare with the, with the RGGI system? 

Franz Litz (20:17)
Yeah, that’s a really good question. In theory, economists will tell us that the states do not need to be contiguous. You could, for example, have Illinois and Minnesota do a program like this and link up to RGGI, and it ought to work quite nicely, at least from an economic standpoint. The program would still work to locate the cheapest reductions. And the more states you have involved, the lower cost, the reductions will be, which of course means the deeper you can go. And the science is telling us, the climate science is telling us we need to go at least to 80% below by 2050. And many think that the electricity sector needs to be at zero carbon by 2050 if we’re going to achieve the climate goals. So the more the merrier, I think it’s a political thing more and perhaps a, you know, there is a sense that it’s better if the states are grouped together in a geographic cluster.

And there is one engineering reason for that. And, and that of course is that the electricity sector is all tied together. You know, for example, Pennsylvania is part of an electricity market called PJM that also brings in New Jersey and Delaware and Maryland and Virginia and Ohio and West Virginia. And so electricity markets are regional. And so perhaps that’s one reason why we’re seeing the clusters that are happening. We recently saw, for example, Virginia decide to do what Pennsylvania’s governor has announced it will do, namely implement a rule that will bring Virginia into RGGI. And of course, Virginia is contiguous as well, contiguous to Maryland. And so it added geographic scope to the program the same way Pennsylvania joining will in terms of what’s happening in the rest of the country. Out on the west coast, we have California, and California chose to implement a very similar kind of program, but they are covering more than just the electricity sector. They’re covering some industrial sectors also. They’re covering transportation fuels and home and building heating fuels, natural gas and heating oil. Here in this region, Pennsylvania and other states are exploring the potential for using this same kind of program. We call it cap and invest for transportation fuels. And that’s through a program called the Transportation Climate Initiative. But that program is still in its nascent stage; it’s being designed as we speak. So it would be lagging behind implementation of RGGI.

Josh Raulerson: (22:45)
So that area is not as far along yet, but in theory, there’s no reason why you couldn’t take the same approach to any number of sources of of carbon emissions.

Franz Litz: (22:53)
Yeah. So there’s the geographical question you, you pose, which is, you know, you could add more states to this program, and really the sky’s the limit. They don’t have to be contiguous to the existing states that are part of the program. And then there’s also this notion that you can also expand the scope in terms of the sectors. It doesn’t have to stay in the electricity sector. You can use this same kind of mechanism to cover transportation, fuels, industrial emissions. That just hasn’t happened yet.

Josh Raulerson: (23:18)
But it’s, it’s a more the merrier situation. And as time goes by, we would expect to see as the market gets bigger, it becomes more impactful in terms of achieving the things that we set out to achieve. Would we then approach a point at some point in the future, ideally, where it becomes more of a, a national or even a global single market, or is there some virtue to having it organized by region this way?

Franz Litz: (23:40)
One of the really nice things about this kind of a mechanism is we are focused on tons of emissions and each ton has an allowance associated with it. Every power plant, for example, in this program, will not be able to emit a ton of carbon without having an allowance in hand. Well, that’s a really neat currency. As long as you’re talking about tons, then you can connect RGGI or a program like it to any other program that is also about reducing tons in this way, in this market based way. So yes, your question’s absolutely right. It, it could be other states in the country, it could be programs in other countries. We have one example of that here in North America. California’s program is actually linked to the province of Quebec’s program. So the national borders don’t really matter either. You could use this kind of a mechanism to connect programs world worldwide in theory.

Josh Raulerson (24:34)
So there’s, yeah, there are no hard limits on how far you could scale it up at the same time, if the end goal is to get to zero at some point, you know, if, if the cap keeps getting lower year after year, you know, at some point we exhaust this avenue, I would think, What happens after that? What are the next steps this gets us on a pathway to zero carbon? Where does that pathway take us? 

Franz Litz: (24:55)
Yeah, that’s a great question. We’ve seen through decarbonization studies, including studies that have been commissioned by your organization, really good studies that give us a sense of what we need to do by mid-century across the economy. And I think it’s fair to say that this kind of a mechanism, this RGGi like mechanism is only one tool, and we’re gonna need lots of different tools to get us to zero carbon if that’s where we need to be in the electricity sector. A lot of people say we need to get to zero carbon in electricity because we’re going to have trouble getting to zero carbon in other sectors. We’re counting on electricity to carry a lot of the weight. If things go well, electricity ends up being the fuel that powers our cars, some of our trucks, our public transportation. It could power more of our, our home heating through things like air source heat pumps and ground source heat pumps.So electricity is expected to play a really big role going forward to decarbonize other sectors. But I certainly wouldn’t want to leave your listeners with the expectation that RGGI or a RGGI-like program is the only thing we need. The RGGI states, for example, if you go look across the RGGI states, they’re also implementing renewable portfolio standards that are designed to spur growth in solar and wind industries in their states and increase the percentage of power that’s generated by renewables. Some of these states have clean energy standards that are designed to help out nuclear plants that need help, and they have programs for energy efficiency investments beyond just the RGGI revenues. It’s almost like a, even within the electricity sector and all hands on deck kind of situation where, this is a great tool, it’s a low cost way to get reductions, but there are other tools in the toolbox and we need to be using many of them.

Josh Raulerson (26:41)
But certainly if you get electricity right, and a lot of the other pieces begin to fall in into place, hopefully,

Franz Litz: (26:46)
Yeah, I mean, electric vehicles, we seem to be on the cusp of a revolution for electric vehicles. A lot of manufacturers saying they’re switching over to all electric in the coming years. Just a proliferation of the models that are available for consumers. And if we do see an explosion, or if we do see a big uptake in electric vehicles, then we’re going to really want to make sure our electricity supply is getting cleaner and cleaner. Otherwise, you know, you’re just shifting emissions from one sector to another. It’s already cleaner to use an electric car than it is to drive a gasoline car. But if we’re going to get to decarbonization by mid-century, we, we need to make it even cleaner to drive electric.

Josh Raulerson: (27:24)
Franz, this has been really helpful. I really appreciate your time today.

Franz Litz: (27:26)
It’s been my pleasure, Josh. Thanks for having me.

Josh Raulerson (27:38)
That was our conversation with Franz Litz, of Litz Energy Strategies, about the Regional Greenhouse Gas Initiative, which he helped to establish almost 20 years ago. Franz Litz has contributed to a substantial body of work published by PEC over the years, looking at ways to substantially reduce greenhouse gas emissions from Pennsylvania’s electricity sector. Find all that research, those reports and recommendations on our [email protected]/energy. That’s pecpa.org/energy on the website. Of course, you’ll find all past episodes of this podcast and news, not just on PEC’s policy, work on energy and climate, but also our programs on trails and outdoor recreation with a focus on equitable access to the outdoors. Also our watersheds program and work on reforestation and legacy mining impacts information on all of that and more at pecpa.org. And that’s it for this episode. Thanks for tuning in. Hope you can join us for the next one. We release them every other Friday on the website and via podcast RSS. So, whatever podcast app you prefer to use, you can find us or just listen on your web browser via the aforementioned pecpa.org. Until next time, for the Pennsylvania Environmental Council, I’m Josh Raulerson and thanks for listening.