Friday, March 25, 2011

Renewable Portfolio Standards: The Future of Greenhouse Gas Regulation

In the absence of a federally mandated cap-and-trade program, many states are taking their own steps to reduce the harmful effects of CO2 emissions from coal-fired power plants (the largest contributor to nationwide CO2 emissions--about 40% of the total). This article talks about New Jersey's use of Solar Renewable Energy certificates as a way to make solar energy more economically feasible and help electricity producers comply with the state's Renewable Portfolio Standards.

This has a lot to do with what I'm working on at RFF, so I thought I'd give my comments on it :) New Jersey is one of the largest and fastest growing solar markets in the US (second to California!). Many states, including Jersey, have statewide Renewable Portfolio Standards (RPS), which require electric power companies to produce a certain amount of energy from renewable sources. This article talks about offsets in the context of Solar RPSs. If an electricity supplier does not comply with the RPS for solar power, they must either pay a large fine or purchase a Renewable Energy Certificate from a solar energy producer (like Rutgers University--the example in the article). This is the classic form of a marketable offset: electricity suppliers conduct their own cost-benefit analysis, weighing the cost of producing their own solar energy to meet the Renewable Portfolio Standards against the cost of purchasing a Renewable Energy Certificate. In many cases, purchasing the certificate is the cheaper option, so electricity suppliers continue to produce most of their power from "conventional" sources (burning fossil fuels), but these emissions are "offset" by firms that independently power their businesses with renewable, clean energy. The creation of the energy certificate market creates an incentive for residents and businesses to harvest solar energy and sell their acquired energy certificates. In the long run, they may profit from the sale of the certificates to energy suppliers. Like cap-and-trade, this is a flexible, market-based approach providing incentives to innovate and discover low-cost ways to produce more environmentally-friendly power. In the absence of an RPS, there would be no market incentive that would make solar power economically feasible at this point in time.

Like I said earlier, offsets are better than no regulation. But in my opinion, they're still not the best option. While the Renewable Portfolio Standard does reduce carbon emissions substantially when compared with a business-as-usual scenario (no regulation), offsets create an inflexible cap--that is, once the RPS is set, there will be a certain amount of CO2 emitted into the atmosphere, and this quantity will not change over time (although the emitting source may vary because of offsets). However, with cap-and-trade that incorporates cost-containment mechanisms (such as a symmetrical safety valve--like a price floor and ceiling for carbon permits), the cap may actually be REDUCED over time, costs will be minimized, and social benefits will be maximized. But in the absence of a federally-mandated emissions-trading scheme, it looks like more prescriptive portfolio standards may be our best bet!


TJE said...

Is cost passed on to consumers?

Maggie said...

There is no question that environmental regulations impose a cost on electricity producers (in NJ's case: either the cost of certificates or the cost of investing in green infrastructure) and consumers (who may pay higher electricity bills as a result of the higher costs that firms now face). In the past, regulators have used inflexible technology standards (also called command-and-control regulations) to combat environmental and public health risks as a result of human activities, such as electricity production. Command-and-control regulations are the most costly type of regulation because they dictate exactly how an electricity producer must comply (for example, past regulations have required sources to install scrubbers so that they emit less SO2). Current policies are moving away from these command-and-control regulations because although they do achieve the environmental benefit, they give firms no leeway in how they want to comply with the regulation, thus causing dramatic price spikes. Economists have long been advocating incentive-based approaches (such as RPS or cap-and-trade) that grant firms the flexibility to choose their own cost-minimizing compliance approach. The SO2 program was the first nationwide experiment in market-based regulations.

But regardless of the type of regulation, there WILL be a cost to society. But overall, the benefits of the regulations FAR EXCEED the costs of the program. This is where market failures, externalities, social costs and benefits come into play. A market failure occurs when individual incentives and societal needs do not align. In the case of the electricity market, this is when an individual profit-maximizing firm's actions given market conditions do not result in the efficient allocation of resources such that social benefit is maximized. This intuitively makes sense: the firm's cost/benefit analysis does not include externalities, which are the costs imposed on society (such as the environmental and public health hazards created by greenhouse gas emissions) and the benefits of emissions abatement. Instead, firms only focus on their individual cost schedules, and in doing so, impose costs on society. This creates the need for government intervention. So when critics of greenhouse gas regulation argue that doing so will raise prices, THEY'RE RIGHT! But their narrow vision of costs and benefits does not include the costs to society. Furthermore, measuring social costs and benefits is not simply an idea; environmental economists have been producing studies for years that show the exact value of emissions abatement to achieve economic efficiency. In other words, they're not advocating an all-or-nothing approach--they are carefully weighing costs and benefits and finding ways to balance firm's individual economic interests with the needs of society.

A good example of this is a gasoline tax. Economists (in fact, RFF-ers!) have found the optimal gasoline tax--about $1, that would achieve the maximum societal benefit at the lowest cost. This is not just speculation, it's science!

So the answer to your question: yes, in part. Firms, consumers, and government share the cost.