The Potential Long-run Impact of California’s Cap-and-trade Plan

California’s first auction of greenhouse gas pollution credits is a landmark effort to combat emissions, says Wharton legal studies and business ethics professor Eric W. Orts. The auctions will be held quarterly and are aimed at reducing California’s greenhouse gas emissions by 30% — to 1990 levels — by 2020. The state expects to cut emissions to 80% below 1990 levels by 2050.

“This is a serious program with potentially large long-term implications,” notes Orts, who is also director of Wharton’s Initiative for Global Environmental Leadership. “It is the next biggest experiment in this area behind the European Union’s program.”

Wednesday’s auction by the California Air Resources Board is the culmination of efforts that began in 2006 to put in place a cap-and-trade mechanism to reduce emissions. Under this plan, the state sets a cap on total emissions and enables polluters to meet individual targets through a market to trade in pollution credits. The effort has overcome numerous legal challenges from businesses over the years, including a last-minute lawsuit from the California Chamber of Commerce to stop the auction. Opponents say the auctions are unfair to large businesses and a threat to jobs.

Major industrial facilities — including cement plants, steel mills and refineries — filed bids at the auction, according to a Los Angeles Times report. Results of the auction will be announced Monday. Polluting entities will initially receive 90% of their credits for free to help the businesses meet the costs of compliance. The auctions enable the firms to buy the rights for every additional metric ton of emissions at a floor price of $10 each.

The Golden State’s experience with the program could have “long-run influence,” although it may not prompt other states or countries to follow its path, says Orts. Several U.S. states have mechanisms to tackle emissions. They include the Regional Greenhouse Gas Initiative (RGGI) in the Northeast, involving nine states. By 2018, the RGGI aims to cut carbon dioxide emissions by 10% in the power sector through auctions of “emissions allowances.”

California’s auction may bring some pressure on the Northeast program “and perhaps arguments for a convergence of the two over time will occur,” Orts notes. But the main outcomes he envisions include increased pressure to create a federal climate change program to preempt state programs, and potential changes in business attitudes toward federal regulation.

To sufficiently incentivize businesses to curb emissions, much more than the California experiment will be needed, it appears. “Businesses need to get off the sidelines and engage proactively with government to address climate change in a rational, pragmatic, and efficient manner,” says Orts. “Piecemeal approaches are likely to be worse for business in the long run.”

Orts worries that the risks of climate change may not provide sufficient political incentive for legislative action. Environmental legislation has traditionally required a clear “disaster” or “crisis,” but climate change doesn’t have “easily identifiable disasters,” he notes. He points to fires caused by pollutants in Ohio’s Cuyahoga River in the late 1960s, and the Niagara Falls Love Canal scandal in the 1970s, in which toxic pollutants caused birth defects, nervous disorders and cancers. The Cuyahoga scare led to the creation of the federal Environmental Protection Agency in 1970 and the Clean Water Act in 1972, in addition to other such measures.

However, climate change analysis can help predict long-term increases in temperature or the potential for even larger and more frequent storms, according to Orts. “The very severe weather experienced in the U.S. in the past year just might provide sufficient political incentive and motivation to do something positive legislatively,” he says. He would like to see the federal government move toward adopting a “climate tax” or “climate charge” to address emissions control. A climate tax would provide flexible funding for measures related to both mitigation (e.g., investment in long-term alternative energy technology) and adaptation (e.g., the construction of sea walls to protect New York City and other vulnerable coastal cities), he notes. “Perhaps the time is right for compromise on this issue. Hurricane Sandy has perhaps provided a sufficient object lesson in the kinds of risks that ‘doing nothing’ will have for our long-term future.”

The budget deficit and need for revenue may also provide an opportunity “to move the ball forward” in emissions control, Orts suggests. California, for example, is expected to raise about $1 billion through its cap-and-trade auctions in the first year.

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