Proportional Reduction Scenario

Equal Reduction Scenario

Minimum Cost Reduction Scenario

Discussion of Alternative Reduction Scenarios

Alternative Emissions Reduction Scenarios

My previous blog entry, Understanding Cap and Trade through Example, Part 1, described how CO2 emissions associated with the generation of electricity from different types of inputs (coal, natural gas, renewable resources) are calculated, how utilities achieve reductions in emissions, and how under the requirement that utilities must reduce emissions, they are better off if they can buy and sell rights to pollute, as opposed to being forced to retool operations so as to achieve reduced emissions on their own.  Now that we have a better understanding of the basics of emissions reductions, let’s consider some alternative scenarios.

Proportional Reduction Scenario

Return to the example from Part 1.  From Figure 4, we have total emissions for the 3 utilities of 2.37 million MT.  We want to reduce their total emissions by 300,000 MT, or 13%.  The current consensus is to initially grant (or sell) permissions to pollute in proportion to current levels of pollution.  As this applies in our example, to achieve a 13% overall reduction in emissions, the 3 utilities would each initially be granted rights to pollute for 1 – 13% = 87% of their original emissions (see column [E] in Figure 5A).  That is, Utility 1 would be granted the right to emit 960,000 tons of CO2, Utility 2 would be granted the right to emit 746,000 tons, and Utility 3 would be granted the right to emit 267,000 tons.

As for the remaining 13% of emissions (see column [D] in Figure 5A), the utilities would then be forced either to retool their systems so as to reduce their emissions by this amount, or to purchase emissions permits from other utilities.  (Utilities will be willing to sell their permits to others if the costs of reducing their emissions are less than the costs other utilities would be willing to pay for those rights to pollute.)

Utility 1 must now either retool his operations and/or buy some of the rights to pollute given to the other utilities, so that in the end he has reduced his own emissions and/or he has purchased the right to pollute from the other utilities for/by a total of 146,000 tons (see column [D] in Figure 5A).  The same goes for Utility 2, which must reduce its emissions and/or buy permits to pollute for/by a total of 114,000 tons and Utility 3, which must reduce its emissions and/or buy permits to pollute for/by a total of 41,000 tons.  If each of the utilities were to pay to retool their operations so as to reduce emissions by the required amounts, it would cost them a combined total of $5.953M (see column [F] in Figure 5A).

Since Utility 1 emits the most CO2, under the proportional reduction scenario, it will face the highest reduction in CO2.  And since Utility 1 also faces the highest costs of reducing emissions, it will end up spending much more than the other utilities to meet the reductions requirements (see columns [F], [G], and [H] in Figure 5A.  Assuming the utilities pass their cost increases onto their customers in the form of price increases, then under this proportional scenario, Utility 1’s customers face the highest price increases.

On the other hand, electricity generated from coal is less expensive than electricity generated from gas, which in turn, is less expensive than electricity generated from renewable (excluding nuclear) sources.  Bloomberg New Energy Finance  produced the following very cool comparison of the pre-subsidies cost of producing energy using alternative inputs (the chart was taken from an article in the WSJ: “Clean Energy Sources: Sun, Wind and Subsidies” by Jeffrey Ball ):

So if all else is the same, Utility 1’s customers will originally have been paying lower prices for electricity than were Utility 2’s customers, which, in turn, will have been paying lower prices than were Utility 3’s customers.  In this case, the forced reduction in emissions will end up making all customers pay more for electricity, though they will now be paying more similar amounts.

A complication is the fact that supply and demand conditions, as well as subsidies and tax breaks, vary across markets and energy input types.  This means that coal plant customers don’t necessarily end up paying less than gas plant customers, and gas plant customers don’t necessarily end up paying less than customers using energy generated from renewable sources.