This is the second in a short series of posts that explain some important but often overlooked policy issues in the Western Climate Initiative. We’ve written extensively on “allocations“—the method of distributing the carbon permits to the public through auctions or free distribution—but there’s a related issue often confused with allocations. Called “apportionment,” it has important ramifications.

I know, I know, nothing gets the skin tingling like the word “apportionment.” But this is a big question for the Western Climate Initiative—the seven-state-four-province regional cap and trade system. Which states and provinces get to pass out the carbon permits? How many does each get? And who gets the revenue if the permits are auctioned? Ultimately, it’s about the money.  Carbon permits have a real cash value, whether they are sold or handed out for free. And we all know that nothing sharpens a negotiation like a pile of money sitting in the middle of the table.

Maybe that’s why WCI has so far produced this masterfully crafted position (pdf):

The Partners are working on an apportionment methodology based on Partner and regional emission reduction goals and requirements. The apportionment methodology will address factors such as production and consumption of electricity, projected population growth and economic activity, and other factors. The Partners intend to have a recommended apportionment methodology by Fall 2008. [Section 7]

Say what?

Before I explain what’s going on here, I’ll put my cards on the table: Sightline believes that state apportionment should be based on protecting consumers and working families—in short, it should be based on climate fairness. That means figuring out where the price impacts will occur and awarding state apportionments there so that auction revenue can be used to assist families. One way to do that might be to apportion permits among states and provinces in proportion to their spending on carbon-energy. I’ll come back to this in a monent, but first I should explain that some of the intuitive answers to apportionment are unfair.

At first blush, it might seem pretty straightforward to figure out the apportionment (sometimes called an “allowance budget”).

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    • Why not award permits based on, say, population or GDP? This sounds pretty good if you live in a state like Washington that emits less per person than the other jurisdictions. Washington’s electricity sector is fairly clean because it relies on lots of hydropower. Washington doesn’t need as many carbon permits as other states do, so pricing pollution won’t raise Washington’s electricity prices much. If permits are apportioned in proportion to population or GDP, the Evergreen State would get more permits than it needs to cover its own emissions. It could sell the extras to businesses in coal-fired states—think: Utah—that need additional permits. So, residents of Utah would be sending checks to Washington. Evergreen staters might be happy, but not the good people of the Beehive state.

    But there are worse ways of setting state carbon budgets.

    Curiously, one of the worst ways is also one of the most popular, perhaps because it seems straightforward: basing state apportionment on historical emissions.

    Why not just distribute the most permits to the places with the highest emissions? Simply, because it rewards energy producers by penalizing energy consumers. Consider this real life example: polluting coal plants in New Mexico generate electricity and sell it to ratepayers in California. Any price increases from cap and trade will be borne by the California consumers. But if New Mexico gets the carbon permits—on the strength of their historic emissions — the value of the permits will accrue to New Mexico. Hence the value of the permits will be unavailable to California to help protect consumers from higher energy prices, a key ingredient in climate fairness. That doesn’t seem right.

    I want to say this clearly: a system that awards allowance budgets based on historical emissions will guarantee inequities—and it make genuine climate fairness very difficult.

    Take a look at this white paper (pdf) from the Pew Center on Global Climate Change, which reports an interesting economic analysis of the state-level impacts of a hypothetical climate policy. (Pew used a CGE model called ADAGE. While we’ve been critical of CGE models in the past, Pew’s results are still instructive for our purposes here.) On page 27 and in Table A-2, Pew calculates the state winners and losers based on a cap and trade program that used historical emissions to set state allowance budgets.

    Big energy-intensive states do very well while cleaner service-economy states do poorly. Wyoming would take in a whopping $1,944 per household while California would net only $188 per household. That’s because the coal and natural gas getting extracted and processed in Wyoming—the source of that state’s big emissions budget—gets consumed elsewhere. So it’s consumers in places like California who would bear the brunt, while the money from the higher prices would be vacuumed into the energy-producing states. That won’t fly.

    What’s the right way to handle the apportionment question? Conceptually, the simplest way might be just to avoid apportionment altogether and simply conduct one regional auction with the proceeds going straight to consumers and never touching state or provincial bodies. (Regional “Cap and Dividend.”) But that doesn’t appear to be either legally or politically practical. After all, we’re talking about seven states and four provinces. So we’ll need to figure out some equitable allowance budgeting system.

    Here’s an idea. (Full disclosure: this is an idea, one that I think gets the high-level principles right; but it’s not a full analysis or detailed plan.) To design an equitable system we need to understand what different consumers will pay. Who will feel the sharpest pain of any price increases under cap and trade?

    We wouldn’t be looking for energy spending exactly, but for carbon-energy spending. This might require some analysis, but I don’t think it would need to be too onerous. It’s pretty easy to figure out how much people in each state spend on transportation fuel and similarly easy for natural gas. Electricity is more perplexing because the supply chains are so tangled, but it should be possible to at least estimate where the carbon-price impacts will occur and where they won’t. Using just these three carbon-energy spending sources—transportation, natural gas, and electricity — should give WCI enough information to proceed.

    The allowance budget should map fairly closely to carbon-energy spending. That way auctioned permits can be used to cushion working families or, at minimum, the allowance va
    lue can be used for other public goals. For example, a relatively clean state like Oregon wouldn’t experience as much price-pain due to a carbon cap and so it would accordingly receive a smaller share of allowances than would a state like Arizona. While Arizona households would feel more carbon price pain, but they would also benefit from the value of the allowances, which the state could choose to refund to ratepayers or to develop cleaner and more efficient energy systems. Oregon doesn’t need as much allowance-value because the impacts are less pronounced and it doesn’t have as much work to do to de-carbonize itself.

    I’ll admit that sometimes people think my proposal sounds counter-intuitive. After all, isn’t the point of carbon pricing to create a signal to avoid pollution? That’s true. But the key is to remember that as long as we have a cap, which does the “work” of reducing emissions, the price signal of carbon still gets communicated. The price signal hits low-income folks too hard, so they need to be compensated, preferably with some form of direct payment. Even if the payments more than cover the cost of higher energy prices—as it should for many folks—the cap is still driving emissions down and sending a carbon price through the economy. Rather than sinking the finances of working households, a smart cap and trade program would provide a gradual and relatively painless path away from carbon-intensive energy.

    Anyway, that’s the nutshell. Let me know what you think. I’m curious to refine and improve this idea.

    I’ll close by adding that it’s worrisome that WCI hasn’t yet clearly stated a position—not even a draft position—on apportionment yet. The July draft is the penultimate version and it has punted on several important questions, including this one.