By Luke Elder, Brenda Meany and Thuy Phung, F&ES M.E.M. candidates
On November 18, Michael Grubb, Professor of International Energy and Climate Change Policy at University College London, and Editor-in-chief of the journal Climate Policy, came to Yale University to speak with students, faculty, and staff at the School of Forestry and Environmental Studies and the School of Management. Professor Grubb engaged with a small group in conversations regarding the theory of carbon pricing, global experiences implementing carbon pricing schemes, and how these lessons could apply to the Yale Carbon Charge Program. Below are key takeaways from the discussions with Professor Grubb.
European Union Emissions Trading Scheme
In his role on the UK Committee on Climate Change, Professor Grubb helped design and implement the European Union Emissions Trading Scheme (ETS), the world’s first and largest carbon market to date, launched in 2005. Unfortunately, the program’s repeated price collapses have disappointed many climate policy advocates. Professor Grubb suggested that for future emissions trading schemes to work, regulators must establish a price floor, which could be done by promising to purchase permits at the floor price. To avoid prohibitively high prices, regulators could also establish a price ceiling, set by promising to issue new permits if the market price reaches the ceiling price. These two fixes would still leave one problem: If the market sat at the floor price there would be no trading as there is no marginal incentive to buy or sell. Professor Grubb believes this could be fixed by retiring permits at the floor price and enabling them to be resold only at a higher price partway between the floor and ceiling prices. Together, these three interventions would constitute what is known as a “price corridor.” California’s Emissions Trading Master Agreement is a current example of a price corridor system.
The EU ETS carbon price has been ineffective for investment purposes because there is no certainty on the carbon price, which is currently too low for a deep decarbonization of the economy. Much private capital is invested in sectors with very low certainty. Given that many countries are looking for increased private investment, if a carbon pricing effort could lock-in a price that will increase over time, then investment could increase with that certainty. Research is needed to examine how the added certainty of carbon pricing could impact investment choices.
Carbon Pricing: Tax or Standard?
The very notion of carbon pricing is most often thought of as the classic debate between a tax or a standard. A carbon tax is an added cost on emissions to incentivize emissions reduction. A carbon standard sets a maximum level of pollution and distributes (often via a governmental auction) emission permits that firms can use or trade. Most simply, a tax reflects a change in price while a standard reflects a change in quantity.
There has been much discussion about the modeling and theory behind what the price of carbon should be, but Professor Grubb pointed out that what matters most now is not where the price is set, but instead the political feasibility of putting a price on carbon at all. As he pointed out, there are many different ways of incorporating carbon pricing into decision making that do not involve a global carbon price, for example: Carbon-backed contracts; and institutional carbon charges, of which Yale’s Carbon Charge is an example. Knowing this, the Yale Carbon Charge Program has not allowed the debate between using a tax or standard to get in the way of setting a price. The Program uses an EPA-informed social cost of carbon, $40 per mtCO2e, and has not experienced any significant pushback on the price.
A single global price on carbon is nearly unimaginable in this century. Yet without one, any national effort to set a price on carbon disadvantages producers in the price-setting country relative to those in any country with a lower price. To address this disparity, a country might “level-up” imported goods by charging a carbon tariff at the border; or it might “level-down” exported goods by rebating exported goods by the value of the national carbon price. Professor Grubb proposed a third approach: Draw the adjustment boundary not at national borders but at the production/consumption border. For example, levy a carbon tax on cars bought instead of on steel produced.
Taxing products based on their embodied carbon content requires tracking that carbon. To task the regulator with that work would be problematically burdensome. A more workable approach would be to set standard embodied energy values based on normal industry production and then let producers prove they manufacture with lower carbon intensity to reduce their tax.
Yale Carbon Charge- Global Carbon Pricing Mechanisms on a Local Scale
The Yale Carbon Charge is testing the efficacy and feasibility of carbon pricing on Yale’s campus. It is finding local illustrations of many issues observed in global efforts to price carbon, and it is developing experience in carbon pricing within an institution. Here are a few examples of the learning taking place on the Yale campus.
Carbon emissions have historically been “free” to the Yale campus, and the politics of pricing are beginning to play out as campus units plan to pay for emissions. As seen in other carbon pricing efforts, Yale is now learning that one of the most important aspects of carbon pricing is finding a compromise between efficient incentives and distributional equity. In another example, just as parties to the EU Emissions Trading Scheme did not know in advance the cost of reducing emissions, Yale decision makers do not yet know the costs of energy efficiency and so cannot predict with confidence the amount of investment required to reduce emissions. Finally, due to the complexity of Yale’s building unit makeup, with some buildings owned entirely by Yale and others partly leased or rented, the university confronts classic split incentive problems and principal-agent challenges. Yale is working to overcome these issues, measuring and reporting energy usage in buildings and comparing that usage to each building’s baseline usage. The Carbon Charge seeks to provide both improved information on energy use to building decision-makers, and couple that information with financial incentives for improved performance.
Yale is already seeing that a carbon charge not only impacts the financial bottom line, but also Yale’s internal and external identity. Encouragingly, Professor Grubb was also enthusiastic about the potential for Yale’s Carbon Charge to yield valuable insights for both the University and the world. He expects Yale will find that a carbon price is a vital tool best used in concert with other strategies in order to drive organizational change. Professor Grubb suggests using the Program to test whether a price on carbon influences major investments at Yale. He wonders if the price should rise over time, on a specified schedule. He notes that certainty may be worth more than the carbon price itself.
Looking to the Future
Professor Grubb posed many questions Yale must consider: What is the political economy of asking people to pay for something that was previously free? How can a price be communicated to get people acclimated to the certainty and longevity of a carbon charge? How do we engineer our way through these challenges?
Yale’s Carbon Charge Program is using the campus as a living laboratory to research how to cut greenhouse gas emissions and reduce energy costs, and how to scale successes not only across the campus, but across a low-carbon economy. Hosting experts like Professor Grubb is one way this initiative can increase the pace of global learning on implementing carbon pricing.