How Michigan can save money while reducing greenhouse gases

Erik Nordman is an associate professor of natural resources management at Grand Valley State University and was a Fulbright Visiting Professor at Kenyatta University, Kenya in 2012-13.

 

The Environmental Protection Agency’s proposed Clean Power Plan will limit greenhouse gas emissions from the power sector. Under the proposed rule, the EPA will assign each state an emissions reduction target for carbon dioxide, the predominant greenhouse gas. Michigan’s proposed target would be to reduce carbon dioxide emissions by 32 percent by 2030 compared to a 2012 baseline.

The EPA, however, does not specify how the individual states must achieve the reductions. This is to allow flexibility for each state to determine a strategy that works best for its unique circumstances. Therefore Michigan will need a strategy to reduce its greenhouse gas emissions. Michigan might want to consider joining the northeastern states in the Regional Greenhouse Gas Initiative (RGGI) as a cost-effective way to achieve its emission reductions.

RGGI (pronounced “reggie”) is an emissions trading agreement among nine northeastern states: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont. (New Jersey was a member but has since withdrawn).

RGGI was created to use the power and flexibility of markets to find the least costly way to reduce greenhouse gas emissions from the electricity sector among its member states. Electricity producers have already traded more than $900 million worth of carbon dioxide permits (or its equivalent in other greenhouse gases) in the first three years of the RGGI market, starting in 2009. When RGGI was first proposed in 2005, the participating states generated 32 percent of their electricity from high-carbon sources such as coal and petroleum. By 2012, high-carbon sources contributed only 12 percent. It appears that the RGGI framework encouraged states to take advantage of low-cost natural gas, renewables and energy efficiency projects.

Economists of all political stripes, including Milton Friedman, have noted that price signal are the most effective, least intrusive means of reducing pollution. It has been successfully tried for reducing sulfur dioxide and nitrogen oxide emissions beginning in 1990 under amendments to the Clean Air Act.

Firms have no in incentive to reduce pollution when nature's waste disposal services are essentially free. But being free because there is no market is different from having no cost. Society pays the cost of pollution through negative health and environmental impairments. Putting a price on pollution gives firms the incentive to reduce emissions and save the waste disposal costs of releasing the pollution into the air. Establishing a price also provides an incentive for innovation to find the most cost-effective way to reduce pollution.

Harvard management professor Michael Porter hypothesized that strict but flexible market based environmental policies can reduce pollution at low cost and foster a culture of innovation within the firm. Twenty years of research has shown that the so-called “Porter Hypothesis” works. Emissions trading puts a price on pollution. The 1990 Clean Air Act Amendments used emissions trading to reduce acid rain-causing sulfur dioxide and nitrogen oxide pollution at a cost far less than was anticipated.

RGGI established a regional cap on total carbon emissions from power plants. Each power company purchases, through an auction, a tradable permit for each ton of carbon dioxide it emits. Firms now have an incentive to reduce emissions – they need to purchase fewer permits.

If a firm can reduce its emissions at low cost, it can sell its extra permits to firms that need additional permits to cover their emissions. The most recent auction in June found permits selling for about $5.50 per ton of carbon dioxide. This is well below the social cost of carbon dioxide (about $40 per ton) which accounts for the economic damages from carbon pollution.

RGGI reduces the emissions cap by 2.5 percent each year thereby lowering the overall emissions from the power sector year by year. Moreover, the permit auction revenues are recycled back to citizens through energy efficiency programs, community-based renewable energy projects, job training and other programs.

The RGGI member states have benefited from the program. The Analysis Group conducted an independent assessment and found that RGGI added $1.6 billion in economic development and 16,000 jobs in the program’s first three years. Investments in energy efficiency, made possible by the recycling of auction revenues, actually lowered electricity prices. These efficiencies more than offset any increase from the costs of carbon permits.

Energy efficiency also led to reduced electricity demand which led to reductions of about $1.6 billion in electric market revenues. Total carbon dioxide emissions fell from 170 million tons in 2005 to less than 100 million tons in 2012. The dramatic drop in emissions was related to many factors, including low natural gas prices, but the emissions trading program played a major role.

There is a precedent for new states joining RGGI. Maryland was not one of the original members but joined in 2007. Member states also span several segments of the electricity grid, including the New England Independent System Operator (ISO), the New York ISO, and PJM. Michigan belongs to the Mid-Continent ISO but that should not pose a barrier to joining.

Michigan could benefit in several ways by joining RGGI to meet its Clean Power Plan obligations. First, pricing emissions, whether through an emissions trading program or by a revenue neutral carbon fee, is the most cost-effective approach for reducing greenhouse gas emissions. Second, it stimulates innovation in the energy sector. Third, it would likely have a positive economic development impact for the state, including jobs. Fourth, RGGI is compatible with other state energy policies including the renewable energy standard.

More research is needed to quantify exactly how Michigan would benefit, but it is worth exploring. Michigan will need to adopt a strategy to reduce its emissions under the Clean Power Plan. Legislators would be wise to consider joining RGGI.

The opinions expressed in this essay are the author’s alone and do not necessarily reflect those of Grand Valley State University.