Supporting standards

One of the features of cap-and-trade legislation is that it typically includes a variety of supporting standards – for example, a renewable portfolio standard in the power sector or a vehicle efficiency standard in the transport sector.

But shouldn’t we just trust the cap-and-trade system to deliver the lowest cost outcome for the economy?

With its tradable allowances, cap-and-trade is designed to move progressively along the abatement curve, driving the implementation of the next best project – which then delivers the lowest cost solution overall. Introducing standards into this mix does two things;

  • It lowers the overall carbon cost within the cap-and-trade;
  • It raises the overall cost of the system to society.

This is because the standard is interfering with the progression along the abatement curve and may be forcing the implementation of projects that are not the next best in terms of cost. Because these projects are then executed, the need to move up the abatement curve to meet the CO2 target is reduced, therefore lowering the overall carbon cost in the cap-and-trade system.

Despite knowing this, we persist in setting such standards. Why do this?

In the case of the transport sector, we (Shell) advocate for the use of standards and I have had input into that thinking. In fact we started from the perspective that cap-and-trade isn’t really the ideal tool in the personal road transport sector at all, but given that inclusion is a reality of US, Australian and New Zealand cap-and-trade policy, we came to the view that supporting standards were still necessary.

With the point of regulation shifted from the emitter to the supplier in the road transport sector, the only signal the emitter (i.e. the driver) sees is a change in price of gasoline. There is plenty of evidence that shows this sector isn’t very price responsive and certainly not at the level of a $50 CO2 price – i.e. about 50 cents a gallon on gasoline. But cost effective “projects” do exist at this price, for example switching to diesel fuel or even choosing a different vehicle when a purchase is made. So if the sector doesn’t respond very well, additional pressure is put on the other sectors, raising the overall CO2 price and of course delaying action in the transport sector itself. Of course the overall reduction is still achieved, but has the cap and trade system delivered the lowest cost outcome – possibly not?

Supplementing the action of cap-and-trade in the road transport sector with a set of standards can redress this balance – at least that is the view we came to. For example, a vehicle efficiency standard can start delivering reductions in the sector at very low cost, at least initially, as vehicle manufacturers may initially try to meet it simply by promoting different types of cars. These are things that should happen anyway under a cap-and-trade and probably would if the vehicle purchase decision was made entirely on financial grounds.

There is a similar arguement in the buildings and commerce sector – standards to drive more efficient appliances and force insulation into homes may be more effective than cap-and-trade at doing this job.

But what about the power sector? Arguably the cap-and-trade system should deliver an outcome balanced between efficiency, renewables, CCS, nuclear and fuel switching, so why have a Renewable Portfolio Standard or, as some have advocated, a CCS standard. This is where other policy objectives come in and the soluiton starts to get messy. Governments are keen to see a shift to renewables for security reasons so they add in a Renewable Power Standard – but it is important to realise that this is potentially undermining the cap-and-trade system and reducing its effectiveness in driving technologies such as CCS.

It may be costing us all more money as well!!