An Upside to Utility-Only Cap-and-Trade

I wrote yesterday about where utility-only cap-and-trade might go wrong. There is, however, a potential upside. If the United States ever gets serious about reducing its use of oil, utility-only cap-and-trade could actually lead to deeper emissions cuts than an economy-wide system. Here’s how.

Assume that we have an economy-wide cap-and-trade system in place. Any other policies (like efficiency standards, renewable electricity requirements, or biofuels incentives) will not lead to further emissions reductions. Instead, they’ll just shift the source of emissions reductions within the economy (that is, under the cap). Imagine, for example, that we were to pass a cap on emissions tomorrow. Then, in 2015, we adopt a serious gasoline tax (maybe for fiscal reasons). Oil consumption goes down. But emissions don’t: instead, the carbon price drops a bit, emissions from the power sector go up from where they otherwise would have been, and the total remains the same. After all, the cap is unchanged.

Now imagine, instead, that we only have a utility-only cap-and-trade system in place. Policies that target oil consumption – which is outside the cap – are now a bonus from an emissions-reduction perspective. Imagine, again, that in 2015 we were to adopt that serious gasoline tax. Oil consumption again goes down. But there is no effect on the cap, since emissions from oil consumption were never part of it in the first place. (We don’t really use oil to generate electricity.) Emissions from utilities continue to drop as planned. Total U.S. emissions are reduced below what they otherwise would have been.

Does this mean that we’re better off on net? That depends on how aggressive the utility-only cap is in the first place and on whether we actually get our act together on oil. Cap-and-trade doesn’t do a huge amount for oil consumption. A solid utility-only system together with serious oil measures could thus come out ahead of economy-wide cap-and-trade. A weak utility-only cap together with continued complacency on oil would lose.