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Tuesday, January 26, 2010

Emission Allowance Allocation to Electricity Local Distribution Companies (LDCs):Considerations for Policymakers

Jonathan L. Ramseur
Specialist in Environmental Policy

Stan Mark Kaplan
Specialist in Energy and Environmental Policy

This report examines a major component of the emission allowance distribution strategy proposed in two major legislative vehicles under consideration in the 111th Congress: H.R. 2454 (Waxman- Markey), which passed the House on June 26, 2009; and S. 1733 (Kerry-Boxer), which was ordered reported by the Senate Committee on Environment and Public Works on November 5, 2009. Both bills (among other provisions) would establish a cap-and-trade program that would distribute—in the program's early years—a substantial portion of allowance value to electricity local distribution companies (LDCs) for the benefit of electricity consumers. Considering the magnitude of allowance value directed to LDCs, the potential consequences and challenges associated with this approach raise fundamental policy issues. 

Although an LDC allocation approach would be effective in mitigating cap-related electricity price increases at the household level, a closer examination of this strategy reveals potential concerns. Recent economic studies indicate that an electricity LDC allowance distribution strategy would alter the carbon price signal. The overall cost of the cap-and-trade program would increase if the price signal is channeled away from economic sectors with abundant low-cost abatement opportunities to economic sectors that have fewer such opportunities. In addition, if the price signal is dampened in one sector of the economy or for a particular subgroup of society, the signal may shift to other sectors or other groups, yielding unintended impacts. Several studies have estimated the efficiency loss. The range of estimates indicates that the magnitude of the efficiency loss due to LDC allocation would be uncertain. This uncertainty may pose a challenge for policymakers, when evaluating trade-offs between various allowance distribution strategies. 

Regions that get electricity from more carbon-intensive sources are generally expected to face disproportionate impacts, and many have argued that an electricity LDC allocation approach could be designed to address these impacts. However, recent economic studies suggest that the differences across regions (for the average household) may be relatively modest. A question for policymakers is whether this disparity is worth addressing with an LDC allocation strategy, especially considering the implementation challenges involved. Robust data exist for the carbon intensity of electricity at the point of generation, but analogous data for the carbon intensity of electricity distributed for consumption are substantially less precise. This information gap would likely pose a significant challenge in terms of distributing emission allowances to LDCs, if policymakers seek to account for different carbon intensities of electricity. In addition, a range of stakeholders has expressed concern that the state Public Utility Commissions, which oversee LDCs, would implement the LDC allowance distribution requirements in different ways. Allowing different applications of allowance value (for the benefit of the electricity consumer) could lead to varied impacts across state lines. Some state agencies may allow LDCs to use allowance value to support efforts (unrelated to electricity bill rebates) that may not be allowed in other states. 

Recent economic models indicate that most households would fare better with a lump-sum distribution. This is likely partly due to the expected efficiency loss associated with the LDC allotment. Another factor is that households in different regions use energy in different ways and consume fuels with different levels of carbon-intensity. The lump-sum distribution approach would likely provide households with more flexibility to offset the cost increases specific to their situation, whereas an LDC allocation would favor those impacted the most by electricity price increases.

Date of Report: January 25, 2010
Number of Pages: 28
Order Number: R41041
Price: $29.95

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