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«Abstract With federal policies to curb carbon emissions stagnating in the US, California is taking action alone. Sub-national policies can lead to ...»

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Leakage from sub-national climate initiatives: The

case of California∗

Justin Caron† Sebastian Rausch‡ Niven Winchester§



With federal policies to curb carbon emissions stagnating in the US, California is

taking action alone. Sub-national policies can lead to high rates of emissions leakage to

other regions as state-level economies are closely connected, including integration of electricity markets. Using a calibrated general equilibrium model, we estimate that California’s cap-and-trade program without restrictions on imported electricity increases out-of-state emissions by 46% of the domestic reduction. When imported electricity is included in the cap and “resource shuffling” is banned, as set out in California’s legislation, emissions reductions in electricity exporting states compensate for leakage elsewhere and overall leakage is 2%.

Keywords: Leakage, sub-national climate policy, tradable permits, embodied emissions, computable general equilibrium modeling.

JEL classification: C68, F18, Q54, R13.

∗ Without implication, we would like to thank John Reilly, Roberton C. Williams III, and participants at the 2012 Allied Social Sciences Association Annual Meeting for helpful comments and suggestions.

† ETH Zürich, Centre for Energy Policy and Economics, Switzerland, and Massachusetts Institute of Technology, Joint Program on the Science and Policy of Global Change, USA. Email: jcaron@mit.edu.

‡ Massachusetts Institute of Technology, Joint Program on the Science and Policy of Global Change, USA.

Email: rausch@mit.edu.

§ Massachusetts Institute of Technology, Joint Program on the Science and Policy of Global Change, USA.

Email: niven@mit.edu.

1 Introduction


Leakage occurs when greenhouse gas (GHG) restrictions in some regions increase emissions elsewhere. Climate policies can cause leakage via their impacts on trade, fossil fuel prices and factor movements. Leakage via the trade channel occurs when relative price changes induce substitution away from production in carbon-constrained regions and towards imports from unconstrained regions. The fossil fuel price channel is generally thought to increase emissions in unconstrained regions, as climate policies reduce fossil fuel prices and increase energy consumption in these regions. However, as noted by Burniaux (2001), if the supply of coal is more elastic than the supply of less carbon-intensive fuels, climate policies may reduce emissions in unconstrained regions (i.e., result in negative leakage). Negative leakage can also arise if energy efficiency improvements induced by the policy cause factor migration from unconstrained regions to constrained regions (Fullerton, Karney and Baylis, 2011).

The mechanisms behind leakage from national climate policies have been thoroughly investigated in the existing literature. The case of sub-national policies, however, is different in that traded good markets are more integrated at the national level than at the international level. Indeed, numerous gravity-based empirical exercises have found national borders to inhibit trade. The first estimates of a "border effect" in McCallum (1995) have been revised by Anderson and van Wincoop (2003), who find trade between US states to be 2.24 times larger than trade between states and Canadian provinces.

With federal initiatives to curb GHGs stalling in the US, sub-national polices have received greater focus. To date, two regional cap-and-trade policies have been legislated in the US. First, 10 states in the northeast are members of the Regional Greenhouse Gas Initiative (RGGI). The program, which began on January 1, 2009, sets state-level caps on electricity emissions and allows trading of emission permits among states. Second, a cap-and-trade program on emissions from electricity generation and certain industrial industries will operate in California beginning in 2013. Transport and other fuels will be included in this program from 2015, by which time the cap will cover an estimated 85% of California’s GHG emissions sources. In addition to restricting emissions from in-state production, the policy requires permits to be surrendered for emissions embodied in imported electricity. At the time of writing, California’s policy is the only economy-wide cap-andtrade program to be enacted in the US and is set to become the second largest carbon market behind the EU Emissions Trading Scheme (ETS).

In this paper, we use a calibrated general equilibrium model to examine the leakage implications of sub-national climate policies using California’s cap-and-trade program as an example. Moreover, legislation in both California and the EU allow for their programs to be linked with other systems and we accordingly investigate the effects of allowing trading of permits between Californian and the EU.

General equilibrium assessments of leakage from federal policies commonly estimate leakage rates between 10% and 30% (see, for example, Felder and Rutherford, 1993;

Bernstein et al., 1999; Babiker and Rutherford, 2005; and Copeland and Taylor, 2005).

Relatively few studies have focused on leakage from sub-national initiatives. One exception is Sue Wing and Kolodziej (2008), who consider the RGGI using a multi-state computable general equilibrium (CGE) model of the US economy. The authors estimate that 49-57% of emissions abated by RGGI electricity generators will be offset by unconstrained sources. A shortcoming in the framework employed by Sue Wing and Kolodziej (2008) is that states source intra-national imports from a national pool of state exports. Additionally, as the authors do not track trade flows between each state and the rest of the world, their framework is unable to consider leakage to international sources.

Our point of difference is a computable general equilibrium (CGE) model calibrated to a dataset which includes 15 US states or regions and 15 countries or regions in the rest of the world. The model tracks bilateral trade among all regions, including trade among US regions and trade between US regions and international regions. Due to its detailed treatment of trade flows, the model is ideally suited to examining leakage from sub-national climate initiatives.

This paper has four further sections. The next section provides an overview of California’s cap-and-trade program. Our modeling framework is outlined in Section 3. Section 4 outlines our scenarios, discusses results and reports findings from a sensitivity analysis.

Section 5 concludes.

2 California’s cap-and-trade program California’s Global Warming Solutions Act of 2006, Assembly Bill 32, was signed into law on September 27, 2006. The bill required the California Air Resources Board (CARB) to develop regulations and market-based measures to reduce California’s GHG emissions to 1990 levels by 2020. The primary emissions reduction tool in the bill is a cap-and-trade program for GHG emissions. The CARB’s finalized details of a cap-and-trade program October 20, 2011 and the legislation was approved by the California Office of Administrative Law on December 13, 2011.

The legislation covers emissions of major GHG gases, including carbon dioxide (CO2 ).

The first phase of compliance for the program begins on January 1, 2013. Covered entities in the first phase include electric utilities, electricity importers, and industrial facilities that emit 25,000 metric tons or more of carbon dioxide equivalent (CO2 e) annually. Industrial sources covered by the policy include petroleum refiners, producers of cement, iron, steel, glass and lime, and pulp and paper manufacturing.

Requiring allowances to be turned in for emissions embodied in imported electricity is similar to imposing an electricity tariff. According to the legislation, emissions embodied in imported electricity are calculated as the sum of emissions from "specified" and "unspecified" sources, with adjustments for electricity from eligible renewable sources, electricity that is imported and exported during the same hour, and electricity from regions with a cap-and-trade policy linked to California. A specified source is a particular generating unit or facility for which electricity generation can be confidently tracked. As a component of embodied emissions are traced back to emissions from individual generating units, a deliverer of electricity to the Californian grid could reduce its CO2 liability by sourcing low-emissions electricity from a new source and diverting high-emissions sources previously sent to California to other states. However, such actions may be prevented by regulations that prohibit "resource shuffling", which is defined as "any plan, scheme, or artifice to receive credit based on emissions reductions that have not occurred, involving the delivery of electricity to the California grid" (CARB, 2011, p. 38). As enforcing the bill’s resource shuffling regulations may require California to sanction importers based on actions by third parties outside of California, the resource shuffling legislation raises several legal issues (Linklaters, 2011).

The second phase of compliance will commence on January 1, 2015 and will expand the set of covered entities to include an 85% of California’s GHG emissions, including emissions from transportation fuels, natural gas and other fuels. The legislation allows limited use of approved offset credits in lieu of allowances. Economic analysis by the CARB indicates that offsets will account for a maximum of 49% of emissions reductions and, due to tight eligibility restrictions, offset usage may be much less (Mulker, 2011).

CARB (2011, Subarticle 12, p. A-153) also sets out conditions for linking the Californian program to other schemes. Once an external ETS has been approved by the CARB, compliance instruments issued by other programs may be used to meet Californian requirements. In this connection, California has pursued a regional approach to climate policy as a member of the Western Climate Initiative (WCI). The initiative was launched in February 2007 (original with five member states) with a goal of reducing region-wide emissions by 15% from 2005 levels by 2020.1 The agreement requires each member to implement its own cap-and-trade system and participate in a cross-border GHG registry.

The first phase of the regional cap-and-trade program was due to begin on January 1,

2012. However, California is the only partner that has set out mechanisms for capping emissions at the time of writing. Progress towards cap-and-trade legislation in other states and provinces has been hindered by the recession and political opposition. Notably, on February 2, 2010, Governor Brewer signed an executive order stating that Arizona would not endorse a cap-and-trade program.

Current WCI partners include the US states of Arizona, California, Montana, New Mexico, Oregon, Utah and Washington and the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec.

Elsewhere, a cap-and-trade program has operated in the EU since 2005. Details of the EU-ETS are set out in Directive 2003/87/EC (European Union, 2003). This legislation allowed the EU-ETS to be linked to regims in other industrialized countries that ratified the Kyoto Protocol. In 2009, the European Commission amended the EU-ETS under Directive 2009/29/EC. One amendment expanded the scope of EU climate policy to allow trading of emissions permits between the EU-ETS and sub-national programs (European Union, 2009, p. 81).

3 Modeling framework

–  –  –

This study makes use of a comprehensive energy-economy dataset that features a consistent representation of energy markets in physical units as well as detailed accounts of regional production and bilateral trade for the year 2004. The datset merges detailed state-level data for the US with national economic and energy data for regions in the rest of the world and is outlined in detail by Caron and Rausch (2011). Social accounting matrices (SAMs) in our hybrid dataset are based on data from the Global Trade Analysis Project (GTAP, 2008), IMPLAN (IMpact analysis for PLANning) data (IMPLAN, 2008), and US state-level accounts on energy balances and prices from the EIA (2009). Table 1 provides an overview of data sources.

The GTAP dataset provides consistent global accounts of production, consumption, and bilateral trade as well as consistent accounts of physical energy flows and energy prices.

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