CommentsonGreenhouseGasEmissionsandEnergyManagementforManufacturingPhase2RulemakingDallasBurtrawPublicCommentJuly20231616PST.NW,SUITE600,WASHINGTON,DC20036•202.328.5000•WWW.RFF.ORGJuly21,2023ColoradoDepartmentofPublicHealthandEnvironment4300SouthCherryCreekDriveSouthDenver,CO80246Towhomitmayconcern:OnbehalfofResourcesfortheFuture(RFF),IampleasedtosharetheaccompanyingcommentsonColorado’sproposedRegulationNumber27–GreenhouseGasandEnergyManagementforManufacturingaddressingtherequirementsofHouseBill21-1266,whichdirectstheAirQualityControlCommission(Commission)toadoptrulesthatreducegreenhousegasemissionsfromtheindustrialandmanufacturingsectoratleast20percentbelow2015levelsby2030.RFFisanindependent,nonprofitresearchinstitutioninWashington,DC.Itsmissionistoimproveenvironmental,energy,andnaturalresourcedecisionsthroughimpartialeconomicresearchandpolicyengagement.RFFiscommittedtobeingthemostwidelytrustedsourceofresearchinsightsandpolicysolutionsleadingtoahealthyenvironmentandathrivingeconomy.WhileRFFresearchersareencouragedtooffertheirexpertisetoinformpolicydecisions,theviewsexpressedherearethoseoftheindividualauthorsandmaydifferfromthoseofotherRFFexperts,itsofficers,oritsdirectors.RFFdoesnottakepositionsonspecificpolicyproposals.MycommentsdrawonexperienceinotherjurisdictionsandscholarlyresearchinordertoinformthedecisionsthatstateregulatorsfaceindesigningtheemissionsregulationsfortheColoradoindustrialsector.Theproposedregulationwouldintroduceahybridsystemwithintensity-basedregulationofenergy-intensive,trade-exposedmanufacturingentitiesandamass-basedregulationofotherlargemanufacturingsources,enablinggreenhousegas(GHG)credittradingwithinandbetweenthesetwosystems.Theproposeddesignhasmanypromisingelements,butitalsohasdrawbackscomparedtoanemissionscap-and-tradeprogram,whichwouldmoreeffectivelyandsimplyachievethesectorspecificemissiontargetandalignthesectorwiththestate’seconomy-wideemissionsreductiontargetsestablishedinHB19-1261andSB23-016.Mycommentsaddressthefollowingsixtopics.1.Theadvantagesofanannualdecliningemissionscapwithbankingthatcoversallemissionsfrommanufacturingsources.2.Thedisadvantagesofbaseline-and-creditsystemscomparedtocap-and-allowancesystems.3.TheadvantagesofaconsignmentauctionfortheissuanceofGHGcredits(allowances)usedforcompliancewithregulations.4.Thedisadvantagesoftradingbetweenintensity-basedcreditsgeneratedbyEITEfacilitiesandmass-basedcreditsgeneratedbynon-EITEfacilities.5.Challengesassociatedwithprovidingoff-siteemissions“offsets”(GHGcredits)atunregulatedsourceswithoutcarefulprotocolsinplace.26.Theadvantagesoffacility-specificemissionslimitsonfacilitiesindisproportionatelyimpactedcommunities.Allcommentsaremyownandaresubmittedinmycapacityasanindependentauthor.Ifyouhaveanyquestionsorwouldlikeadditionalinformation,pleasecontactDallasBurtrawatburtraw@rff.org.Sincerely,DallasBurtrawResourcesfortheFuture3CommentsonGreenhouseGasEmissionsandEnergyManagementforManufacturingPhase2Rulemaking1.Theadvantagesofanannualdecliningemissionscapwithbankingthatcoversallemissionsfrommanufacturingsources.AnannualdecliningemissionscapprovidesthemostdirectwaytoachievethegoalsofHB21-1266,HB19-1261,andSB23-016.TheregulationofindustrialsourcesunderconsiderationaspartofGreenhouseGasEmissionsandEnergyManagementforManufacturing(GEMM)canplayanimportantroleinachievingColorado’sstatewidegreenhousegasreductiontargets.However,theanticipatedchallengesinachievingacost-effectiveimplementationofemissionsreductionsinthemanufacturingsectorunderGEMM,andparticularlytheuncertainoutcomefromthisregulation,willunderminetheabilitytoachievetheoverallemissionsreductiontargets.Theemissionsreductionscanbesecuredwithanannualdecliningemissionscap.Regulationscancomplementanemissionscapbydrivinginnovation,investment,andtechnologicalchangesupportinganindustrialtransformationinColorado.AnemissionscapdirectlyenforcesthedesiredemissionsreductionsbylimitingtheamountofGHGemissionsthatregulatedsourcesareallowedtoemit.Anannualdecliningemissionscapisdesignedtocontrolthecumulativeemissionsfromcoveredsourcesoveraperiodoftime,ensuringcumulativereductionsthatareconsistentwiththeemissionstarget.Anemissionscapreducesemissionsbyconstrainingoverallemissionsallowedundertheprogram’s“emissionsbudget.”Theemissionsbudgetdescribesthenumberofallowancesthatwillbeissuedeachyear.Overmultipleyears,theemissionsbudgetgenerallydelineatesthecumulativeemissionsallowedundertheprogram.Theemissionsbudgetisenforcedbyissuingan“allowance”—equaltoonetonofGHGemissions.Underanenforceableemissionscap,emissionsfromtheregulatedsourcescannotexceedthelevelofcumulativeemissionsestablishedbytheemissionsbudget.Annualemissionsmayvaryfromtheemissionsbudgetforthatbudgetifinter-periodbankingofallowancesisallowed.Underbanking,forexample,afirmmayover-complyinanearlyperiodandbankunusedallowancesforuseinalaterperiod,butthecumulativeemissionsoutcomewillcomplywiththeemissionsbudgetestablishedundertheprogram.Inotherjurisdictions,includingCalifornia,theRegionalGreenhouseGasInitiative(RGGI)innortheasternandmid-Atlanticstates,andinternationally,includinginQuebecandtheEuropeanUnion,annualdecliningemissionscapshaveproveneffectiveatensuringemissionsreductionsconsistentwiththecumulativebudget.Bybringingalltheregulatedmanufacturingsources,includingenergy-intensivetrade-exposed(EITE)andnon-EITEfacilities,underonecap,thebroaderemissionscapwillfacilitatethediscoveryoflow-costemissionsreductionopportunitiesacrossallsources,loweringoverallcostsforthestate.EITEsourcesareincludedintheCaliforniaandWashingtonemissionscaps,aswellasintheEuropeanUnion.Anemissionscapcanembodythespecificemissionstargetsandidentifyamarginalcost(allowanceprice)thatcanbeusedbyfirmstocoordinateandplantheirindividualemissionsmitigationactivities.Thepricealsoisreflectedinthefinalpriceofgoodsandservices,whichprovidesasignalfordownstreammanufacturers4andfinalconsumerstosubstituteawayfromemissionsintensiveinputsandproductstowardoneswithasmallercarbonfootprint(andsmallerembodiedcarbonprice).Anemissionscapwithallowancetradingcreatessubstantialeconomicvalueassociatedwithallowancesthatcanbeusedforcomplianceorboughtandsoldbyfirms.Thereareseveralalternativesforhowthisvaluecanbedistributedintotheeconomy.Theallowancevaluecanberealizedthroughtheauctionofallowances,orasindicatedabove,itcanbedirectlyandfreelyallocatedtofirmsandmonetizedthroughaconsignmentauction.Alternatively,theallowancescanbeauctioneddirectlybythestatewithauctionproceedsbeingusedtoaddressaffordability,relievetheenergyburdenforlow-incomehouseholds,orinvestininfrastructureandotherprogramstoacceleratedecarbonization.Further,anemissionscapwithanallowancepriceprovidesthebasisforlinkingasinglestate’switheffortsinotherjurisdictions,whichofferssubstantialpotentialbenefitsbyreducingcosts,providinggreaterprogramresilience,andmitigatingleakage(Burtrawetal.2013).Anemissionscap-and-tradeprogramoffersseveralopportunitiesformanagingcosts.Oneofthemostimportantisbanking,whichenablesfirmstocapturelow-costemissionsreductionopportunitiesthatexceedtheircomplianceobligationinagivenyearandtoapplytheassociatedunusedallowancestocomplianceinalateryear.Bankingenablestheprogramtoalsoalignemissionsreductioneffortsacrosstimebystaginginvestmentplanningtominimizecosts.Emissionsreductionsthatoccurfasterthanrequiredbytheprogramcapwillcontributetoacceleratedimprovementsinairquality.2.Thedisadvantagesofbaseline-and-creditsystemscomparedtocap-and-allowancesystems.Thelimitationsofabaseline-and-creditsystemareilluminatedinavoluminouseconomicsliteraturespanningsixdecades.1Intheproposedregulation,emissionsreductiontargetsforregulatedfacilitiesaredeterminedonanidiosyncraticbasisweighingseveralfactors,includingthefacility’schangeinemissionsintherecentpastandthemagnitudeofitstotalemissions.Theemissionsreductiontargetsrangefrom0percentto16percentbelowbaselinelevels.Allfacilitiesmustconductanaudittoidentifytechnicallyfeasiblemeasures.Thisapproacheffectivelyestablishesabaselineforeachfacilityequaltoitsemissionsreductiontarget,andtheprogramenablesfacilitiesthatsurpasstheemissionsreductiontargettogenerateGHGcredits,whichcanbetransferred(sold)tootherfacilitiesorbankedforfuturecompliancewithinthreeyears.FacilitiesthatdonotachievetheiridiosyncratictargetmayacquireGHGcredits—generatedrelativetootherfacilities’baselines—tocomplywiththeirobligation.Consequently,thisapproachcanbedescribedasa“baseline-and-creditsystem,”withindividualbaselinesidentifiedforeachfacility.Inaddition,theexistingemissionsintensity-basedregulationofEITEmanufacturingentitiesestablishesanintensitybaseline-and-creditsystem.Underthisprogram,EITEfacilitieshavesimilarlyidiosyncraticemissionsintensitytargetsthatgoverntheamountofGHGemissionseachsourcecanemitperunitproduced.Theemissionsintensitystandardforeachfacilityeffectivelyestablishesabaseline,relativetowhichfacilitiescangenerateGHGcreditsiftheysurpasstheintensitystandard.GHGintensitycreditscanbebankedforfutureuseorsoldtootherEITEfacilitiesforcompliancewiththeiridiosyncraticemissionsintensitystandard.1AseminalreferenceisTietenberg(1985).AnexcellentintroductioncanbefoundatTheWorldBank’sCarbonPricingDashboard:https://carbonpricingdashboard.worldbank.org/what-carbon-pricing.5Althoughtheproposedregulationcallsforauditstoidentifytechnicallyfeasibleemissionsreductionmeasures,thisinformationisnotknowntotheregulatorbeforeemissionsreductiontargetsareassignedtoeachfacility.Consequently,thestringencyofthetargetsislikelytoreflectsubstantialvariationinthemarginalcostofemissionsreductionsacrossfirms.Moreover,althoughauditscanidentifytechnologicalopportunitiesatafacility,theydonotaccountfortheuniverseofoptionsthatexistforacompanytoreduceitsemissions,and,consequently,themeasuresthataretakenareunlikelytobecost-effectivefromacompanyviewpointorfromasocialperspective.Generally,theeconomicsliteratureestablishesthatemissionsreductionsatafacilitycanbeachievedthroughthreechannels(Goulderetal.1999).Oneisthroughchangingtheinputsintoaproductionprocess,likethesubstitutionofoneenergysourceforanotherorthesubstitutionofcapitalforfuelthroughtechnologicalchangeandenergyefficiencyimprovementsatafacility.Secondisabatement,forexample,throughcarboncaptureatafacility.Thirdisoutputsubstitution,meaningthatdownstreamfirmsorconsumerssubstituteawayfromtheuseofhighlycarbon-intensivegoodsandservicestolowercarbon-intensivegoodsandservices.Afourthchannelwithinafirmcanbethediversionofproductiveactivitybetweenfacilities.Abaseline-and-creditsystemperformspoorlyinexercisingeachofthesefouremissionreductionopportunities.Theauditexclusivelyisintendedtoidentifyopportunitiesinthefirstchannel(inputsubstitution)andsecondchannel(abatement).However,changesinproductionprocessesthattheauditidentifiesarelikelytoreflectonlytheshort-runoperationsandbusinessstrategyofthefirm.Newproductsoractivitiesthatmightenablechangesinoperationsareunlikelytobeconsideredaspartoftheauditprocedure.Changesintheproductlinethatmayhaveeconomicmeritarealsounlikelytobeconsidered.Consequently,evenformeasuresthatcanbeidentifiedbytheaudit,theopportunitycoststothefirmwillnotbetransparentorrevealedinestimatedtechnologycosts.Anappropriatecharacterizationoftheroleofexternalauditsisthattheyprovidedataforadecisionaboutpotentialinvestments,buttheydonotprovideadecisionbecausetheycannotcapturethehostofadditionalconsiderationsthatareinternaltothefirm.Theopportunityforchangesinproductusedownstreamandbyconsumersisnotrevealedinabaseline-and-creditsystem.Further,generalcompanyoperations,includingtheallocationofproductionatvariousfacilities,arelikelytoescapeconsiderationsinanaudit,whichtypicallyisfocusedonanindividualfacility.Theconsequenceoftheincompleteaccountingandinadequateprovisionofincentivestoachieveemissionreductionsisthatthebaseline-and-creditsystemwillfailtoachieveacost-effectiveoutcomewithinthefirmorbetweenfirmswithintheindustrialsector.Aclassicprobleminregulatingfirmbehavioristhatthefirmhasprivateinformationaboutbothtechnologicaloptionsandstrategicplansthatisnotvisibletotheregulator.Theauditisintendedtorevealtechnologicaloptions,butasdescribedabove,itcanonlypartiallydosobecauseofthelimitedscopewithinthefirm’soveralldecision-makingprocess.Theeconomicsliteraturebroadlyandalmostuniformlyrecommendstheintroductionofcarbonpricinginsomeformtoaddresstheinadequacyofbaseline-and-creditsystems.Thisisthereasonthatotherstateshavepursuedcap-and-allowanceregulationsandhavelargelyeschewedbaseline-and-creditsystems.AnapproachthatwouldfulfiltherequirementsofHB21-1266,whichisthelegislativebackbonefortheregulationofindustrialsources,isamass-basedemissionscap.6Anemissionscapwithallowancetradingwouldidentifytheopportunitycostassociatedwithemissions,whichisrevealedbythepriceofemissionsallowances.Theemissionscapwouldincentivizethefirmtoidentifyemissionsreductionopportunitiesthatarenotvisibletotheregulator,andwhichsurpassthosethatcanbeidentifiedbyatechnologyaudit.Theemissionscapfurtherincentivizesthefirmtoimplementthoseemissionreductionopportunities.Theresultingeffortacrossallindustrialsourceswillbecost-effective,meaningthattheywillexhibitasimilarmarginalabatementcostacrosssources,anoutcomethatcannotbeachievedbyabaseline-and-creditsystem.Thecosttofirmsandtothestateeconomyfrominefficientimplementationofemissionsreductiontargetscouldbesubstantial,basedontheheterogeneityofemissionsreductiontargetsassignedtovariousfacilitiesandthediversityofindustrialactivitiesaffectedbytheprogram.Comparisonsofdirectregulation,baseline-and-creditsystems,andemissionscap-and-tradeinothersettingssuggesttheircostsvarywidely,andexpostempiricalassessmentsarenearlyimpossiblebecauseacounterfactualcannotbeestablishedafterajurisdictionhaschosenaregulatorypathway.However,amultitudeofsimulationmodeling,forexampledatingbacktoTietenberg(1985),andincludinganalysisappearinginseveralofmyownarticles,2suggestssubstantialcostadvantagestocarbonpricing.Theinformationprobleminsuchacomplexregulatorysettingisenormous.Amass-basedemissionscapwithallowancetradingisespeciallywell-suitedtoaddressthiscomplexproblembecauseitprovideseachfirmwiththeincentivetoactbasedonitsprivateinformationtominimizecostsandmaximizeprofits,consistentwithachievingtheaggregatecumulativeemissionscap.3.TheadvantagesofaconsignmentauctionfortheissuanceofGHGcredits(allowances)usedforcompliancewithregulations.ColoradocouldcomplywiththestatutoryparametersleadingtofreeallocationtoEITEfacilitieswhileachievingoverallmass-basedemissionreductiongoals,cost-effectively,usingaconsignmentauctionconstruct.Theimplementationofrevenue-neutralconsignmentauctionsforallGHGcredits(allowances)—representingallemissionsthatareallowableundertheprogram—wouldboosttheefficiencyoftheGHGmitigationprogramandminimizecostsforfirms.Consignmentauctionsareeasytoadministerandhavevirtuallyzerotransactioncosts.Theycanbeseamlesslyimplementedunderboththeintensity-basedstandardsforEITEindustriesandthemass-basedstandardsforotherlargemanufacturers.AconsignmentauctionalsoservestoprovideaninstitutionalfoundationfortheconsolidationofColorado’smitigationprogramsforindustryintoasinglemass-basedprogramwithanemissionscap.Thestate’sproposedregulationeffectivelyprovides100percentfreeallocationofcredits/allowancestoregulatedindustries;itdoesnotimposeacostonemissionsallowedunderthetargets.However,theproposallacksamechanismtodiscoverthecostofcompliance,whichisanalogoustothepriceofanemissionsallowanceinacap-and-tradeprogram.Inmanysituations,freeallocationdoesnottriggerasearchtofindemissionsreductionopportunitieswithinthefirmthatwillminimizecostsofachievingemissionsreductionsovertheprogramingeneral.FreeissuanceofGHGcreditsforcompliancebyafirm,whetherintensity-basedormass-based,isunlikelytoresultinleastcostmitigationofemissionswithoutadditionalprogramstructure,suchasthroughtheexplicitidentificationofacostassociatedwithcompliance.Theconsignmentauction,ontheotherhand,providesamechanismtorevealthecostofcompliance,whichisreflectedinthevalueofGHG2Forexample:Burtrawetal.2017;BurtrawandWoerman2013;BurtrawandEvans2008;Burtraw2007;BurtrawandPalmer2004;Burtraw1996.7credits,andtomaketransparentwithinthefirmandintheprogramthevalueofGHGcreditsthatarefreelyissuedtofirms.DrawingfromBurtrawandMcCormack(2017),onefindsthateveninacompetitivemarket,thevalueoffreelyallocatedGHGcreditsisunlikelytobeproperlyrecognizedandactedonbythefirm.Thedecisionmakingprocesseswithinafirmarenecessarilyinefficient.Whendescribedontheleveloftheindividual,thislimitationisoftencharacterizedasboundedrationality(Simon,1955,1979)andreferstothenotionthatindividualshavealimitedcapacitytomake“rational”decisionsduetocognitiveconstraints,finitetime,andlackofcompleteandfreeinformation.Costsoftimeandthedelayindecisionmaking,costsofinformation,andcognitiveandcomputationalcostsallmaypreventrationaltheoryfrombeinganoptimal,orindeedapossible,decisionmakingframework(Simon,1955;Radner,1996).Similarly,firms,especiallylargeones,deviatefromthebehaviorpredictedbyrationalchoicetheory(Radner1996).Onereasonisthedecisionmakingprocessofindividualactorsisconstrained,andinformationwithinfirmsisnecessarilydecentralized.Therefore,communicationcostsleadtodecisionmakinginwhichonlysomeinformationisavailabletoinformeachdecision.Second,thestructureofthefirmandthelimitedinformationofitsworkersposetoocomplexaproblemfortheorganizerofthefirmtosolveinawaythatcanbemodeledbyrationalchoicetheory.Malloy(2001)notesthatforanabatementopportunitytobeactedon,thepersonmanagingenvironmentaldecisions(the“gatekeeper”)mustrecognizetheopportunityasworthyofattentiongiventheirpersonalobjectives,whicharelikelynarrowlydefinedasmeetingcompliancewhileminimizingcosts.Ifthecomplianceactivityisnotmandatory,theopportunitymustalsoout-competeotherinvestmentsinthefirm's“internalcapitalmarket.”Basedonbehavioralphenomena,consignmentauctionsmaybeimportantnotonlybecausetheymaketheGHGcreditvaluemoresalientbutalsobecausetheyframetheuse,sale,oracquisitionofcreditsinafullerwaywithinthefirm’sdecisionmakingprocess.BeyondaspectsoforganizationalbehaviorwithinfirmsthatarelikelytolimittherecognitionofmitigationcostsandtheopportunitycostsoffreelyallocatedGHGcredits,otherphenomenaposebarrierstoefficienttransactionsinfirms(KahnemanandTversky,1979;Kahnemanetal.,1991).Thesebarriersincludetheendowmenteffect,whichdescribesthetendencyofindividualstovalueanendowmentsuchasfreeallocationmorehighlythantheirwillingnesstopayforthesameiteminthemarket,statusquobias(HahnandStavins,2010),andlossaversion(Kreutzer,2006).Thesephenomenawillleadorganizationstoadheretoinitialcircumstancesandoperationsandwillnotincentivizethemtosearchfornew,innovativewaystoreduceemissions.Importantly,however,theendowmenteffectdoesnotapplytosituationswhengoodsareexpectedtoberesold(Kahnemanetal.,1990;Kreutzer,2006).Kreutzer(2006)suggeststhattheabilitytoconvertallowancestocashthroughmarkettransactionsmaythereforemitigatetheendowmenteffect.Followingthislogic,aconsignmentauctionwouldbeexpectedtoreducetheendowmenteffectinthreeways.First,consignmentoftheGHGcreditstotheauctionseversthesenseofapropertyrightassociatedwithholdingacreditinitially.Second,byensuringtheliquidityofthemarket,itwouldcreateanassuranceoftheabilityoffirmstorealizeacashconversionofaGHGcredit.Third,byrequiringfirmsreceivingfreeGHGcreditstoimmediatelysellandrepurchaseGHGcreditsinconsignmentauctions,anticipationisbuiltforresaleintotheprocessofreceivingfreeGHGcredits,evenifsomecreditswouldneedtoberepurchasedforcompliance.8FlexiblecompliancewithintheGHGmitigationprogramforindustryisimportanttominimizingcostsandpromotingeconomicactivityandgrowthinColorado.OnecoreprincipleinminimizingcostsisthatGHGcreditsareusedforcompliancewheretheyhavethehighestvalue.AsecondcoreprincipleisthatfirmsrecognizetheopportunitycostsofusingGHGcreditsthatotherwisecouldbeusedelsewhereinthemarketandthattheyusetheeconomicvalueofcreditstocalibrateemissionsreductionmeasureswithinthefirm.Ascurrentlyproposed,theregulationwillincompletelyimplementtheseprinciples,andtheseprincipleswouldbemorefullyembodiedintheprogramthroughtheuseofconsignmentauctions.Theintensity-basedstandardthatappliestoEITEindustriesestablishesanemissionsrateperformancebenchmark.GHGcreditsareinstantiatedbasedonthisbenchmark(tons/unitproduct)multipliedbythelevelofeconomicactivity(unitproduct)(FischerandFox2007).ThefreedistributionofGHGcreditsconveyssubstantialvaluetotherecipient,suggestinganendowmenteffectmaybeinvoked.Moreover,thevaluewillbeidiosyncraticandvaryacrossfirmsastheyseekcompliancethroughinternalmeasures,andthevaluewillnotbeevidentacrossfirmsortootherstakeholdersorregulators.Consequently,costswillnotbeminimizedataprogramlevel,imposingunnecessarycostsonthestateeconomy.AconsignmentauctionprovidesawaytomakethevalueofGHGcreditstransparenttoallpartieswhilethevalueremainswiththeoriginalowneroftheGHGcredit.RequiringtheconsignmentoffreelyallocatedGHGcreditstotheauctionbeforetheycanbeusedforcompliancecanachievethecoreprinciplesoutlinedabove(BurtrawandMcCormack2017).ConsignmentoffreelyallocatedGHGcreditsoffersasimple,virtuallyzero-cost,market-basedstrategythatsupportsstrongprogramdesign.EconomistsgenerallyfavortheuseofauctionsfortheinitialdistributionofintangibleassetssuchasGHGcreditsinordertofacilitatepricediscovery,especiallyinnewandevolvingregulatoryormarketframeworks(BinmoreandKlemperer2002).Therearelong-termbenefitstoreducingevenshort-terminefficienciesinthedistributionanduseofGHGcredits,suchasimprovedcapitaldecisions,lowercompliancecosts,andimprovedmarketcompetition.ConsigningGHGcreditssupportsthediscoveryofminimumcostopportunitiestoreduceemissionsandreducesthelikelihoodofanticompetitivebehaviorthatmayemergewhentheopportunitytoobtainorsellGHGcreditsoccursinathinandilliquidmarket.Theconsignmentframeworkprovidesautomaticliquidityinthemarket.Asealedbid,uniformpriceauctionisthepreferreddesignformulti-unitauctions(meaningauctionsformultipleidenticalitems).Bidsintheauctionaresubmittedbeforetheauctionisconducted,includingbidsfromfirmsthatoriginallyreceivedfreeallowances.AllGHGcreditsaresoldatthepricethatclearstheauction.Theauctionclearingpriceisidentifiedbyorderingbidstopurchaseallowancesandfulfillingbidsstartingwiththehighestbidandworkingdownthescheduleuntilidentifyingthebidatwhichsupplyisexhausted.Thepriceofthemarginalbididentifiestheauctionclearingprice.Auctiontheoryforasingleunitauctionfindsthisdesignensuresparticipantswillbidtheirtruewillingnesstopay,avoidingstrategicbehaviorintheauction.Theintuitionfromthatfindingcarriesovertosuggestthesamereasoningappliesinmulti-unitauctions,andthisisthedesigntypicallyimplementedinallowanceauctionsinpublicprograms.Basedontheauction-clearingprice,theoriginalholderofconsignedGHGcreditsisreimbursedbyreceivingrevenuefromtheauctionequaltothemarketvalueofconsignedcreditssoldintheauction.Assuch,afacilitythatinitiallyreceivestheexactnumberofGHGcreditsthatitneedsforcomplianceeffectivelyrealizesfreeallocation.AnEITEcomplianceentityorotherindustrialfirmmaychoosetobuyGHGcreditsinthesameauctionandwouldpayanet-zeropriceonallowancesitsellsandrepurchases.Indeed,the“re-allocation”ofcreditstothefirmcanhappenautomatically:theauctioncanallowafirmtosubmitanoncompetitivebidfora9limitedportionofitsconsignedallotmentguaranteeingthepurchaseofthatportionatthemarketclearingprice.Creditsthatarenotsoldcanbecancelled,therebypotentiallyreflectingtheopportunitytoincreasethepaceofemissionsmitigation.TheopportunitycostofauctionedGHGcreditsistransparenttofirmsintheauction.TheexplicitidentificationofacreditpriceprovidesasignalofthevalueofGHGcreditsforfirmsthatreceivefreeallocation.ThevisiblevalueofGHGcreditscanbeassimilatedintooperationsandinvestmentplanninginthesamewayasfuelpurchasedecisions.ProgramadministratorsmaybeconcernedthatafreeallocationofGHGcreditstovariousindustrialfirmsmightbeperceivedbysomeasunfair.Aconsignmentauctionenablestransparencyaboutthecreditvaluegiventoindustrywhileprovidingafullypotentpricesignaltopromoteemissionsreductionsamongtheaffectedentities.Thistransparencyhelpsestablishcredibilitywithstakeholders.Secondary-marketbilateralsalesofGHGcreditsmayalsooccuranddonotinterferewithorinvolvetheconsignmentauction.Aconsignmentauctionissimpletorunatminimaladministrativecostsforallparties,andthegovernmentdoesnotneedtobeinvolved.Infact,inthefirstdecadeoftheUSsulfurdioxide(SO2)tradingprogram,consignmentauctionswererunbytheChicagoBoardofTradeatzerocosttothegovernment.Twootherfirmsalsoofferedtoruntheauctionatzerocosttothegovernment.TheauctionintheSO2programappliedtoonlyasmallfractionofthesumofallowancesthatwerefreelydistributedintheprogramandnonethelesscontributedtothediscoveryofamarketpriceatatimewhenexpectationsaboutcompliancecostsvariedacrosstheindustry(Hausker,1992;Ellermanetal.,2000).Similarly,expectationsaboutcompliancecostswillcertainlyvaryinthestate’sindustrialsectorregulation.Comparedtoarevenue-raisingauctionthatmightrequirelegislativeauthorization,therevenueneutralityoftheconsignmentauctionanditspotentialadministrativeindependencefromgovernmentensuresthatitcannotbeconstruedasataxandimpliesthatitlikelydoesnotrequirethelegislativeauthorizationthatmaybeneededforarevenue-raisingauction(Peskoe,2016).4.Thedisadvantagesoftradingbetweenintensity-basedcreditsgeneratedbyEITEfacilitiesandmass-basedcreditsgeneratedbynon-EITEfacilities.TheproposedinteractionofEITEandnon-EITEsources,giventheirdifferentregulatoryframeworks,hasthepotentialtounderminethesector-specificgoals.Anintensity-basedemissionsstandardforEITEfacilitiesembodiestwosimultaneousincentivesfortheregulatedfirms.Thecomplianceobligationrequiresthatemissionsintensity(tons/unitproduct)satisfiesaperformancebenchmark.Thiscanbeachievedbyreducingemissions(tons)orbyincreasingoutput(unitproduct).Theintensity-basedstandardsuppressesthechangeinthepriceoffinalgoodsandthereforeprotectsthecompetitivenessoftheregulatedindustry.ItdoesthisbyeffectivelyawardingGHGcreditsattheperformancebenchmarkemissionsrate.Thismechanismprovidesaproductionincentiveforthefirmbecauseforeachunitofproduction(holdingemissionsconstant),thefirmearnscreditsthatcouldbetransferredtootherfirms.Evenifthefirmdoesnotintendtotransfercredits,thefreeinstantiationofGHGcreditsassociatedwitheachunitofproductioncreatesavaluethatiscapturedbythefirmandusedforcompliance.10Incontrast,otherindustrialfacilitiesinColoradothatarenotEITEentitiesareassignedamass-basedemissionsbaselineagainstwhichtheymustachieveemissionsreductionsoracquireGHGcredits.ThesefirmswillexhibitapotentialwillingnesstopayforGHGcreditsthatcouldbeinstantiatedandmadeavailablebyincreasedproductionactivityatEITEfacilitiesthatareregulatednotbyamass-basedemissionstarget,butbyanintensitystandardthatawardsthemmoreGHGcreditsastheyexpandproduction.TheinteractionofpotentialdemandforGHGcreditsfromnon-EITEfirmswiththeabilityofEITEfirmstoexpandproductioncreatesanincentivetoactuallyincreaseemissionsatindustrialfacilitiesinthestate.BecausetheincentivetoreduceemissionsacrosstheentireindustrialsectormaybeunderminedbytheinteractionofEITEandnon-EITEsources,giventheirdifferentregulatoryframeworks,theproposedregulationhasthepotentialtounderminethesector-specificgoalsofHB21-1266andtheeconomy-widegoalsofHB19-1261andSB23-016,whichestablishthestate’scomprehensiveemissionsreductiontargets.Theimplementationofemissionsintensitystandardsdoesnotnecessarilyhavetoundermineanemissionsreductiontargetifthestandardsdescribethemethodforallocatingemissionsallowancesinthecontextofanoverarchingemissionscap-and-tradeprogram.Inthiscontext,theintensitystandardisdescribedas“output-basedallocation”ofemissionsallowances(FischerandFox2007).ThepracticaleffectfortheEITEindustrieswouldbethesameinprovidinganincentivetomaintainorgrowproductiveactivity;however,thisincentivedoesnotunderminetheoverallemissionsgoalifEITEemissionsarecoveredundertheoverarchingemissionscap.ThisapproachissuccessfullyusedtoprotectEITEindustriesintheEuropeanUnion’sEmissionsTradingSystem(ETS),inCaliforniaandWashingtoncap-andtrade-programs.Withthisapproach,thereisnotradeoffbetweentheprotectionoftrade-exposedfirmsandenvironmentalintegrity;bothobjectivesareachieved.theprotectionoftrade-exposedfirmsandenvironmentalintegrity;bothobjectivesareachieved.5.Challengesassociatedwithallowingoff-siteemission“offsets”(GHGcredits)atunregulatedsourceswithoutcarefulprotocolsinplace.Toprotecttheintegrityofthestate’semissionsreductionprograms,offsetcreditsmustaccuratelyreflectclimatebenefits.Amuchsimplerapproachtoreducingemissions,andonewithgreaterenvironmentalintegrity,wouldbetoexpandtheuniverseofregulatedsourcestoencompassallsourceswhereemissionsreductionscanbeachievedandapplyanemissionscaptothesesources.TheGreenhouseGasEmissionsandEnergyManagementforManufacturingPhase2(GEMM2)proposalwouldallowregulatedfacilitiestomeettheircomplianceobligations,throughemissionreductionsorremovalsoutsidetheuniverseofregulatedsourcesiftheycannotsecureenoughabatementon-siteunderacertaincost-threshold.Forinstance,theproposedregulationwouldallowfacilitiestogenerateGHGcreditsthroughdirectaircaptureprojects;theproposedregulationwouldalsoallowregulatedfacilitiestocomplythroughreducingemissionsatotherindustrialfacilitiesownedoroperatedbythecompanyoranaffiliate,includingfacilitiesthatarenotcoveredbytheproposedregulation.Whilethesecompliancemechanismsarenotreferredtoas“offsets”intheproposedregulation(insomecases,theyarereferredtoas“GHGcredits”),theyneverthelessconstituteoffsetsasthetermisbroadlyusedinthecontextofGHGmitigation:instrumentsthatallowforthecontinuedemissionofacertainamountofgreenhousegasataregulatedsourcewhile,intheory,achievingequivalentclimatebenefitsatsourcesnotdirectlycoveredbytheregulation.Generally,complianceoffsetsplayaroleinmanagingcostsforcompliance11entities.However,onecanidentifyatleasttwoimportantconcernsabouttheuseofoffsetsintheproposedregulation.1.Thelackofprotocolstoensureoffsetsconstitutevalidemissionsreductions.Theconsiderationofemissionsreductionsatunregulatedsources(offsets)asanoptionforcomplianceforregulatedsourcesinvitesmoralhazardandadverseselectionthatcanunderminetheemissionsreductionprogram.Thestatelacksrigorousprotocolstoensureoffsetscauseadditionalreductionsthanwouldotherwisehavebeenrealized(adverseselection),constitutepermanentemissionsreductions,anddonottriggerashiftineconomicactivityandanincreaseinemissionsatotherlocations(moralhazard).Forexample,emissionsreductionsatanunregulatedfacilitymaybetheresultofotherwiseintendedreductionsintheutilizationofthatfacility,perhapsexplicitlylinkedtoanincreaseinproductiveactivityandemissionsatanotherfacility.Ifanoffsetsprogramissuesmorecreditsthantheclimatebenefitsitachievesinpractice,itunderminesthemitigationactionstakenbyothercoveredentities.Toprotecttheintegrityofthestate’semissionsreductionprograms,offsetcreditsmustaccuratelyreflectclimatebenefits.Ifoffsetsarerigorouslyimplemented,theyacttoreducetotalprogramcompliancecosts(byprovidingagreaternumberofoptionsbywhichregulatedemitterscancomplywithprogramrequirements)andcreatefundingformitigationactivitiesoutsideprogramcaps(ascoveredemitters’purchaseofoffsetcreditsfundsclimateprojectsinuncappedsectorslikeforestry).However,itisnotappropriatetouseoffsetsasanabatementmechanismforsourcesthatcanberegulatedunderaprogramcap.Ensuringoffsetcreditsaccuratelyreflectclimatebenefitsrequirescarefulandoftenadministrativelycomplexaccountingandmonitoring.Suchproceduresandprotocolsaremissingfromtheproposedregulation.Amuchsimplerapproachwouldbetoexpandtheuniverseofregulatedsourcesandapplyanemissionscaptothissetofsourcestoencourageemissionsreductionswheretheyareleastexpensivetoachieve.2.Offsetsmayunderminetheenvironmentalbenefitsthatareexpectedfromtheregulationofindustrialfacilities.Anotherimportantconcernistheimpactofoffsetsonbroadenvironmentaloutcomes,includingairquality,watermanagement,andecologicalsustainability.Byshiftingsomeclimatemitigationeffortsawayfromregulatedindustrialsources,especiallyregulatedfacilitiesindisproportionatelyimpactedcommunities,theavailabilityofoffsetsgeneratedfromoutsidethesetofregulatedsourcescouldnegativelyaffectairpollutionatfacilitieslocatedinhistoricallydisproportionatelyimpactedcommunities.Onemeasurethatwouldaddressthisconcernwouldbearequirementthatoffsetsprovidedirectenvironmentalbenefitstothestateandtothecommunitieswhereindustrialfacilitiesarelocated.Anotherprogramelementtoensurecommunitiesarenotnegativelyaffectedbytheuseofoffsetswouldbeadditionalfacility-specificemissionslimitsonfacilitiesindisproportionatelyimpactedcommunities.6.Theadvantagesoffacility-specificemissionslimitsonfacilitiesindisproportionatelyimpactedcommunities.Providingasafeguardtoensurethatthebenefitsofindustrialsectorcarbonmitigationeffortsaccrueatleastasfullyineachdisadvantagedcommunityasinothercommunitiescouldbroadenthesocialvalue12andincreasepublicsupportforacap-and-tradeprogram,enablinggreatercost-effectivenessandgreaterambitioninthestate’sclimatepolicy.Flexiblecomplianceopportunities,includingthepotentialtransferofGHGcreditsamongfacilities,reducethecostofcompliance.However,theemissionsreductionsthatresultmaynotbewhereemissionsreductionsareneededtomitigatepreexistinginequitiesinpollutionexposure.Residentsindisadvantagedcommunitiesexperiencerelativelygreaterexposuretoairpollution,resultinginmoreseverehealthimpacts(Clarketal.2014).Increasingly,thehealtheffectsfrompollutionhavebeenfoundtobeexacerbatedbyothercommunity-levelstressors.3Reductionsingreenhousegasesareexpectedtoleadtoassociatedreductionsinconventionalairpollution(Thompsonetal.2016).However,nitrogenoxides,volatileorganiccompounds,andotherpollutantsemittedcoincidentallywithgreenhousegaspollutantshaveshorteratmosphericlifetimesandhencehighlyvariablelocaleffects(PappinandHakami2013).Consequently,althoughthelocationandtimingofgreenhousegasemissionsreductionsmakelittledifferencetotheirclimateimpact,theircorrelationwithotherpollutantscansignificantlyaffectlocalpublichealth.Directregulationofcoincidentpollutantswouldbesuperiortotheirancillarycontrolthroughtheregulationofgreenhousegasesbecausethecorrelationofpollutantsisnotperfect(Andersonetal.2018).However,formanyreasons,directregulationofpollutionhasnotrectifiedtheenvironmentallegacyindisproportionatelyimpactedcommunities.Whenconsideringtheintroductionofnewregulationstoregulategreenhousegases,itisimportanttobuildsocialsupportatthecommunitylevelforthechangesthatwilloccur.Inthiscontext,manyadvocateshavearguedthatregulatoryprocessestomitigategreenhousegasemissionsshouldprioritizeactionsthatwillhelpthesecommunities.Facility-specificemissionscapspresentaregulatoryopportunitytoensurethatenvironmentalimprovementsassociatedwithgreenhousegasreductionsaccrueequitablythroughoutthestate.Anexampleapproachtoafacility-specificcapwouldrequirethatregulatedfacilitieslocatedindisproportionatelyimpactedcommunitiesachieveemissionsreductionsataratethatmeetsorexceedstheaveragerateacrossallfacilitiesregulatedbytheprogram.Thisapproachrepresentsabackstoptoensurethatthemostdisadvantagedcommunitiesbenefitatleastaswellasothercommunitiesonaverageundertheregulatoryprogram.Witharegulatorybackstopsuchasfacility-specificemissionscapsnestledwithinthestate’soverarchingregulationofGHGemissionsatindustrialfacilities,therearetwooutcomesthatcanresult.Oneisthatthefacility-specificcapsareunnecessarybecauseemissionsreductionsareachievedatleastasquicklyinthesecommunitiesaselsewhere.Thisresultmightoccurbecauseavarietyofotherregulatoryprogramsarespecificallyfocusedonimprovingairqualitywhereitisrelativelypoor,andtheconfluenceofregulationsmightleadtonewinvestmentsinmanufacturingefficiencythatprovideoverallenvironmentalimprovements.Inthiscase,thefacility-specificcapswouldnothaveaneffectorimposeanyspecificcosts.3Forexample,theUSEnvironmentalProtectionAgencypublishedaproposedruleonApril25,2023,settingairtoxicstandardsforhazardousairpollutants;itinvolvesacommunity-basedriskassessmentthatgoesbeyondfacility-specificrisksandconsidersrisksposedbyotherfacilitiesinthearea.https://insideepa.com/sites/insideepa.com/files/documents/2023/apr/epa2023_0776a.pdf.13Theotherpossibilityisthatthecapsdohaveaneffectbecausetheyarenecessarytoensureanadequaterateofenvironmentalprogress.Inthiscase,theconcernsofenvironmentaljusticeadvocateswillhavebeenmeaningfullyaddressed,andtheaffectedcommunitiescanbeconfidentthattheyshareinthestate’soverallenvironmentalgains.ArecentRFFreport(BurtrawandRoy,2023)examiningthepotentialroleoffacility-specificcapsinthecontextoftheCaliforniacap-and-tradeprogramfindsthatbetween2013and2020,carbondioxideemissionsatfacilitiesregulatedbycap-and-tradeindisadvantagedcommunities(asdefinedbyCalifornia)havefallenby21percentcomparedwith13.8percentatregulatedfacilitiesoutsidethosecommunities.Emissionsatunregulatedfacilitieshavefallenmoreslowlythanatfacilitiesregulatedbycap-and-trade.However,wefindseveralinstancesofspecificfacilitieswheretheoppositeistrue,wheresomefacilitiesindisadvantagedcommunitieshavefailedtokeeppaceeventhoughintheaggregateemissionsatfacilitiesindisadvantagedcommunitiesfellmorequickly.Moreover,thesefacilitiesareoftenindenselypopulatedareas.AttheinitiationofregulationstocoverindustrialsourcesinColorado,thestatecanbuildinsafeguardsattheoutsetthatwillhelpbuildabroadercommunity-levelconsensusandnotharmandmayinfactaccentuatetheenvironmentalbenefitsthatareachievedbytheprogram.14ReferencesAnderson,C.M.,K.A.Kissel,C.B.Field,andK.J.Mach.2018.ClimateChangeMitigation,AirPollution,andEnvironmentalJusticeinCalifornia.EnvironmentalScienceandTechnology52(18):10829–38.doi:10.1021/acs.est.8b00908.Binmore,Ken,andPaulKlemperer.2002.TheBiggestAuctionEver:TheSaleoftheBritish3GTelecomLicenses,EconomicJournal112(478):74-96.Burtraw,Dallas,andNicholasRoy.2023.HowWouldFacility-SpecificEmissionsCapsAffecttheCaliforniaCarbonMarket?RFFReport23-09.Burtraw,Dallas,andKristenMcCormack.2017.ConsignmentAuctionsofFreeAllowances.EnergyPolicy107:337-344.Burtraw,Dallas,KarenPalmer,AnthonyPaulandHangYin.2017.“UsingProductionIncentivestoAvoidEmissionsLeakage,”EnergyEconomics,68:45-56.Burtraw,Dallas,andMattWoerman2013.“EconomicIdeasforaComplexClimatePolicyRegime,”EnergyEconomics,40:S24-S31(FifthAtlanticWorkshopinEnergyandEnvironmentalEconomics.Guesteditors:CarlosdeMiguel,AlbertoGago,XavierLabandeiraandBaltasarManzano).Burtraw,Dallas,KarenPalmer,ClaytonMunnings,PaigeWeberandMattWoerman.2013.“LinkingbyDegrees:IncrementalAlignmentofCap-and-TradeMarkets,”RFFDiscussionPaper13-04.Burtraw,Dallas,andDavidEvans,2008.“TradableRightstoEmitAirPollution”AustralianJournalofAgriculturalandResourceEconomics,53:59-84.SeealsoRelatedRFFDiscussionPaper08-08.Burtraw,Dallas,2007.“CapandTradePolicytoAchieveGreenhouseGasEmissionTargets,”InGrowingtheEconomyThroughGlobalWarmingSolutions,Newton,MA:CivilSocietyInstitute.Burtraw,Dallas,andKarenPalmer,2004.“TheSO2Cap-and-TradeProgramintheUnitedStates:A“LivingLegend”ofMarketEffectiveness,”inChoosingEnvironmentalPolicy.W.Harrington,R.D.MorgensternandT.Sterner(eds.)WashingtonDC:ResourcesfortheFuture.Burtraw,Dallas,1996."TheSO2EmissionsTradingProgram:CostSavingsWithoutAllowanceTrades,"ContemporaryEconomicPolicy,Vol.XIV(April)pp.79-94.Clark,L.P.,D.B.Millet,andJ.D.Marshall.2014.NationalPatternsinEnvironmentalInjusticeandInequality:OutdoorNO2AirPollutionintheUnitedStates.PLOSONE9(4):e94431.doi:10.1371/journal.pone.0094431.Ellerman,A.D.,Joskow,P.L.,Schmalensee,R.,Montero,J.,Bailey,E.M.,2000.MarketsforCleanAir:TheU.S.AcidRainProgram.CambridgeUniversityPress.Fischer,C.,Fox,A.K.,2007.Output-basedallocationofemissionspermitsformitigatingtaxandtradeinteractions.LandEcon.83,575–599.Goulder,LawrenceH.,IanW.H.Parry,RobertonC.WilliamsIII,andDallasBurtraw.“TheCost-EffectivenessofAlternativeInstrumentsForEnvironmentalProtectioninaSecond-BestSetting,”1999,JournalofPublicEconomics,Vol.72,No.3(June)pp.329-360.Hahn,R.W.,Stavins,R.N.,2010.Theeffectofallowanceallocationsoncap-and-tradesystemperformance(workingpaper15854).NationalBureauofEconomicResearch,Cambridge,Massachusetts.Hausker,K.,1992.Thepoliticsandeconomicsofauctiondesigninthemarketforsulfurdioxidepollution.J.PolicyAnal.Manag.11,553–572.15Kahneman,D.,Tversky,A.,1979.Prospecttheory:ananalysisofdecisionunderrisk.Économ.:J.Econom.Soc.,263–291.Kahneman,D.,Knetsch,J.L.,Thaler,R.H.,1990.ExperimentaltestsoftheendowmenteffectandtheCoasetheorem.J.PoliticalEcon.,1325–1348.Kahneman,D.,Knetsch,J.L.,Thaler,R.H.,1991.Anomalies:theendowmenteffect,lossaversion,andstatusquobias.J.Econ.Perspect.5,193–206.Kreutzer,J.,2006.Capandtrade:abehaviora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