Capitalizing On Cap And Trade: Long-Term Energy Sustainability For Rhode Island

Abundant, cheap, fossil fuel sources of energy have been a key driver of economic growth since the industrial revolution. However, these traditional energy sources are not only limited in supply, they also emit harmful pollutants that have myriad environmental and health consequences. One of the most troubling outcomes of fossil fuel use is climate change caused by accumulating stocks of carbon dioxide (CO₂) in the earth’s atmosphere. 

Developing a clean, innovative, and sustainable energy sector and decreasing reliance on fossil fuels are now crucial components of any long-term economic growth policy. Governments have attempted a range of solutions for promoting clean energy and reducing pollution, from encouraging voluntary action in the private sector to forcing change through regulation to offering market-based incentives like cap and trade programs.

The first of its kind in the U.S., the RGGI program was launched in 2005 with Rhode Island and Massachusetts as the initial signatory states.¹ It currently involves nine Northeastern states: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont. Participating states have mutually agreed to limit CO₂ emissions to 10% below 1990 levels by 2020. The target that is enforced by requiring power plants to purchase or trade permits in order to pollute specific amounts.

This article explores the outcomes of the RGGI program in participating states, particularly Rhode Island, within the context of the overall relationship between economic growth, energy use, and CO₂ emissions.² Data from 1990 to 2012 show that moderate economic growth occurred in the state at the cost of higher levels of energy use and CO₂ emissions, which continued well after the launch of RGGI. This experience is unlike that of other RGGI states, whose economic growth has been progressively less energy and pollution intensive. How Rhode Island invests revenue from the RGGI program may have played a role in the different outcomes it experienced compared to other states.

A Market-based Response to Pollution

In cap and trade systems, a cap limits the total amount of emissions, with the allowed amount typically decreasing over time. The cap is divided up into pollution allowances that are sold and traded by firms that wish to pollute specific amounts. The total number of permits does not exceed the overall cap amount. In 2014, the nine RGGI states set a collective cap of 91 million short tons of CO₂.  The cap will decline by 2.5 million tons each year from 2015 to 2020.⁴

Textbox 1: The History of Cap and Trade Programs

A cap applies to a designated set of polluting sources; in the case of RGGI, regulated sources include fossil-fuel-fired power plants with a capacity of 25 megawatts or greater. A single permit allows for the emission of one unit of CO₂ from a regulated source, and facilities are only allowed to release emissions up to the level of permits they have. Permits or “emission allowances” are issued by a federal or state regulatory authority and are either allocated for free among a group of emitters or, as is the case with RGGI, sold at auction.^(b) As of June 2015, RGGI allowance auctions had generated nearly $2 billion in proceeds for member states, including $41 million in cumulative proceeds for Rhode Island.⁵ 

The key concept of a market-based solution to reducing emissions, such as a cap and trade program, is the provision of a mechanism to value the social and environmental costs of pollution. Setting a cap and allowing firms to trade permits establishes a market that assigns value to CO₂ emissions. This value gets added to the cost of production in sectors affected by the program, inherently increasing product prices in the short term. Higher prices in turn create pressure on participating industries to invest in more cost-effective and environmentally sustainable technologies. 

Flexibility in the program design further incentivizes companies and industries to innovate in order to reduce emissions and use fewer permits, thereby saving them money. Alternatively, money can be earned by banking and selling unused permits. As long as the overall cap is met, it is quite possible for individual firms that would find it expensive to reduce emissions to initially pollute more by buying more permits. Indeed, that choice is part of the program’s flexibility. However, the program’s intent is that emissions will eventually decline over time for all firms. 

The Impact of RGGI on Emissions, Energy Use, and Economic Growth

The RGGI program has succeeded in its primary objective of reducing CO₂ emissions in participating states, from both the economy as a whole and the power sector in particular. As expected, the decline in emissions from the power sector is sharper than in other sectors. Despite a regional population growth of over 11% from 1990 to 2012, in 2012 the RGGI states used 11% less energy, emitted 18% less CO₂ from all sources, and emitted 40% less CO₂ from the power sector than in 1990. By 2020, combined greenhouse gas emissions in the region are projected to be 25% lower than in 1990.⁶

Although regional emissions stabilized and began trending downward in recent years, Rhode Island emitted 19% more CO2 in 2012 than in 1990. In terms of emissions from the power sector, the key target of RGGI regulations, Rhode Island’s power sources generated 401% more CO2 in 2012 than in 1990. The state is the only current RGGI member where power sector emissions increased relative to 1990.^(c) 

The significant growth in emissions from the power sector in Rhode Island is notable given that natural gas, which is less polluting than coal, is the primary fuel used to generate power by all six of the Rhode Island facilities regulated under RGGI. In addition, while overall energy use in the state increased from 1990 to 2012, it did so by only 20%, not nearly as steep a climb as CO₂ emissions from the power sector. 

An important goal of RGGI is to reduce emissions without stifling economic growth. Real gross state product (GSP) growth in the RGGI region almost tripled between 1990 and 2012 while energy use and emissions declined, bucking the conventional wisdom that greater energy consumption is needed to fuel economic growth. As in the European Union and California, areas that also have CO₂ cap and trade programs, economic growth in the RGGI region has steadily been turning “green” over the past two decades. Rhode Island’s experience, however, is different from the rest of the region – not so much in terms of economic growth, but rather the energy intensity of the growth.^(d) While the Rhode Island economy grew by 90% between 1990 and 2012, the state also increased its energy use by 20%. 

First, the relatively small size of the state and its energy sector, compared to larger states such as Massachusetts and New York, means small changes in emissions and energy use in absolute terms translate into larger percentage changes. 

More generally, the significant growth in energy consumption and emissions in Rhode Island could be explained by the type of fuel used in local power plants and its carbon content, the availability of non-fossil-fuel alternatives, the behavioral choices of consumers, and other factors like economic conditions, energy prices, or even weather.⁷ How states choose to invest their RGGI auction proceeds may also explain some of the variation in energy use and emission levels across states. Determining which of these factors accounts for the significant growth in emissions and energy use in Rhode Island, compared to other RGGI states, would require more detailed data analysis.

Investing RGGI Revenues

In addition to reducing emissions, cap and trade programs like RGGI offer a significant secondary benefit: the revenues from the sale of pollution permits, which are typically reinvested in programs to promote cleaner, more efficient energy. RGGI auctions raised a total of $2 billion from 2008 to mid-2015.⁵ This revenue had a significant economic impact. An independent analysis of the first three years of the program found that member states turned $912 million in proceeds into $1.2 billion in economic value, while adding 16,000 new job-years in the aftermath of a recession.⁸ In Rhode Island, $14 million in RGGI proceeds were converted to $69 million in added economic value and 567 job-years.^(e)

Economic theory suggests numerous uses for cap and trade auction revenue, such as state support for clean energy adoption; investments in infrastructure, including land use and public transportation; spending on education, healthcare, or closing state budget gaps; or payments to households to offset higher energy costs.² The key is to choose an investment portfolio that efficiently addresses a state’s economic and social equity priorities. 

Under RGGI, member states spend cap and trade proceeds in four main ways: 

• provide rebates to electricity consumers through direct bill assistance programs; 
• invest in initiatives that promote energy efficiency; 
• support greenhouse gas (GHG) abatement programs^(f) that reduce the emissions produced by energy use; and
• invest in the development and deployment of clean, renewable energy sources.^(g)

Rhode Island currently has a largely monolithic investment strategy, as it spends all of its RGGI revenue (after administrative costs) on energy efficiency programs. While almost all states spend the majority of their RGGI funds on energy efficiency, as required by program rules, some states also spend significant portions in other areas.² For instance, Connecticut invests 23% of its RGGI proceeds in clean and renewable energy, while Delaware devotes 10% of the funds to GHG abatement. As of 2012, the RGGI states on average spent 65% on energy efficiency, 6% on renewable energy, and 6% on GHG abatement technologies. These averages are largely driven by Connecticut, Delaware, Maryland, and New York, all of which have relatively diverse investment strategies. 

Though perhaps not surprising for a small state, Rhode Island has the highest administrative costs (as a percentage of overall program spending) in the RGGI system, with 8% of proceeds going toward program administration.^(h) Massachusetts spends an even larger share of its total RGGI funds on energy efficiency than Rhode Island, but still has money left over for GHG abatement programs because it keeps administrative costs low. 

The Impact of RGGI Investment Choices

The state’s strict building energy codes were cited as an example of an energy efficiency strategy for others to emulate.  While these improvements are impressive, they do not appear to have translated into reduced energy consumption. Energy use increased 20% in Rhode Island between 1990 and 2012, while it declined in the overall RGGI region by 11% during the same period. Energy prices in Rhode Island are also increasing at a faster rate than in the rest of the RGGI region,⁽ⁱ⁾ a trend that hurts consumers and businesses and can deter companies from locating in the state.¹² While cap and trade systems can be expected to increase energy prices in the short- and medium-term, energy efficiency programs should counterbalance this effect by eventually reducing prices and consumer expenditures through lower demand. 

Research suggests that consumers often participate in energy efficiency programs, such as home weatherization, at lower rates than projected, despite the potential cost savings these programs offer.¹³ Higher income home owners and those who are better informed are more likely to participate, while other consumers may not take advantage of the initiatives.¹⁴ Moreover, the cost savings from practicing energy efficiency can theoretically lead to a “rebound effect,” wherein lower energy bills cause consumers to use more, not less, energy. Ultimately, desired consumer responses are related to achieving behavior changes through demand-side-management strategies such as energy efficiency programs. Methodical program evaluation is thus needed to clarify the effectiveness of current energy efficiency programs.

Through proactive demand-side management, Rhode Island can do much more to translate its energy efficiency gains into lower electricity demand and prices and, eventually, reduced CO₂ emissions. Doing so would require continued but lower investments in energy efficiency, as well as greater investments in renewable energy sources and greenhouse gas abatement.¹⁵ Promoting energy efficiency is typically considered the “low-hanging fruit” in the array of clean energy policies. Energy efficiency programs can lead to reductions in power demand, prices, and expenditures in the short to medium term and in CO₂ emissions in the long run, but the benefits are largely concentrated among the individuals and companies that take advantage of the programs. While there are some spillover macroeconomic benefits for the larger economy, a comprehensive strategy for long-term energy sustainability should also include investment in clean, renewable energy sources and greenhouse gas reduction.

Capitalizing on Cap and Trade

There are three primary ways to potentially deepen the impact of RGGI in Rhode Island, with an eye toward long-term efficiency in planning and implementation. The first is rigorous assessment of the returns on state energy efficiency programs to understand their effectiveness at the margins and to inform long-term program priorities and investment choices. The analysis presented here raises important questions about the overall efficacy of Rhode Island’s current suite of programs in lowering long-term energy use. The state could examine how existing programs targeting the residential, commercial, and industrial sectors are affecting electricity consumption, demand, and prices. 

Rhode Island might also want to assess programs that have offered broader long-term gains in Connecticut, Massachusetts, and New York, who (along with California and Oregon) are recognized by the ACEEE as “true leaders” in developing energy efficiency.¹¹ The state could also experiment with ways to reduce RGGI administrative costs, which are now the highest in the system. 

A second option is the distribution of RGGI revenues over more program categories, particularly renewable energy and clean public transportation initiatives. States such as Maryland, New York, Delaware, and California have found a blended investment approach an effective way to maximize long-term environmental and economic benefits.¹⁶ Rhode Island could diversify its public investment portfolio by incorporating programs such as renewable energy, clean public transportation, worker retraining, education that prepares students for green jobs, and consumer bill assistance.^(j) 

Energy investment portfolio choices in other states have been guided by rigorous economic modeling tailored to the state’s medium- and long-term goals for economic growth, energy use, environmental sustainability, and social equity. This type of modeling can help explain the multiplier effects of program choices and the net benefits of diversifying energy-related spending in the state. 

A third strategy is to reap the benefits of the potential expansion of RGGI. The program may grow in the coming years to include states outside the current consortium that are looking to meet the EPA’s new Clean Power Plan standards requiring reductions in CO₂ pollution from the power sector nationwide.¹⁷ With the right preparation, Rhode Island can leverage its programmatic and institutional experience with cap and trade programs in general to quickly and seamlessly transition to a larger CO₂ auction market with higher revenue potential.¹⁸