With the U.S. economy currently in a free fall, some utility industry leaders and elected officials argue that carbon cap legislation should be put on hold while the country recovers financially. However, President Barack Obama has a different game plan.

"We will start with a federal cap and trade system. We’ll establish strong annual targets that set us on a course to reduce emissions to their 1990 levels by 2020, and reduce them a further 80 percent by 2050," Obama said on November 18.

During his campaign, Obama emphasized that his proposed cap-and-trade policy would require all pollution credits to be auctioned, and companies would have to buy all of the allowances they need through government auctions.

Under the Edison Electric Institute plan, allowances would be allocated for free in the early years.

Two Approaches to Allowances

The cap-and-trade approach advocated by Obama builds on U.S. experience with the acid rain provisions of the 1990 Clean Air Act Amendments, which imposed SO 2 emissions cuts on many electric power plants.

A conventional cap-and-trade program establishes an economy-wide or sectoral cap on emissions (in terms of tons per year or other compliance period) and allocates or auctions tradable allowances (the right to emit a ton of greenhouse gases, such as CO 2) to large emitters, such as electric power plants.

Allowance allocation has long been one of the most divisive issues in the utility industry. Generators, especially heavy emitters, frequently take the position that they need free allowances in order to finance the carbon capture and storage technology they will have to utilize if they are to continue using coal under a greenhouse gas (GHG) emission cap. They also maintain that they are most in need of allowances to help offset their larger cleanup costs and thereby shield their rate payers from large rate increases. In contrast, generators that have less carbon-intensive power plants often argue that free allowances would unfairly compensate their competitors that produce more CO 2 emissions.

For example, the Senate bill (S. 2191), sponsored by Sens. Joseph Leiberman (I-Conn.) and John Warner (R-Va.), was criticized by FPL Group Chairman and CEO Lewis Hays in 2007 for rewarding "the country’s biggest emitters of CO 2 with billions of dollars of free allowances they don’t need."

Industry’s Hybrid Allocation Plan

Now it appears that many in the utility industry are trying to work together. On January 14, the Edison Electric Institute (EEI), an advocacy group that represents investor-owned utilities, released its own proposal for how to allocate carbon allowances. In its effort to promote the swift enactment of federal legislation capping GHG emissions, it adopted an updated climate change framework that calls for an 80% reduction of carbon emissions from current levels by 2050.

The EEI framework for the first time presented Congress with a unified industry position for allocating emissions allowances distributed to the utility sector under potential cap-and-trade legislation. The EEI Board recommends that the initial emission allowance allocation to the electric power sector should be 40%, equal to its portion of U.S. carbon emissions. Under the EEI plan, allowances would be allocated for free in the early years. The program would gradually transition from free allowances to auctioned ones at a rate of 3% of allowances per year, beginning in the 2020 to 2025 timeframe.

"Any federal climate policy will come with a hefty price tag, and it is essential that we do all that we can to mitigate costs to customers," EEI President Tom Kuhn said. "The best way to do this is to pass the benefits of allowances directly to them, which is precisely what our formula would do." The EEI allocation formula would provide allowances to electricity customers through local distribution companies, and it also would provide allowances for merchant coal generators.

To protect customers and the international competitiveness of U.S. industries, the EEI framework also calls for a "price collar," which would include both a firm price floor and ceiling for the cost of carbon, according to the EEI. The EEI Board recommends that the cost collar be narrow at the start and gradually expand over time as climate-friendly technologies become more readily available. Offsets also are an important means of addressing costs, it said.

First-Level Consensus Reached

The need for some type of federal CO 2 allowance allocation program is clear. The current patchwork of state and regional allowance trading systems is leading to a balkanization of carbon pricing in the U.S.

It’s a promising sign that the EEI has reached an industry consensus on how to allocate emissions allowances. Now it is time for our federal elected officials to move beyond gridlock and start negotiating with the utility industry and other stakeholders to reach an agreement on a coherent and cost-effective GHG reduction program as soon as possible.

–Angela Neville, JD is POWER’s senior editor.