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[Music] hello I'm Bob Wyman I'm a partner in the Los Angeles and Washington DC offices of Latham & Watkins practicing in the environmental regulation and litigation practice groups we're honored to have with us today professor Robert Stevens the AJ Myer professor of energy and economic development at Harvard's Kennedy School of Government and we're going to share some of Rob's other credentials because they're relevant to today's conversation professor Stevens is also the director of several programs at Harvard including the Harvard environmental economics program the graduate studies for the doctoral program both in public policy and in political economy and government and the Harvard project on climate agreements he also co-chairs the Harvard Business School and Kennedy School joint degree programs Rob has also had some interesting experience with other governments and with the US government in providing important advice on the development of their own climate programs so I'll start with the US EPA for which on both Republican and Democratic administrations professor Stevens chaired the environmental economics Advisory Committee for the US EPA and also worked with the Intergovernmental Panel on Climate Change serving as a coordinating lead author of the UN work so thank you rob I'm delighted to be here Bob so before we get into our conversation let me start by setting the stage a bit regarding our topic we're going to be talking about the California climate change program and I with apologies in advance we may slip into using some acronyms so let me share them with you the most important of these is a b32 which stands for Assembly Bill 32 which is one of the major bills it was the first bill in 2006 to give life to the California greenhouse gas program there are a couple of others we may mention including SB 32 Senate bill 32 which essentially took the 2020 end date for the a t32 program and extended it to the year 2030 while deepening the emission reduction tar to 40% you may also hear us talk about a B 398 or Assembly Bill 398 which was one of the bills passed last year to insure that the extended program was designed in a prudent and cost-effective manner so we'll talk about those during our presentation let me also share a couple of characteristics of the California a b32 program to frame our discussion because they're somewhat different from what from other air pollution programs so first this is a program that is not just the cap and trade program that Professor Stevens and I will be discussing it's actually a very comprehensive economy-wide program and it includes not just the cap and trade program component but a number of so-called complimentary measures by which the state of California has set specific performance targets for a number of important sectors including the motor vehicle program the transportation fuels program power plant emissions and even emissions related to land use decisions made by Metropolitan Planning organizations so it's a broad comprehensive program that affects the economy on an economy-wide basis we'll be talking today about the cap-and-trade component the second aspect of the California program that's probably worth stating by way of introduction is that the state legislature when enacting ab32 directed the state agency the California Air Resources Board or and here's another acronym carb directed carb to consult actively with other nations and with other states in the development of their own programs and this was for two purposes one was to ensure that California used the very best program design and to learn from the experience that others had experienced with their programs but the second continuing and overriding consideration for this for this exercise of ab32 was to encourage California to design their program a way that would enable ultimate linkage globally with all of the jurisdictions serious enough to take action on the stabilization of the climate and so we'll talk we're particularly blessed today to have professor Stevens because professor Stevens is an active adviser to many jurisdictions not only here in the United States but internationally and it can comment in as informative manner as anyone regarding best design and how best to link the California program with other jurisdictions so Rob let's talk a bit about a t32 happy to do so let me just ask the basic question what is the purpose for using a cap-and-trade program so I'll tell you cap and trade programs which we've had for quite a while now have some very important properties the most important one is that they deliver environmental performance at lower cost or another way to look at it is that at given cost they deliver even more environmental performance they do this by assigning essentially a permit or allowance to each one of the entities that needs to comply the emitters of a given pollutant and then those sources are allowed to trade to buy and sell and if a particular source can control even more than the permits it has it controls more as long as it can sell those allowances at a price that makes it sensible to do so and likewise another source that faces very high cost of control can buy some allowances so the total number of allowances forms a cap but as a result of what our voluntary trades the costs are going down and they enable us to achieve the environmental performance whatever it is at the lowest possible cost the allowance price might be for co2 it might be ten dollars a tonne or 15 dollars a tonne as it currently is approximately in California it might be 30 or 50 or higher as we talked about at any of those levels there are real costs involved and there is real abatement taking place as long as it's a binding constraint that is as long as the overall cap is less than business as usual what sources would be doing anyway and in California that is certainly the case okay so one of the issues that you report addresses and that California is evaluating for purposes of designing the next ten years of its program is the price ceiling could you give us some idea of what a price ceiling is how it functions what factors California should consider in setting the price ceiling and why well I would start with the reality that the governor the legislature the Air Resources Board I think everyone recognizes that climate change is a serious significant problem to address but that at the same time so is the cost that we take on to do that therefore wisely they have included in the design going forward what they refer to as a price ceiling so that the costs don't get too high the reason being if a costs get too high what will happen is that politically the program will be abandoned so that'll be bad for the environment to be bad for everybody so the way they do this with to put in place the ceiling on costs is to put a ceiling on the price of allowances because if allowances are available from the government at a certain price no firm is ever going to incur costs greater than that they'll simply buy an allowance instead therefore where the government does with the price ceiling it makes available an infinite number of allowances at a stated price that's the price ceiling that's the purpose of it think of it like a guardrail along on a steep mountain road it's a way of making sure that we don't go over the cliff so how would one set the price ceiling where do you set the guardrail so that's that's the key question you're a high heart how high should the guardrail be and that's the key question now that the Air Resources Board is facing and we analyzed this in the paper that you mentioned that we did at analysis group and what we found is that the most important thing that that guardrail that that ceiling can do is to make sure that what economists referred to as I essentially our own Hippocratic oath you know don't kill the patient for us it's don't make the world worse off in other words make sure that the benefits of a policy exceed the costs of a policy make sure that the damages that are being avoided the climate change damages that are being avoided are not actually less than what the costs are that are being incurred now fortunately we have a number for that and a fairly reliable number because the Obama administration put together a very talented interagency task force I see very talented partly because a number of them were my former students put together this task force to analyze the social cost of carbon to analyze what are the damages in a particular year such as 2030 of one additional ton of emissions and they weren't looking at just the damages to the United States or certainly not just the damages to California they're looking at global damages and in doing that they estimated as we translate it in for the year 2030 to a number of about $79 per ton those are the damages therefore those are the benefits at that point of reducing emissions if the price of allowances goes beyond that then that means that the cost is actually greater than the benefits it means that although actions are being carried out they're actually making the world worse off that's violation of the Hippocratic oath now are there any other factors that you considered any report or that should be considered that might have you adjust that standards so such as linkage with other jurisdictions or any other issues that you think California should consider so there are because as I said this is a starting point for thinking about it it's the right concept to have as the social cost to carbon but one thing to keep in mind is the threat of leakage this is when I say leakage I'm talking about the reality that when a given jurisdiction such as California puts in place policies again no matter how meritorious they may be but that have the effect of increasing the cost of producing goods and services in proportion to their carbon intensity in their production then that provides comparative advantage in economic terms for the production of those same goods and services outside of the jurisdiction in areas where they don't face that same compliance costs that might be a state next door such as Arizona or it might be a country on the other side of the world such as Vietnam but there's a comparative advantage shift the result is then that there is a shift of production that's employment leakage jobs leakage there's a shift of emissions so that nothing additional may actually be accomplished within the state they're just relocating emissions to other jurisdictions so that's the reality of economic leakage in emissions leakage that's driven by one factor one number the allowance price the marginal cost of control in California so a very important thing for the state for the Air Resources Board to keep in mind when adjusting that social cost of carbon is that one way and the most powerful way to control that leakage is going to be by having a ceiling which is perhaps even lower than that by having a very firm ceiling because it's those spikes and going above that ceiling that's what drives leakage the other one that you mentioned is something that is a similar-sounding word but something quite different which is linkage that as you pointed out this interesting reality that back in the original ab32 there was actually a mandate for California both to learn from and to communicate with and to other jurisdictions around the world after all given the very small share of global emissions that California actually accounts for it's not really going to affect climate change California even with its most ambitious actions is not going to directly affect sea-level rise along the California coast it's not going to affect temperatures or precipitation because it's such a small part of the emissions what California can do is to influence other jurisdictions that's other states or in a previous administration or a future one perhaps the federal government and for that matter other countries and I can tell you this is not theory on my part this is reality because I just came back from Beijing and Seoul just four days ago where in fact I was meeting with both researchers and government officials talking about their climate policies and in fact the subject of our discussion was the design of China's cap-and-trade system on co2 which will be the largest in the world they're looking at California countries around the world are watching California not for the stringent see not for how ambitious the program is but rather for the efficacy of its design in its performance that to me is why it's so important at California get to design right oh that's really helpful thank you very much now we've heard in the last few weeks of other factors that some of suggested should be considered in setting a price ceiling such as a corporate shadow price or maybe the cost of Technology abatement do you have a view on whether or the factors are appropriate and how they should be considered in the analysis so I think that neither of those are appropriate although they're much talked about so the shadow price on carbon is essentially what corporations are using corporations across the country and for that matter and other jurisdictions for their own internal investment decisions so it's a number they plug into a spreadsheet when they're making a decision about an investment we don't know what those different numbers are furthermore if they write up in the annual report that they're using a particular number we don't know if they actually are using those numbers and those numbers are all over the map they range from one dollar a ton to I've seen something that was $400 a ton so there's no reason to take those as a guide to what the damages are of emissions and therefore the benefits of control again I go back to this importance of the social cost of carbon we have no idea whatsoever how those relate to it so trying to look at this shadow price of carbon that's used in private industry are talked about in private industry I think is a blind alley oh thank you and so what about technology at bateman costs is that relevant to the setting a price ceiling so I think that looking at technology abatement costs and specific technologies is is getting getting the whole analysis backwards the merit of a carbon pricing system such as cap-and-trade is that it's technology neutral I mean I don't know you don't know the governor doesn't know no one knows what the best technology is going to be ten twenty thirty years from now to reduce carbon emissions and as you well know you know the government has a terrible track record at trying to select those technologies so instead we try to put in place a policy that provides incentives so it makes it in the interest both for individuals and firms to adopt and eventually to innovate develop new low-cost technologies that's what the cap-and-trade system does so the cap-and-trade system is the horse that's pulling the cart of technological change and to focus on tech change and to look at specific technologies I think that is just a very big mistake well thank you that's very helpful so let's move to another topic one of the other areas where a B 398 directed the California Resources Board to do some design analysis was in the use of what we call colloquially speed bumps so Rob what do you think about speed bumps what are they where should they be placed how should they be approached so this is an interesting idea that has come forward that's now being considered of the so called speed bumps you know my view is that is important that those are placed at a dollar level a price level so that they're going to have the desired effect and as you can see on the figure that in fact our view what we studied and came up with is that probably they ought to be placed if there are going to be two speed bumps along the way you place the first one about one third of the way to the price ceiling and you place the second one two thirds of the way to the price ceiling they're evenly spaced the way I think about this is that I'm driving in a car at 60 miles an hour and I'm heading towards a cliff now there's a barrier at the cliff which we think is well designed but we're not sure that's the price ceiling I'm a mile away I'm gonna put some speed bumps in place to slow me down don't put them five feet and 1 feet away from the edge of the cliff have them 1/3 of a mile and 2/3 of a mile so that I'm going to slow down and I'll slow down by the time I get to that price ceiling if there are problems with the price ceiling I'm not going to go off the cliff that's the same thinking here well that's very helpful so I take it from your report that one of the objectives of a speed bump is to minimize the risk of price volatility and the impact that could have on the marketplace and so one of the considerations that California is addressing is how to so call populate the speed bumps in terms of how how much of a supply of allowances will be in the speed bump and available at the speed bump price do you have a view as to how the state should allocate the allowances between the speed bumps or this price ceiling well there are additional allowances that are being brought forward that would be a good use of the allowances as - you don't have them available at the speed bumps the important thing is to me is that the speed bumps are sufficiently populated with a quantity of allowances because there's a difference between a speed bump that sticks up you know a quarter of an inch above the surface of a road and one that sticks up a half a foot and it's the same here so if there's not a sufficient number of allowances then they're not going to reduce price volatility price volatility is important because this is actually a problem that has plagued several previous cap-and-trade systems and so it really needs to be addressed we need to reduce it because greater price volatility is going to harm the market it's not going to be good therefore in the long term for environmental performance well maybe I'll use the opportunity to share one of those examples Rob and I have discussed some of the past examples and one of them is the reclaim program the regional clean air incentives market which address the reduction of oxides of sulfur nitrogen in the Metropolitan Area in Southern California and what we observe there was during the power crisis where the demand for electricity outstripped the available supply of electric generation and the basin when hydro supplies from outside the basin were not as available as as traditionally were the the trading credit price in the south coast essentially shot up overnight and it reflected the fact that the power plants in Southern California for which the air district had assumed about a 14% demand 14 percent of the available allowances in that year in those years 2000-2001 actually needed 64 percent of the allowances so if you get that kind of an activity shift particularly if it's unanticipated you need these speed bumps and they need to be well populated with available allowances so let's move over to banking obviously one of the problems with reclaim is that it had no banking provision and therefore no mechanism to deal with unanticipated activity shifts but of course the good news is the ab32 program has banking and most of the if not all of the other jurisdictions around the globe when addressing this issue have a very strong banking program the air be the California agency is looking at the banking program and some have suggested that the banking element should somehow be restricted I wonder if you could just share with us your view of the role of banking and how it should be approached so the first thing to recognize is that banking which essentially means companies carrying out additional emissions reductions now so that they save their allowances that are therefore not needed to use them later so it's good for the environment to start with that banking has been an exceptionally important element of every existing cap-and-trade system in the world in fact the system that was most thought about when the California system was really being designed was the u.s. so2 allowance trading system which I worked on at the George HW Bush White House and in that system to date the lion's share of the gains from trade in other words the cost savings that were about we're not due to cross sectional trading of one firm to another but we're intertemporal trading banking so banking is very very important in terms of bringing down the costs it allows complying firms to still meet the objectives and to do it in a cost-effective way one of the worst things therefore that could be done in terms of design in terms of efficacy to California's climate program would be to constrain banking activity it's something that I believe everyone will come to regret if they do that now one of the characteristics of banking as you described is its intertemporal character which means of course that as allowances are used and reductions achieved emissions may deviate from year to year some critics of the program have suggested recently that the program should actually achieve a fixed emissions level in the year 2030 now I'll just share with you the leap my legal view of that which is that that's a mischaracterization of the program because the statute actually provides for the reductions to occur over a period of years both ab32 and its extension bill SB 32 talk about achieving reductions by no later than a date over the entire period of years and even use language such as in the aggregate so there's a strong legal footing for for supporting banking and allowing the you know the reductions and the emissions to work out inter temporarily in a way that's the most cost effective and that encourages early reductions but I'd be interested in your thoughts about how you view such a claim about either you've already mentioned restricting banking but about you know fixing any particular year for performance so it's interesting to hear what you had to say about the the legal perspective on this and what the law has to say the science and economics goes along exactly with what you said the the striking reality that's very important to understand about global climate change is that this is a stock not a flow environmental problem that what I mean by that is that the damages are not a constant of the emissions at any particular point in time but of the accumulated stock so if I may if I may explain you know what I'm talking about is that we have a bathtub the water's coming out of the drain there's a very slow be coming out of the faucet there's a very slow drain and as a result of that the level of a tub is rising that's the accumulated stock that's what matters so therefore in the context of California what's most important to recognize is what the add added up emissions are over the time period of its twenty one twenty twenty one to twenty thirty for example that's what matters the cumulative emissions what the emissions are on Thursday afternoon or in 2023 don't really matter it matters what the total is that's very important because of banking because if a weren't that way if it mattered what the daily emissions are as it does for some other kinds of environmental problems then we could debate banking but here's a situation which is ideally suited for a very liberal policy of banking get it done limit the globe the total cumulative stock over the ten-year period and don't get fixated on this year by year issue it's inconsistent with the science to do that and it violates the economics because if you restrict banking you're driving up costs because of the fact that firms are making cost-effective investment decisions and then they realize those through their banking activity and then if we take that discussion back to where we started which is a consideration of both best international program design and of ultimately linking with other jurisdictions are we correct in concluding that it's these considerations that are the very same that other jurisdictions are grappling with and that are likely to use for the same purpose as you described well that's why I hope that California goes ahead with a really excellent design I mean the program in California has some very good design elements and there's the opportunity going forward to now to make it even better I hope not to make it worse but to make it even better that it's been both to make it consistent with programs in other jurisdictions other countries other states and provinces but also so that they will pick up on these design elements because that's essentially how California is going to affect the world on this problem well thank you very much for sharing your insights with us today Rob we really appreciate it I've enjoyed talking with you and thank you for listening to our session today for anyone interested in learning more we refer you to the link that you'll see here on our screen for our environmental land and resources page where you can find other information thank you for joining us today you