In a prior blog post, I describe the contribution of energy efficiency to state emissions-reduction targets in EPA’s Clean Power Plan. As EPA has pointed out, including energy efficiency in states’ targets does not mean that states will necessarily choose to include energy efficiency programs in the compliance plans they submit to EPA. Many factors will no doubt play a role in a state’s decision on what to do about energy efficiency, but here are a few points to keep in mind.
First, it matters if a state chooses to convert its emissions rate target (tons CO2 per MWh of electricity generation) to a mass budget (tons CO2)—the proposal allows states to do so if they choose. Limiting emissions to a mass budget can be done in a variety of ways but economists have long advocated imposing a cap and allowing trading across sources of emissions under it, or imposing an emissions fee on covered sources calibrated to achieve a similar level of reductions—as at least one state is already considering and some in Congress have advocated.
Energy Efficiency under a Mass Target
If states use either of these policies to raise revenue and reduce other preexisting taxes (and there are many good reasons why a state might want to do that, as discussed in the RFF carbon tax FAQs) electricity prices could rise by as much as 10 percent in 2020, according to a recent RFF analysis. That increase in prices could lead to substantial changes in behavior and investment that improve energy efficiency. However, if a state selects a budget approach with emissions trading and then returns revenues to local electric distribution companies or to generators, the policy will have only modest impacts on electricity prices. This would provide little direct incentive for consumers to adopt more efficient appliances or equipment. This makes separate policies to encourage energy efficiency more attractive.
Indeed, in those states that have already adopted CO2 budgets, including the RGGI states and California, energy efficiency does play an important role as a “complementary policy.” In RGGI a large portion of the revenues from the emissions allowance auction is used to fund energy efficiency programs in each of the participating states. It is important to recognize that if an emissions budget is binding (that is, the target is below emissions levels that would have occurred without the budget) then energy efficiency policies are unlikely to reduce emissions below the budget target. Instead the effect will be to reduce the price of CO2 emissions allowances (which my colleague Tim Brennan reminds us makes the energy efficiency policy and the CO2 budget substitutes, not complements, from a strict economics perspective).
However, if the budget or cap-and-trade program includes a floor on the price of emissions allowances (as is the case in both California and RGGI) and that price floor is binding (as was the case during much of the first phase of the RGGI policy) then energy efficiency programs could actually increase the likelihood that allowance prices will be at the price floor and thus contribute to reductions in emissions below the budget target level as allowances are withheld from the market to enforce the price floor.
Energy Efficiency under a Rate Target
If a state aims instead for EPA’s emissions rate target, then the integration of energy efficiency policies into the plan to becomes more complicated. First, there is the issue of evaluation, measurement and verification (EM&V) of energy savings resulting from particular efficiency policies. EPA requires that states have a plan to verify the energy savings that result from their efficiency efforts. This is an important first step for ensuring real reductions in emissions. It is particularly important since, as I’ll cover in a future post, we know less than is generally assumed about how effective existing efficiency policies have been. . Once energy savings have been verified, these savings have to be translated into avoided CO2 emissions that are part of states’ rate targets.. EPA describes a number of potential approaches for doing this calculation. Reconciling approaches across states could be important if states want to join forces and implement regional trading of emissions rate reduction credits.
One more consideration for states is that incorporating state energy efficiency policies into Clean Air Act plans will make those policies federally enforceable and potentially limit a state’s flexibility with respect to changing or modifying the programs in the future. Whether this is a deterrent or not remains to be seen.
