A major concern with cap-and-trade proposals to reduce greenhouse gas emissions is the uncertainty over the future costs of compliance. Indeed, those who had the chance to see an eight-page overview of the forthcoming Senate climate legislation say the bill will take steps to mitigate cost uncertainty and ease volatility. From Darren Samuelsohn of GreenWire:
Layers of certainty for industry come via a "hard price collar" that limits greenhouse gas allowances to between $10 and $30 per ton tagged to inflation, with an increase at a to-be-determined "fixed rate" over time. The legislation would also set aside a "strategic reserve" of 4 billion greenhouse gas credits that could be released into the market to help control price volatility fluctuations.
According to a new Weekly Policy Commentary from RFF’s Harrison Fell and Richard Morgenstern, price collars, that is to say adding a floor and a ceiling to emissions prices can go a long way toward curbing price volatility in a cap-and-trade system:
With the introduction of a price collar, the expected total cost of compliance was lower and the range of cost outcomes was narrower, yet expected emissions increased only slightly. Importantly, we also found that the range of possible cumulative emissions outcomes could actually be smaller with a price collar compared to a no-collar policy if both the offset supply shock was highly persistent and the negative correlation between offset uncertainty and abatement cost uncertainty was large. As expected, the range of possible price paths was smaller than with no-collar policies.
Read more about the effectiveness of price collars and its functionality as a complement to other cost containment strategies in Fell and Morgenstern’s, Collaring Price Volatility in a Carbon Offset Market, here.
