A policy that limits average emissions for products could be more politically palatable than carbon taxes or cap and trade. But research is needed about how best to implement such a policy.
For many years, cap and trade and carbon taxes have been primary tools in the policy tool kit to address climate change. This is for good reason: these policies are well-supported by economic theory, and leaders have successfully implemented them in dozens of jurisdictions worldwide, including several US states, the European Union, and China.
While economic theory supports the efficiency of cap and trade and carbon taxes, there is more to a good policy than economic efficiency. Consumers care about affordability. Corporations care about industrial competitiveness. And politicians care about what consumers and corporations care about. A broad tool kit allows policymakers to address all these metrics in the hope of eventually passing a policy into law.
In this blog post, I’ll explore a different, increasingly prominent policy, the product carbon intensity standard (PCIS). This policy can target the amount of greenhouse gases generated when making an individual product, whether it be industrial products such as steel and cement or anything else one might purchase, even a car or an appliance. For this reason, a PCIS has many different features compared to cap and trade and carbon taxes, which both target the total greenhouse gases generated by a sector.
There are notable differences between a PCIS and these traditional emissions-reduction policies with respect to affordability, competitiveness, and efficiency. A PCIS is not necessarily better than cap and trade or carbon taxes. It is, however, a tool that policymakers can take advantage of, should they be motivated to mitigate greenhouse gas emissions, particularly in the electricity and industrial sectors.
What Is a Product Carbon Intensity Standard?
Put simply, a PCIS is any policy that limits the amount of greenhouse gases emitted in the course of creating an individual product. A lot is hiding in the term “product carbon intensity standard,” including what a product is and what it means for greenhouse gases to be emitted while creating a product.
The simplest type of PCIS specifies that only individual products with a carbon intensity below a given target will satisfy the standard. Examples of this type include green procurement policies in Australia and several European countries, as well as the now-rescinded Buy Clean Initiative in the United States. Under these policies, certain government purchases were required to be products with low carbon intensity.
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A PCIS also can target the average carbon intensity of a class of products. Policies that set threshold standards that each individual product must meet can lead to inefficiencies, particularly when many similar products are on the market. It may be cheaper to reduce the carbon intensity of some products rather than others. Since climate change really depends on the total amount of greenhouse gases emitted, what matters is really the amount of greenhouse gases emitted in creating the class of products, rather than the emissions for each individual product. Translated into carbon intensities, from the point of view of climate change, one can just as well target the average carbon intensity of a class of products rather than set a target for the carbon intensity of each separate product.
Familiar, related examples are the Corporate Average Fuel Economy standards and the European Union’s vehicle standards program, which target the average fuel efficiency of automobiles rather than specify that each individual car must achieve a given number of miles per gallon. A PCIS could similarly target the average carbon intensity of a product, such as electricity or cement, rather than each unit produced.
What’s New About a Product Carbon Intensity Standard?
Understanding a PCIS is easier if we compare it to more traditional methods of emissions reductions. A carbon tax or a cap-and-trade system, for example, tends to increase the prices of products significantly. These price hikes incentivize consumers (both businesses and households) to buy less of the product and therefore reduce emissions. However, a major problem with price increases has become more salient in recent years: consumers hate high prices.
The higher prices associated with carbon taxes and cap and trade also have an impact on international trade. If other countries do not have a carbon policy in place with correspondingly high prices, consumers may purchase imported products from those countries rather than purchase higher-priced domestic products. This effect, termed “leakage,” both hurts domestic competitiveness and reduces the effectiveness of the policy in mitigating emissions, since the products end up being produced in regions without a carbon policy and with a potentially higher carbon intensity. While most existing cap-and-trade policies (such as those in California, Washington State, and the European Union) include various measures to mitigate leakage, these measures add complexity to the policy.
A PCIS that targets average carbon intensity has a much lower impact on product prices than a typical carbon tax or cap-and-trade system. Policies like a cap-and-trade system or carbon tax encourage both cleaner production and a shift away from high-emissions products. However, once the target carbon intensity of a PCIS is met for a particular class of products, purchasing fewer of those products does not change the carbon intensity. In a sense, the lower prices in the PCIS are because there is no need for the higher product prices associated with carbon taxes and cap and trade to incentivize reduced consumption. These comparably lower product prices also reduce the impact of the PCIS on competitiveness and leakage.
Another potential benefit (but also potentially a pitfall) of a PCIS is that it is inherently tailored sector by sector or even product by product. In particular, policymakers can choose carbon-intensity targets that provide gentler mitigation paths for some products relative to others, beyond focusing on general goals such as affordability and competitiveness. While other policies can be augmented to provide similar outcomes, the ability to tailor a PCIS is the result of a multitude of levers and switches that are intrinsic to a PCIS.
Implementing a Product Carbon Intensity Standard
Designing a PCIS requires many detailed policy decisions. First, policymakers must decide how to define a product and carbon intensity.
On the product side, it may not make sense to separately target every distinct product. For example, thousands of products are prevalent in the chemicals industry, and regulating each one would be an enormous burden. Instead, regulators might want to group similar products together, setting the carbon intensity standard for the group as a whole.
Another possibility is to move upstream in the supply chain and look at precursors. Regulating a precursor could allow policymakers to regulate fewer products, potentially leading to a more effective, implementable policy. Such a policy could still achieve emissions reductions while sacrificing some ability to tailor the policy design to specific products. For example, in the fertilizer sector, it might be easier to apply a PCIS to ammonia rather than the multiple nitrogen-based fertilizers of which ammonia is a precursor.
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Turning to carbon intensity, the basic idea is to identify how much carbon an individual product embodies. We can calculate carbon intensity by dividing the amount of carbon by the amount of product. Both the numerator and the denominator of this division need definition. Starting with the denominator, for products that are not identical, policymakers must define how to measure the product. Per unit? Per pound of product? Per dollar of product? Each of these choices will have different implications for a PCIS.
For the numerator, the main question is whether to look at direct emissions (emissions that occur while producing the product) or to broaden the definition to include any or all indirect emissions (emissions that occur when making the ingredients that go into a product and potentially any emissions generated in creating the manufacturing infrastructure for the product). Deciding whether and which indirect emissions should be included in carbon-intensity calculations is a policy choice. Deciding how to quantify indirect emissions falls under the umbrella of carbon accounting, which is a source of considerable nuance and complication.
Another question is how to implement a PCIS that targets the average carbon intensity of a class of products. One way to implement this type of PCIS is through tradable credits. When a product’s carbon intensity is below the target, a manufacturer generates credits, which it can sell. On the other hand, when a product’s carbon intensity is above the target, the manufacturer is required to purchase credits to make up the difference. This setup, called a tradable performance standard, guarantees that the overall carbon intensity of a class of products equals the specified target while rewarding the producers that can beat the target.
Because manufacturers pay for only those emissions above a target, and products that are manufactured with below-target emissions actually may be cheaper because of credit sales, PCISs have less of an impact on price than carbon taxes or cap and trade (which involve paying for all of a product’s emissions). However, this simple description of trading hides implementation decisions, such as allowing credit trading across sectors, which will be the subject of future research.
Challenges with Product Carbon Intensity Standards
The flexibility of a PCIS can be both a boon and a curse. The multitude of levers, including many not discussed here that will be an important part of follow-up work from Resources for the Future (RFF), provides significant flexibility to policymakers who are looking to balance the metrics of cost-effectiveness, affordability, and competitiveness, along with the politics needed to get such a policy passed into law. But like any effort, too much complexity can be a liability: the bill could collapse under its own weight and, even if passed, could be difficult to implement.
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While the effect of a PCIS on product prices can be beneficial to consumers, these low prices can reduce economic efficiency and make achieving a specified level of emissions more expensive for society. For example, the higher price of a particularly carbon-intensive product under a broad cap-and-trade policy typically encourages consumers to use less of that product—and that’s efficient. Under a PCIS, that conservation effect doesn’t happen, and more expensive emissions reductions have to happen elsewhere. A key question that RFF research will seek to answer is how, whether, and when a PCIS will raise overall costs.
What’s Next?
Thanks to a grant from Carbon Measures, RFF is embarking on a two-year research program to investigate PCIS designs. In the coming months and years, we will produce detailed reports and blog posts explaining the ins and outs of PCISs and the many decisions policymakers must make in the design of these tools. RFF also will deploy its suite of economic models to look at the impacts of these design choices and to inform PCIS design with lessons learned from other policies that reduce emissions. Stay tuned.
Full disclosure: Carbon Measures is an RFF funder. The views expressed here are those of the individual author and may differ from those of other RFF experts, its officers, its directors, or the institutions that support RFF. Carbon Measures was not involved in any analysis performed for, or the writing of, this article.
