Wheeling & Dealing: A Cap-and-Trade Program for Vehicle Fuels by Policy Integrity
EPA should use its authority under the Clean Air Act to implement a cap-and-trade program for vehicle fuels.
Economists nearly all agree that the most efficient method to reduce greenhouse gas pollution is to give individual polluters maximum flexibility while still creating incentives for economy-wide emissions reductions. A cap-and-trade program achieves these goals by mandating a total cut in emissions and allowing the market to achieve those reductions in the cheapest manner possible. To create such a trading system for the transportation sector, the United States Environmental Protection Agency (EPA) can use its authority under Section 211 of the Clean Air Act to “cap” the nation’s total emissions from vehicle fuels at an optimal level and distribute a corresponding number of permits, or “emissions allowances,” to upstream emissions sources, such as oil refineries and fuel importers. These sources can then “trade” (i.e., buy and sell) permits with each other. Sources that can reduce emissions at a relatively low cost will benefit from doing so and selling any excess permits. Conversely, sources with relatively high reduction costs will be better off buying permits from others. In this way, the market will determine the most efficient allocation of emissions among regulated sources.
An ideal cap-and-trade program would cover all sectors of the economy, not just the transportation sector. A vehicle fuels-only program under Section 211, however, is far more politically feasible, because it can be implemented by EPA pursuant to existing statutory authority, without cooperation from Congress or individual state governments.
Category of the action
Building efficiency: Physical Action
What actions do you propose?
We propose that EPA cap greenhouse gas emissions from the transportation sector by taking advantage of its existing statutory authority over vehicle fuels. Pursuant to Section 211(c)(1) of the Clean Air Act, EPA may control or prohibit the manufacture or sale of any fuel that (1) causes or contributes to air pollution that (2) may reasonably be anticipated to endanger the public health or welfare. Greenhouse gas emissions generated by vehicle fuels undoubtedly “contribute” to air pollution within the meaning of Section 211(c)(1). The transportation sector is responsible for almost a third of U.S. greenhouse gas emissions, and the vast majority of the sector’s emissions are the result of fuel combustion.
As for the second requirement, EPA expressly concluded in 2009 that “greenhouse gases in the atmosphere may reasonably be anticipated both to endanger public health and to endanger public welfare.” Thus, under the express language of the Clean Air Act, EPA may “control or prohibit” the sale of greenhouse gas–emitting vehicle fuels. In a cap-and-trade program, this “control” will be exercised by requiring upstream fuel sources to possess a sufficient number of permits to cover the emissions-generating potential of any fuel they sell.
Who will take these actions?
EPA will set the cap, and fuel refiners and importers will bear the responsibility of complying with it. By putting a price on carbon, however, the cap-and-trade program will incentivize all market participants—not just regulated entities—to reduce their emissions by the cheapest means possible. To illustrate, if a refinery subject to the cap wants to increase production, it must either (1) lower its per-gallon emissions rate by using a greater percentage of low-carbon fuel, or (2) purchase additional emissions allowances. Either way, marginal production costs will rise, resulting in higher fuel prices for downstream consumers. These higher prices, in turn, will motivate individual consumers to adopt their own least-cost strategies for minimizing fuel use, such as carpooling, moving closer to their place of work, or investing in a more fuel-efficient vehicle.
While higher fuel prices will provide an indirect incentive for downstream emissions reductions, EPA could more directly encourage downstream innovation through the use of carbon offsets. Under a downstream offset scheme, investments in emissions-reducing policies or technologies by entities not subject to the cap—such as local transportation departments—would generate credits that refiners could purchase as a (potentially lower-cost) substitute for emissions allowances. EPA could also allow offsets for emissions-reducing activities outside the transportation sector.
Finally, as noted above, some refiners may comply with the cap by blending more low-carbon biofuel into their gasoline. In determining the carbon reductions associated with such blending, EPA should consider the relative “life cycle” emissions of the biofuel and the gasoline it replaces (i.e., the emissions associated not just with use, but also production, distribution, and disposal). Not all biofuels are created equal in this regard, and greater reduction credit should be awarded for the use of cellulosic fuels made from inedible plant matter.
Where will these actions be taken?
The EPA's program will affect the United States only. If the program is a success, however, it could provide a template for similar trading initiatives in other countries.
How much will emissions be reduced or sequestered vs. business as usual levels?
Theoretically, EPA could require any degree of reduction, but a properly calibrated emissions cap will be set at the point where the marginal abatement cost (based on reasonable technology projections) is equal to the social cost of carbon—that is, the point where the price of preventing an additional ton of greenhouse gas emissions is equivalent to the harm the additional ton of emissions imposes on society. At that stringency, the cap will incentivize the market to perform all abatement that is cost-benefit justified. The cap can be tightened over time as abatement technologies improve or as the estimated costs of climate change increase.
What are other key benefits?
In addition to providing a larger and more predictable volume of emissions reduction, a cap-and-trade program will offer greater flexibility and lower compliance costs than existing EPA programs for the transportation sector. This is because a cap-and-trade program is indifferent to the means by which reductions are achieved. Technology mandates like renewable fuel quotas and vehicle emissions standards, on the other hand, “pick winners” among abatement strategies. For example, renewable fuel quotas prioritize the development of a low-carbon fuel supply over initiatives to reduce fuel demand (such as greater investment in electric cars or mass transit). Yet there is no reason to believe that biofuels are always the most cost-effective abatement option for the transportation sector. Under certain circumstances, increasing bus ridership may prove a cheaper means of reducing emissions than increasing the supply of butanol.
What are the proposal’s costs?
As explained above, an ideal cap will be set at the point where the cost of preventing an additional ton of emissions is equal to the harm those emissions impose on society. The federal government currently—and conservatively—estimates that the social cost of a ton of carbon dioxide emitted in 2015 will be just over $41 (in 2014 dollars). If EPA uses that estimate to calibrate the cap, regulated entities will spend a maximum of $41 to abate a ton of emissions. And because benefits will consistently outweigh compliance costs for each abated ton, the program as a whole will generate significant net benefits for society.
EPA already has statutory authority to create the cap-and-trade program described above. As a result, this proposal can be implemented at any time.
Jack Lienke & Jason A Schwartz, Inst. for Policy Integrity, Shifting Gears: A New Approach to Reducing Greenhouse Gas Emissions from the Transportation Sector (2014).