On the effectiveness of tradable performance-based standards

Abstract

Two types of emission trading programs are allowed under the US federal Clean Power Plan (CPP): mass-based cap-and-trade (C&T) program, and the performance-based trading program. While a C&T sets a total emission cap for a region, a performance-based program under CPP relies on trading the emission rate credits (ERCs), which represent an equivalent MWh of energy generated or saved with zero associated CO2 emissions, to reduce emission costs. This paper examines the theoretical properties of the tradable performance-based policy and compares it to a C&T program. We distinguish two kinds of tradable performance-based policy: (1) a regional policy, under which all states are subject to a regional performance-based standard, and (2) a state-by-state policy, under which each state adopts its performance-based policy within a regional power market while trading of ERCs is allowed. Our findings indicate that under a state-by-state policy, power prices across states could be different even without any transmission congestion, reflecting varying stringency of tradable performance-based standards among states within an interconnected market. We also identify a counterintuitive result that even if ERCs trading is allowed under the state-by-state performance policy, the permit prices could diverge. Two models are simulated in our analysis: three-state and the Pennsylvania-Jersey-Maryland (PJM) regional power market. While the three-state example allows us to illustrate the theoretical properties of the policies, the PJM-based simulation allows us to gauge the performance of the policies. Our PJM analysis shows that a C&T policy is the most effective, while the comparison between a regional and state-by-state tradable performance policy is ambiguous.