Policy Archives - Page 10 of 17

The 2009 World Energy Outlook

Following up on Carlos Ferreira’s comment, I looked up the new IEA WEO, unveiled today. A few excerpts from the executive summary:

The financial crisis has cast a shadow over whether all the energy investment needed to meet growing energy needs can be mobilised.
Continuing on today’s energy path, without any change in government policy, would mean rapidly increasing dependence on fossil fuels, with alarming consequences for climate change and energy security.
Non-OECD countries account for all of the projected growth in energy-related CO2 emissions to 2030.
The reductions in energy-related CO2 emissions required in the 450 Scenario (relative to the Reference Scenario) by 2020 — just a decade away — are formidable, but the financial crisis offers what may be a unique opportunity to take the necessary steps as the political mood shifts.
With a new international climate policy agreement, a comprehensive and rapid transformation in the way we produce, transport and use energy — a veritable lowcarbon revolution — could put the world onto this 450-ppm trajectory.
Energy efficiency offers the biggest scope for cutting emissions
The 450 Scenario entails $10.5 trillion more investment in energy infrastructure and energy-related capital stock globally than in the Reference Scenario through to the end of the projection period.
The cost of the additional investments needed to put the world onto a 450-ppm path is at least partly offset by economic, health and energy-security benefits.
In the 450 Scenario, world primary gas demand grows by 17% between 2007 and 2030, but is 17% lower in 2030 compared with the Reference Scenario.
The world’s remaining resources of natural gas are easily large enough to cover any conceivable rate of increase in demand through to 2030 and well beyond, though the cost of developing new resources is set to rise over the long term.
A glut of gas is looming

This is pretty striking language, especially if you recall the much more business-as-usual tone of WEOs in the 90s.

Marginal Damage has (or will have) more.

The Rygg study, pining for the fjords

The DEQ dead parrot skit continues in the Revised Evans EA, which borrows boilerplate from the Morgan EA I reported on yesterday. It once again cites the spurious Rygg study, overgeneralizes its findings, and repeats the unsubstantiated Fairbanks claims. At least in the Morgan EA, DEQ reviewed some alternative evidence cited by Orville Bach, indicating that gravel pit effects on property values are nonzero. In the Evans EA, DEQ omits any review of evidence contradicting Rygg; evidently DEQ’s institutional memory lasts less than 3 months.

Even the review in the Morgan EA was less than coherent. After discussing Rygg, they summarize Bach’s findings and two key articles:

He includes a figure from one of the citations showing the impact on residential property values based on distance of the property from the gravel mine – the closer the property, the greater the impact. Based on this figure, properties less than a quarter mile from the mine experienced up to a 32% decline in value. The impact on property value declined with increased distance from the gravel mine. Properties three miles away (the farthest distance in the analysis) experienced a 5% decline. …

Researchers have used the hedonic estimation method to evaluate impacts to housing prices from environmental “disamenities” (factors considered undesirable). Using this multivariate statistical approach, many characteristics of a purchased good (house) are regressed on the observed price, and thus, one can extract the relative contribution of the environmental variables to the price of the house (Boyle and Kiel 2001). Research has been conducted in many locations in the country, and on many types of disamenities (landfills, power plants, substations, hazardous waste sites, gravel mines, etc.). The study cited by Mr. Bach (Erickcek 2006) uses techniques and data developed by Dr. Hite to evaluate potential effects on property values of a proposed gravel mine in Richland Township, Michigan. Dr. Hite’s study evaluated effects of a gravel mine in Ohio. Both the Erickcek and Hite studies showed decreases in property values resulting from proximity of the property to the mine (Erickcek 2006).

DEQ latches onto one footnote in Erickcek,

However, Erickcek states in footnote 6, ‘Only those owning property at the time of the establishment of the gravel mine would experience a loss in equity. Those purchasing property near an established mine would not experience an equity loss because any negative effects from the mine’s operation would have been incorporated into the purchase price.’

Note that this is a statement about property rights and the distribution of harm. It doesn’t in anyway diminish the existence of harm to someone in society. Evidently DEQ doesn’t understand this distinction, or thinks that Rygg trumps Hite/Erickcek, because it concludes:

Irreversible and Irretrievable Commitments of Resources: The Proposed Action would not result in any irreversible or irretrievable commitments of resources related to the area’s social and economic circumstances.

Could Rygg trump Hite? Let’s consider the score:

Attribute	Rygg	Hite
sampling	ad hoc	census
sample size	6+25	2812
selection bias	severe	minimal
control for home attributes	ad hoc	4 attributes
control for distance	no	yes
control for sale date	no	yes
statistical methods	none	proper
pit sites	1	multiple
reported diagnostics	no	yes
Montana?	yes	no

That’s Hite 9, Rygg 1. Rygg’s point is scored on location, which goes to applicability of the results to Montana. This is a hollow victory, because Rygg himself acknowledges in his report that his results are not generalizable, because they rely on the unique circumstances of the single small pit under study (particularly its expected temporary operation). DEQ fails to note this in the Evans and Morgan EAs. It’s hard to judge generalizability of the Hite study, because I don’t know anything about local conditions in Ohio. However, it is corroborated by a Rivers Unlimeted hedonic estimate with a different sample.

A simple combination of Rygg and Hite measurements would weight the two (inversely) by their respective variances. A linear regression of the attributes in Rygg indicates that gravel pits contribute positively to value (ha ha) but with a mean effect of $9,000 +/- $16,000. That, and the fact that the comparable properties have much lower variance than subject properties adjacent to the pit should put up red flags immediately, but we’ll go with it. There’s no way to relate Rygg’s result to distance from the pit, because it’s not coded in the data, but let’s assume half a mile. In that case, the roughly comparable effect in Hite is about -$74,000 +/- $11,000. Since the near-pit price means are similar in Hite and Rygg, and the Rygg variance is more than twice as large, we could combine these to yield a meta measurement of about 2/3 Hite + 1/3 Rygg, for a loss of $46,000 per property within half a mile of a pit (more than 30% of value). That would be more than fair to Rygg, because we haven’t accounted for the overwhelming probability of systematic error due to selection bias, and we’re ignoring all the other literature on valuation of similar nuisances. This is all a bit notional, but makes it clear that it’s an awfully long way from any sensible assessment of Rygg vs. Hite to DEQ’s finding of “no effect.”

Montana DEQ – rocks in its head?

Lost socks are a perpetual problem around here. A few years back, the kids would come to me for help, and I’d reflexively ask, “well, did you actually go into your room and look in the sock drawer?” Too often, he answer was “uh, no,” and I’d find myself explaining that it wasn’t very meaningful to not find something when you haven’t looked properly. Fortunately those days are over at our house. Unfortunately, Montana’s Department of Environmental Quality (DEQ) insists on reliving them every time someone applies for a gravel mining permit.

Montana’s constitution guarantees the right to a clean and healthful environment, with language that was the strongest of its kind in the nation at the time it was written. [*] Therefore you’d think that DEQ would be an effective watchdog, but the Opencut Mining Program’s motto seems to be “see no evil.” In a number of Environmental Assessments of gravel mining applications, DEQ cites the Rygg Study (resist the pun) to defend the notion – absurd on its face – that gravel pits have no impact on adjacent property values.Â For example:

Several years ago, DEQ contracted a study to determine “whether the existence of a gravel pit and gravel operation impacts the value of surrounding real property.” The study (Rygg, February 1998) involved some residential property near two gravel operations in the Flathead Valley. Rygg concluded that the above-described mitigating measures were effective in preventing decrease in taxable value of those lands surrounding the gravel pits.

The study didn’t even evaluate mitigating measures, but that’s the least of what’s wrong (read on). Whenever Rygg comes up,the “Fairbanks review” is not far behind. It’s presented like a formal peer review, but the title actually just means, “some dude at the DOR named Fairbanks read this, liked it, and added his own unsubstantiated platitudes to the mix.” The substance of the review is one paragraph:

“In the course of responding to valuation challenges of ad valorem tax appraisals, your reviewer has encountered similar arguments from Missoula County taxpayers regarding the presumed negative influence of gravel pits, BPA power lines, neighborhood character change, and traffic and other nuisances. In virtually ALL cases, negative value impacts were not measurable. Potential purchasers accept newly created minor nuisances that long-time residents consider value diminishing.”

First, we have no citations to back up these anecdotes. They could simply mean that the Department of Revenue arbitrarily denies requests for tax relief on these bases, because it can. Second, the boiled frog syndrome variant, that new purchasers happily accept what distresses long-term residents, is utterly unfounded. The DEQ even adds its own speculation:

The proposed Keller mine and crushing facility and other operations in the area … create the possibility of reducing the attractiveness of home sites to potential homebuyers seeking a quiet, rural/residential type of living environment. These operations could also affect the marketability of existing homes, and therefore cause a reduction in the number of interested buyers and may reduce the number of offers on properties for sale. This reduction in property turnover could lead to a loss in realtors’ fees, but should not have any long-term effect on taxable value of property. …

Never mind slaves to defunct economists, DEQ hasn’t even figured out supply and demand.

When GOMAG (a local action group responding to an explosion of gravel mining applications) pointed me to these citations, I took a look at the Rygg Study. At the time, I was working on the RLI, and well versed in property valuation methods. What I found was not pretty. I’m sure the study was executed with the best of intentions, but it uses methods that are better suited to issuing a loan in a bubble runup than to measuring anything of import. In my review I found the following:

’¢ The Rygg study contains multiple technical problems that preclude its use as a valid measurement of property value effects, including:

o The method of selection of comparable properties is not documented and is subject to selection bias, exacerbated by the small sample
o The study neglects adverse economic impacts from land that remains undeveloped
o The measure of value used by the study, price per square foot, is incomplete and yields results that are contradicted by absolute prices
o Valuation adjustments are not fully documented and appear to be ad hoc
o The study does not use accepted statistical methods or make any reference to the uncertainty in conclusions
o Prices are not adjusted for broad market appreciation or inflation, though it spans considerable time
o The study does not properly account for the history of operation of the pit

’¢ The Fairbanks review fails to consider the technical content of the Rygg study in any detail, and adds general conclusions that are unsupported by the Rygg study, data, original analysis, or citation.
’¢ Citations of the Rygg study and the Fairbanks review in environmental assessments improperly exaggerate and generalize from its conclusions.

I submitted my findings to DEQ in a long memo, during the public comment period on two gravel applications. You’d think that, in a rational world, it would provoke one of two reactions: “oops, we’d better quit citing that rubbish” or, “the review is incorrect, and Rygg is actually valid, for the following technical reasons ….”Â Instead, DEQ writes,

The Rygg report is not outdated. It is factual data. The Diane Hite 2006 report upon which several of the other studies were based, used 10 year old data from the mid-1990’s. Many things, often temporary, affect property sale prices.

Huh? They’ve neatly tackled a strawdog (“outdated”) while sidestepping all of the substantive issues. What exactly does “factual data” mean anyway? It seems that DEQ is even confused about the difference between data and analysis. Nevertheless, they are happy to proceed with a recitation of Rygg and Fairbanks, in support of a finding of no “irreversible or irretrievable commitments of resources related to the area’s social and economic circumstances.”

So much for the watchdog. Where DEQ ought to be defending citizens’ constitutional rights, it seems bent on sticking its head in the sand. Its attempts to refute the common sense idea, that no one wants to live next to a gravel pit, with not-even-statistical sleight of hand grow more grotesque with each EA. I find this behavior baffling. DEQ is always quick to point out that they don’t have statutory authority to consider property values when reviewing applications, so why can’t they at least conduct an honest discussion of economic impacts? Do they feel honor-bound to defend a study they’ve cited for a decade? Are they afraid the legislature will cut off their head if they stick their neck out? Are they just chicken?

Companies – also not on track yet

The Carbon Disclosure Project has a unique database of company GHG emissions, projections and plans. Many companies are doing a good job of disclosure; remarkably, the 1309 US firms reporting account for 31% of US emissions [*]. However, the overall emissions picture doesn’t look like a plan for deep cuts. CDP calls this the “Carbon Chasm.”

Based on current reduction targets, the world’s largest companies are on track to reach the scientifically-recommended level of greenhouse gas cuts by 2089 ’“ 39 years too late to avoid dangerous climate change, reveals a research report ’“ The Carbon Chasm ’“ released today by the Carbon Disclosure Project (CDP).

It shows that the Global 100 are currently on track for an annual reduction of just 1.9% per annum which is below the 3.9% needed in order to cut emissions in developed economies by 80% in 2050. According to the Intergovernmental Panel for Climate Change (IPCC), developed economies must reduce greenhouse gas emissions by 80-95% by 2050 in order to avoid dangerous climate change. [*]

Of course there are many pitfalls here: limited sampling, selection bias, greenwash, incomplete coverage of indirect emissions, … Still, I find it quite encouraging that companies plan net cuts at all, when many governments haven’t yet managed the same feat, so top-down policy isn’t in place to support their actions.

Allocation Oddity

Mining my hard drive for stuff I did a few weeks back, when the Waxman Markey draft was just out, I ran across this graph:

It shows prices for electricity and petroleum from the ADAGE model in the June EPA analysis. BAU = business-as-usual; SCN 02 = updated Waxman-Markey scenario; SCN 06 = W-M without allowance allocations for consumer rate relief and a few other provisions. Notice how the retail price signal on electricity is entirely defeated until the 2025-2030 allowance phaseout. On the other hand, petroleum prices are up in either scenario, because there is no rate relief.

Four questions:

Isn’t it worse to have a big discontinuity electricity prices in 2025-2030, rather than a smaller one in 2010-2015?
Is your average household even going to notice a 1 or 2 c/kwh change over 5 years, given the volatility of other expenses?
Since the NPV of the rate relief by 2025 is not much, couldn’t the phaseout happen a little faster?
How does it help to defeat the price signal to the residential sector, a large energy consumer with low-hanging mitigation fruit?

Things might not be as bad as all this, if the goal (not mandate) of serving up rate relief as flat or fixed rebates is actually met. Then the cost of electricity at the margin will go up regardless of allowance allocation, and there would be some equity benefit. But my guess is that, even if that came to pass, consumers would watch their total bills, not the marginal cost, and thus defeat the price signal behaviorally. Also, will people with two addresses and two meters, like me, get a double rebate? Yippee!

Constraints vs. Complements

If you look at recent energy/climate regulatory plans in a lot of places, you’ll find an emerging model: an overall market-based umbrella (cap & trade) with a host of complementary measures targeted at particular sectors. The AB32 Scoping Plan, for example, has several options in each of eleven areas (green buildings, transport, …).

I think complementary policies have an important role: unlocking mitigation that’s bottled up by misperceptions, principal-agent problems, institutional constraints, and other barriers, as discussed yesterday. That’s hard work; it means changing the way institutions are regulated, or creating new institutions and information flows.

Unfortunately, too many of the so-called complementary policies take the easy way out. Instead of tackling the root causes of problems, they just mandate a solution – ban the bulb. There are some cases where standards make sense – where transaction costs of other approaches are high, for example – and they may even improve welfare. But for the most part such measures add constraints to a problem that’s already hard to solve. Sometimes those constraints aren’t even targeting the same problem: is our objective to minimize absolute emissions (cap & trade), minimize carbon intensity (LCFS), or maximize renewable content (RPS)?

You can’t improve the solution to an optimization problem by adding constraints. Even if you don’t view society as optimizing (probably a good idea), these constraints stand in the way of a good solution in several ways. Today’s sensible mandate is tomorrow’s straightjacket. Long permitting processes for land use and local air quality make it harder to adapt to a GHG price signal, for example.Â To the extent that constraints can be thought of as property rights (as in the LCFS), they have high transaction costs or are illiquid. The proper level of the constraint is often subject to large uncertainty. The net result of pervasive constraints is likely to be nonuniform, and often unknown, GHG prices throughout the economy – contrary to the efficiency goal of emissions trading or taxation.

My preferred alternative: Start with pricing. Without a pervasive price on emissions, attempts to address barriers are really shooting in the dark – it’s difficult to identify the high-leverage micro measures in an environment where indirect effects and unintended consequences are large, absent a global signal. With a price on emissions, pain points will be more evident. Then they can be addressed with complementary policies, using the following sieve: for each area of concern, first identify the barrier that prevents the market from achieving a good outcome. Then fix the institution or decision process responsible for the barrier (utility regulation, for example), foster the creation of a new institution (to solve the landlord-tenant principal-agent problem, for example), or create a new information stream (labeling or metering, but less perverse than Energy Star). Only if that doesn’t work should we consider a mandate or auxiliary tradable permit system. Even then, we should also consider whether it’s better to simply leave the problem alone, and let the GHG price rise to harvest offsetting reductions elsewhere.

I think it’s reluctance to face transparent prices that drives politics to seek constraining solutions, which hide costs and appear to “stick it to the man.” Unfortunately, we are “the man.” Ultimately that problem rests with voters. Time for us to grow up.

MAC Attack

John Sterman just pointed me to David Levy’s newish blog, Climate Inc., which has some nice thoughts on Marginal Abatement Cost curves: How to get free mac lunches, and Whacking the MAC. They reminded me of my own thoughts on The elusive MAC curve. Climate Inc. also has a very interesting post on the psychology of US and European oil companies’ climate strategies, Back to Petroleum?.

The conclusion from How to get free mac lunches:

Of course, these solutions are not cost free ’“ they involve managerial time, some capital, and transaction costs. Some of the barriers are complex and would require large scale institutional restructuring, requiring government-business collaboration. But one person’s transaction costs are another’s business opportunity (the transaction costs of carbon markets will keep financial firms smiling). The key point here is that there are creative organizational and managerial approaches to unlock the doors to low-cost or even negative-cost carbon reductions. The carbon price is, by itself, an inefficient and ineffective tool ’“ the price would have to be at a politically infeasible level to achieve the desired goal. But we don’t have to rely just on the carbon price or on command and control; a multi-pronged attack is needed.

and Whacking the MAC:

Simply put, it will take a lot more than a market-based carbon price and a handout of free allowances to utilities to unlock the potential of conservation and energy efficiency investments.Â It will take some serious innovation, a great deal of risk-taking and capital, and a coordinated effort by policy-makers, investors, and entrepreneurs to jump the significant institutional and legal hurdles currently in the way.Â Until then, it will continue to be a real stretch to bend over the hurdles in an effort to reach all the elusive fruit lying on the ground.

Here’s my bottom line on MAC curves:

The existence of negative cost energy efficiency and mitigation options has been debated for decades. The arguments are more nuanced than they used to be, but this will not be settled any time soon. Still, there is an obvious way to proceed. First, put a price on carbon and other externalities. We’d make immediate progress on some fronts, where there are no barriers or misperceptions. In the stickier areas, there would be a financial incentive to solve the institutional, informational and transaction cost barriers that prevented implementation when energy was cheap and emissions were free. Service providers would emerge, and consumers and producers could gang up to push bureaucrats in the right direction. MAC curves would be a useful roadmap for action.

Bolivia Barking

I recently wondered whether developing countries were asking for the wrong thing in Bonn. Now Bolivia is barking up the right tree with a proposed “climate debt” concept. The idea’s actually quite old; it’s already well developed in the Greenhouse Development Rights framework.

The trick is, how to achieve an equitable outcome that’s consistent with the physics of climate? Consider this reaction to ideas like climate debt:

Obama’s Global Tax

By INVESTOR’S BUSINESS DAILY | Posted Tuesday, July 29, 2008 4:20 PM PT

Election ’08: A plan by Barack Obama to redistribute American wealth on a global level is moving forward in the Senate. It follows Marxist theology – from each according to his ability, to each according to his need.

…

Obama would give them all a fish without teaching them how to fish. Pledging to cut global poverty in half on the backs of U.S. taxpayers is a ridiculous and impossible goal.

…

We already transfer too much national wealth to the United Nations and its busybody agencies. …

…

If you’re worried abut gasoline and heating oil prices now, think what they’ll be like when the U.S. is subjected in an Obama administration to global energy consumption and production taxes. Obama’s Global Poverty Act is the “international community’s” foot in the door.

…

Obama has called on the U.S. to “lead by example” on global warming and probably would submit to a Kyoto-like agreement that would sock Americans with literally trillions of dollars in costs over the next half century for little or no benefit.

“We can’t drive our SUVs and eat as much as we want and keep our homes on 72 degrees at all times . . . and then just expect that other countries are going to say OK,” Obama has said. “That’s not leadership. That’s not going to happen.”

Oh, really? Who’s to say we can’t load up our SUV and head out in search of bacon double cheeseburgers at the mall? China? India? Bangladesh? The U.N.?

I suspect that these sentiments are quite prevalent, at least in the US. I’m even sympathetic in at least one respect: transfers from the global rich to poor are beneficial in principle, but difficult to execute. Transfers from country to country are susceptible to capture by elites. Direct transfers among individuals could be facilitated by a global carbon market with allowances allocated to individuals (one of the few good arguments for emissions trading in my mind), but would undemocratic regimes permit their citizens to participate?

I don’t see agreement on this front any time soon. I could see things going a different way: the US, EU and a few other developed nations move to reduce, then goad developing nations along with a mixture of carrot (offset projects and other transfers) and stick (border carbon adjustments).

Strategic Excess? Breakthrough's Nightmare?

Since it was the Breakthrough analysis that got me started on this topic, I took a quick look at it again. Their basic objection is:

Therein lies a Catch-22 of ACES: if the annual use of up to 2 billion tons of offsets permitted by the bill is limited due to a restricted supply of affordable offsets, the government will pick up the slack by selling reserve allowances, and “refill” the reserve pool with international forestry offset allowances later. […]

The strategic allowance reserve would be established by taking a certain percentage of allowances originally reserved for the future — 1% of 2012-2019 allowances, 2% of 2020-2029 allowances, and 3% of 2030-2050 allowances — for a total size of 2.7 billion allowances. Every year throughout the cap and trade program, a certain portion of this reserve account would be available for purchase by polluters as a “safety valve” in case the price of emission allowances rises too high.

How much of the reserve account would be available for purchase, and for what price? The bill defines the reserve auction limit as 5 percent of total emissions allowances allocated for any given year between 2012-2016, and 10 percent thereafter, for a total of 12 billion cumulative allowances. For example, the bill specifies that 5.38 billion allowances are to be allocated in 2017 for “capped” sectors of the economy, which means 538 million reserve allowances could be auctioned in that year (10% of 5.38 billion). In other words, the emissions “cap” could be raised by 10% in any year after 2016.

First, it’s not clear to me that international offset supply for refilling the reserve is unlimited. Section 726 doesn’t say they’re unlimited, and a global limit of 1 to 1.5 GtCO2eq/yr applies elsewhere. Anyhow, given the current scale of the offset market, it’s likely that reserve refilling will be competing with market participants for a limited supply of allowances.

Second, even if offset refills do raise the de facto cap, that doesn’t raise global emissions, except to the extent that offsets aren’t real, additional and all that. With perfect offsets, global emissions would go down due to the 5:4 exchange ratio of offsets for allowances. If offsets are really rip-offsets, then W-M has bigger problems than the strategic reserve refill.

Third, and most importantly, the problem isn’t oversupply of allowances through the reserve. Instead, it’s hard to get allowances out of the reserve – they check in, and never check out. Simple math suggests, and simulations confirm, that it’s hard to generate a price trajectory yielding sustained auction release. Here’s a test with 3%/yr BAU emissions growth and 10% underlying demand volatility:

Even with these implausibly high drivers, it’s hard to get a price trajectory that triggers a sustained auction flow, and total allowance supply (green) and emissions hardly differ from from the no-reserve case.

My preliminary simulation experiments suggest that it’s very unlikely that Breakthrough’s nightmare, a 10% cap violation, could really occur. To make that happen overall, you’d need sustained price increases of over 20% per year – i.e., an allowance price of $56,000/TonCO2eq in 2050. However, there are lesser nightmares hidden in the convoluted language – a messy program to administer, that in the end fails to mitigate volatility.

Strategic Excess? Insights

Model in hand, I tried some experiments (actually I built the model iteratively, while experimenting, but it’s hard to write that way, so I’m retracing my steps).

First, the “general equilbrium equivalent” version: no volatility, no SR marginal cost penalty for surprise, and firms see the policy coming. Result: smooth price escalation, and the strategic reserve is never triggered. Allowances just pile up in the reserve:

Since allowances accumulate, the de facto cap is 1-3% lower (by the share of allowances allocated to the reserve).

If there’s noise (SD=4.4%, comparable to petroleum demand), imperfect foresight, and short run adjustment costs, the market is more volatile:

However, something strange happens. The stock of reserve allowances actually increases, even though some reserves are auctioned intermittently. That’s due to the refilling mechanism. An early auction, plus overreaction by firms, triggers a near-collapse in allowance prices (as happened in the ETS). Thus revenues generated in the reserve auction at high prices used to buy a lot of forestry offsets at very low prices:

Could this happen in reality? I’m not sure – it depends on timing, behavior, and details of the recycling implementation. I think it’s safe to say that the current design is not robust to such phenomena. Fortunately, the market impact over the long haul is not great, because the extra accumulated allowances don’t get used (they pile up, as in the smooth case).

So, what is the reserve really accomplishing? Not much, it seems. Here’s the same trajectory, with volatility but no strategic reserve system:

The mean price with the reserve (blue) is actually slightly higher, because the reserve mainly squirrels away allowances, without ever releasing them. Volatility is qualitatively the same, if not worse. That doesn’t seem like a good trade (unless you like the de facto emissions cut, which could be achieved more easily by lowering the cap and scrapping the reserve mechanism).

One reason the reserve fails to achieve its objectives is the recycling mechanism, which creates a perverse feedback loop that offsets the strategic reserve’s intended effect:

The intent of the reserve is to add a balancing feedback loop (B2, green) that stabilizes price. The problem is, the recycling mechanism (R2, red) consumes international forestry offsets that would otherwise be available for compliance, thus working against normal market operations (B2, blue). Thus the mechanism is only helpful to the extent that it exploits clever timing (doubtful), has access to offsets unavailable to the broad market (also doubtful), or doesn’t recycle revenue to refill the reserve. If you have a reserve, but don’t refill, you get some benefit:

Still, the reserve mechanism seems like a lot of complexity yielding little benefit. At best, it can iron out some wrinkles, but it does nothing about strong, sustained price excursions (due to picking an infeasible target, for example). Perhaps there is some other design that could perform better, by releasing and refilling the reserve in a more balanced fashion. That ideal starts to sound like “buy low, sell high” – which is what speculators in the market are supposed to do. So, again, why bother?

I suspect that a more likely candidate for stabilization, robust to uncertainty, involves some possible violation of the absolute cap (gasp!). Realistically, if there are sustained price excursions, congress will violate it for us, so perhaps its better to recognize that up front and codify some orderly process for adaptation. At the least, I think congress should scrap the current reserve, and write the legislation in such a way as to kick the design problem to EPA, subject to a few general goals. That way, at least there’d be time to think about the design properly.