Question 2 - Allocation (Page 3)

Pew Center on Global Climate Change Response to:

"Design Elements of a Mandatory
Market-Based Greenhouse Gas Regulatory System"

Issued by Sen. Pete V. Domenici and Sen. Jeff Bingaman
February 2006

Question 2

Should the costs of regulation be mitigated for any sector of the economy, through the allocation of allowances without cost?  Or, should allowances be distributed by means of an auction?  If allowances are allocated, what is the criteria for and method of such allocation?

Pew Center Response (continued)

Clarifying Questions 2a

       Technology R&D and Incentives

• What level of resources should be devoted to stimulating technology innovation and early deployment?
• What portion, if any, of the revenues from permits or the auction of allowances should be reserved for technology development?   If some portion is reserved for this purpose, should that set-aside flow to the federal government with funds spent through the traditional appropriation process?  Or should the funds be allocated directly to a non-profit research consortium, chartered by the federal government, which would then administer technology development and deployment projects?  Or should there be some combination of these two options?
• What criteria should be used to determine how such funds are spent and which projects are chosen?
• What other mechanisms should be used to promote technology deployment? Options include tax credits, cost-sharing for demonstration projects, assistance to state energy programs, etc.

Pew Center Response

Effective research, innovation, development, and deployment strategies will be critical to enabling a low-carbon energy future. Current levels of federal RD&D need to be significantly increased to reflect parity with other sectors in the U.S. economy (on the basis of RD&D dollars spent per GDP) and with the magnitude of the challenge of enabling a low-carbon energy future. Equally as important, strategies for managing these funds need to be revamped. Current RD&D efforts on low-carbon technologies suffer from a cultural focus on niche markets, inter- and intra-agency “stove-piping,” uncertainty caused by the annual appropriations process and cycle, and detrimental Congressional earmarks on scarce funds. The federal government needs a more integrated approach to RD&D in order to focus the appropriate agencies and resources on critical RD&D needs at appropriate times within a long-term R&D framework. Management modeled on the Defense Advanced Research Projects Administration (DARPA) is needed to instill a culture focused on development and commercialization of these technologies, and forward funding would help reduce the level of uncertainty and detrimental earmarks. Public/private partnerships and government procurement have a key role to play as developers and incubators of technology and to foster “learning by doing”—a critical step in bringing down the cost of low-carbon technologies and increasing deployment. While support for breakthrough technologies is often appealing, experts point out that what often appears to be a breakthrough is indeed the result of years of incremental investment and work. Public/private partnerships are an effective vehicle for enabling sustained incremental improvements in the performance and cost of low-carbon technologies.

Policy-makers should be wary of the dangers of “picking winners” among technologies, but some support to push the likely candidates along can overcome cost barriers that would otherwise be insurmountable [1]. Research has shown that focusing exclusively on technology-push policies (instruments that offer technology funding incentives without motivating a corresponding demand for these technologies) or exclusively on technology-pull policies (mandates that generate demand for advanced technologies without corresponding support for their development) is more expensive than a combination of the two approaches [2]. Opportunities to introduce competition into the incentive process will reduce the costs of the program and avoid picking winners.

A competitive process to distribute incentives will reduce the costs of the program and avoid picking winners. A “reverse auction”, in which bidders compete to provide some technology or service for the lowest cost, would allow reduction projects to compete for these incentives on a level playing field. An auction could specify technology categories as well as offer a broad competition to elicit new, as-yet-unknown technologies. Alternative funding mechanisms include forward funding, technology prizes [3], tax rebates, guaranteed government purchase agreements (i.e., renewable energy or IGCC-CCS energy), green loans and public-private partnerships.

The private sector is generally a more efficient engine of technological innovation than the government. The private sector is particularly good at identifying and allocating resources to those technologies that have the best potential to become financially self sustaining, since private investment is almost uniquely profit-oriented and return-driven. One example raised by companies is in energy efficiency programs. If the government creates frameworks incentivizing but not directing the private sector (tax credits, cap and trade rules that allow efficiency-based offsets, etc.) and allowing private companies and investors to easily monetize the value of efficiency investments, there is ample evidence that the private sector can achieve these at costs per kilowatt or BTU lower than those for which the government is an intermediary.

When it comes to large-scale, longer-term technologies, companies note that it can be effective to match private investment with public funding in some way, as in the case of existing partnerships for clean coal, nuclear power, and fuel cells. Companies expressing a view favor direct government investment and guidance for early stages of research development – the pre-commercial stages of product life cycle. Where infrastructure and programs already exist and are successful, (e.g., NIST grants or the Department of Energy’s Industrial Technologies Program) these should be used and consistently funded.

Given the relative advantages of the private sector in generating innovation, while it is important to fund federal R&D and deployment activities for certain climate-friendly technologies, it is also important to design a GHG cap-and-trade program to leave the greatest share of the money in private hands, where it will be most efficiently spent, rather than flowing to the federal agencies. For example, a cap-and-trade program that sets a meaningful target and allocates a high percentage of allowances for free to a large number of covered emitters would likely foster a robust private market in allowances. The money in such a market would stay in private hands, without the government acting as middle-man, creating with minimum waste a direct incentive for every company to deploy climate-friendly technologies and practices.