Cap and Trade and Regional Grid Integration Go Hand in Hand

California recently reauthorized the central element of its cornerstone climate initiative, which sets a declining cap on the amount of greenhouse gas emissions (GhG) that industrial and other sources can release into the air, and sets rules for industries to acquire and trade permits to emit pollution under the cap’s limit. This approach, called Cap-and-Trade, which puts a price on carbon, is one reason California has become a world leader in fighting global warming. It also is part of an escalating trend in which California and other progressive states are committing to meeting and perhaps even exceeding the emissions reduction goals of the Paris climate accords.

California’s move to extend its cap-and-trade program is of global significance because what happens in the world’s fifth-largest economy (according to the International Monetary Fund) has a major impact on the choices other states and nations make on climate change. With a lack of U.S. government leadership on climate change right now, state and city policies will have to substitute and the rest of the world will need to follow through on the commitments they made in Paris, and do much more over time.

Meanwhile, the success of California’s cap-and-trade policy will depend upon on a historic transformation in the electricity sector in which power is used more efficiently and clean resources from across the entire western United States are used instead of fossil fuels.

Central to this strategy is the ability to rapidly, reliably and cost-effectively replace fossil-fuel energy resources with renewable ones, not just in the electricity sector but in other sectors of our economy too (the building and transportation sectors are equally critical). To do this, we must increasingly reduce our energy consumption and electrify our lives with power from clean sources, switching from gas heating and gasoline-powered cars to options like heat pumps, electricity storage, and electric vehicles of all kinds. Switching fossil-fueled end uses to electricity does not help much if that electricity is made with polluting fuels.

The U.S grid has three main components: the eastern interconnection, stretching from the Atlantic Ocean to the western plains; the western interconnection, from the Rockies to the Pacific, including parts of Canada and Mexico; and, the Electricity Reliability Council of Texas which serves that single state. Each interconnection is mostly separate from the others, with just a few connections between them that allow power to flow from one to the other. Within these interconnections, independent organizations, called Regional Transmission Organizations, operate the generation and transmission system distribution of electricity from the power plants they control.

While most of the country’s electrical system is operated by regionally integrated grids, in the West 38 different operators are running their own discrete parts of the system.

Regional grid Integration—centrally coordinating the operations of the grid via an organized electricity market—is the essential element to the renewable energy transition in the western U.S. Here, as with cap and trade, California’s leadership will be critical.

In an integrated grid, energy sources with the lowest marginal cost (fuel cost, operations and maintenance and related compliance costs) have an intrinsic advantage because grid operators dispatch the lowest-cost electricity first to the utilities serving our electric needs. This means that renewable energy, which has no fuel costs and very low overall marginal costs, will be selected in the energy market by the independent system operators managing the electricity system to run most hours of the day instead of fossil fuels—provided renewables are available. In a large geographic footprint where the wind is blowing at different times, and the sun is usually able to generate power when other locations are obscured by clouds, renewable energy resources can be relied upon more and more to replace coal and gas generation. The less fossil plants are used, the more rapidly they can be retired, accelerating the transition we need to prevent climate catastrophe.

The synergy between carbon markets and energy markets is already evident in the northeastern and Mid-Atlantic U.S. where states have coordinated to form a regional carbon market dubbed RGGI, for Regional Greenhouse Gas Initiative. RGGI operates in a nine-state region (Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont) that already has regional grid integration via the New England and New York wholesale electricity markets where utilities buy and sell power (ISO New England and NYISO, respectively) and the world’s largest wholesale electricity market, PJM. PJM coordinates the dispatch of wholesale electricity in all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. RGGI’s carbon price integrates seamlessly into these markets. While not all these states share common climate goals and policies, many do, and because the cost of carbon in RGGI states is considered when selecting resources to operate in their day-ahead and real time electricity markets, there has been a steady decline of coal-fired power generation in their service territories. Some of this decline has been the result of competition from cheap natural gas, but not all. The rapid addition of renewable resources, driven by plummeting capital costs and zero fuel costs, has also had a major effect.

In states or regions with carbon markets the progress can go even faster. RGGI’s market design includes an increased energy cost or “adder” representing part or all the social cost of carbon or the market price for carbon in a trading regime. The Environmental Protection Agency defines the social cost of carbon as: “a comprehensive estimate of climate change damages and includes changes in net agricultural productivity, human health, property damages from increased flood risk, and changes in energy system costs, such as reduced costs for heating and increased costs for air conditioning.”

The New York ISO is considering a carbon “adder” right now. In the California Independent System Operator’s (CAISO) regional energy imbalance market (EIM), California’s carbon policy is reflected in a “bid adder” for out-of-state resources being chosen to serve California’s real-time electricity needs. The adder increases the electricity cost of carbon-emitting power plants and mostly prevents them from being selected to serve California. The adder does not apply to transactions between other states in the EIM that do not have carbon pricing, but as states add pricing polices (as Washington State is considering) the market could accommodate these costs in its economic dispatch (calling on generators to turn on based on their lowest respective marginal cost).

For regionally integrated systems whose state policies may conflict (such as those that mix coal-dependent states with states with progressive climate policies), market forces are driving the clean energy transformation. Market efficiencies are delivering billions of dollars of benefits to all participating states, ranging from lower electricity costs to consumers and businesses, to avoided power plant construction. Regionally integrated systems, because they facilitate the sharing of generating and reserve power, reduce the amount of energy needed to prevent or recover from a major emergency or to meet unusually high demand. And regionally integrated systems—because they plan for and centrally use the entire power line network across larger areas, make better use of the existing transmission system, preventing the construction of costly and unnecessary power lines. No state is coerced to follow another’s policies.

In other words, carbon markets and electricity markets inform and influence each other. Together they make meeting the ambitious goals of the Paris climate accords possible, in the timelines we need. 

California’s next great leadership step? Authorize the expansion of the CAISO market across the West. An essential first step is to authorize a transition to a fully independent board, repealing the statutory requirement that California’s Governor appoint all the board members. This will open the door to voluntary membership by utilities and power generators across the West, who understandably balk at today’s California-only governance structure. All who join can then take advantage of the benefits of grid coordination, such as being able to sell excess renewable generation to other states or buy renewable power from the other states when needed. California legislative action could come as soon as the coming weeks.