Carbon Policy Economic Modeling Inception Report - Revised Implementation Plan

Berkeley Economic Advising and Research, LLC

Contents Contents .......................................................................................................................................... 1

1 Introduction ............................................................................................................................ 2

2 Overview of Modeling Assumptions and Scenarios ............................................................... 2

2.1 Structure and Assumptions of the Assessment Model .................................................. 2

2.1.1 Production ............................................................................................................... 3

2.1.2 Consumption and Closure Rule............................................................................... 4

2.1.3 Trade ....................................................................................................................... 4

2.1.4 Dynamic Features ................................................................................................... 4

2.1.5 Profits, Adjustment Costs, and Expectations .......................................................... 5

2.1.6 Dynamic calibration ................................................................................................ 5

2.1.7 Modelling Emissions ............................................................................................... 6

2.2 Scenarios ......................................................................................................................... 7

3 Description of the literature and data to be used ................................................................ 10

3.1 Source Material ............................................................................................................. 10

3.2 Data Resources for the Project ..................................................................................... 12

4 Structure for the Draft and Final Report and Executive Summaries .................................... 16

4.1 Detailed Report Structure ............................................................................................. 16

4.1.1 Business-as-Usual Scenario ................................................................................... 16

4.1.2 Covered Sectors .................................................................................................... 17

4.1.3 Allowance Allocation ............................................................................................ 17

4.1.4 Considerations for Emissions Intensive and Trade Exposed (EITE) Sectors ......... 18

4.1.5 Stringency of the Cap and Cap-decline Rates ....................................................... 19

4.1.6 Linkage with the Larger Western Climate Initiative and Regional Markets ......... 19

4.1.7 Interaction with Existing Energy/Climate Policies and Initiatives ........................ 20

4.1.8 Investment of Allowance Proceeds ...................................................................... 20

4.1.9 Cost Control Measures.......................................................................................... 21

4.2 Presentations ................................................................................................................ 22

5 References ............................................................................................................................ 23

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1 Introduction

Based on discussion and feedback from the Inception/Kickoff Meeting held in Portland on

Monday, October 22, BEAR has produced the following Revised Implementation Plan. In

this Inception Report we document and confirm all the main component methods,

information resources, and deliverables for the project, as well as committing to the

timeline agreed at our first meeting. All details below are subject prior approval and

ongoing consultation regarding CPOs needs with respect to policies evaluated,

assumptions made, and standards for results communication.

2 Overview of Modeling Assumptions and Scenarios

2.1 Structure and Assumptions of the Assessment Model

1. The BEAR model is a dynamic economic forecasting model for evaluating long-term

growth prospects for Oregon. The model is an advanced policy simulation tool that

models demand, supply, and resource allocation across the Oregon economy, estimating

economic outcomes annually over the period 2016–2050. This kind of Computable

General Equilibrium (CGE) model is a state-of-the-art economic forecasting tool, using a

system of equations and detailed economic data that simulate price-directed interactions

between firms and households in commodity and factor markets. The role of government,

capital markets, and other trading partners are also included, with varying degrees of

detail, to close the model and account for economy-wide resource allocation, production,

& income determination.

2. Technically, a CGE model is a system of simultaneous equations that simulate

price-directed interactions between firms and households in commodity and factor

markets. The role of government, capital markets, and other trading partners are also

specified, with varying degrees of detail and passivity, to close the model and account for

economywide resource allocation, production, and income determination.

3. The role of markets is to mediate exchange, usually with a flexible system of prices,

the most important endogenous variables in a typical CGE model. As in a real market

economy, commodity and factor price changes induce changes in the level and

composition of supply and demand, production and income, and the remaining

endogenous variables in the system. In CGE models, an equation system is solved for

prices that correspond to equilibrium in markets and satisfy the accounting identities

governing economic behavior. If such a system is precisely specified, equilibrium always

exists and such a consistent model can be calibrated to a base period data set. The

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resulting calibrated general equilibrium model is then used to simulate the economywide

(and regional) effects of alternative policies or external events.

4. The distinguishing feature of a general equilibrium model, applied or theoretical, is

its closed-form specification of all activities in the economic system under study. This can

be contrasted with more traditional partial equilibrium analysis, where linkages to other

domestic markets and agents are deliberately excluded from consideration. A large and

growing body of evidence suggests that indirect effects (e.g., upstream and downstream

production linkages) arising from policy changes are not only substantial, but can

sometimes outweigh direct effects. Only a model that consistently specifies economywide

interactions can fully assess the implications of economic policies or business strategies.

In a multi-country model like the one used in this study, indirect effects include the trade

linkages between countries and regions which themselves can have policy implications.

5. The model we use for this work has been constructed according to generally

accepted specification standards, implemented in the GAMS programming language, and

calibrated to the new Oregon SAM estimated for the year 2016.1 The result is a single

economy model calibrated over the thirty five-year time path from 2016 to 2050.2 Using

the very detailed accounts of the Oregon SAM, we include the following in the present

model:

2.1.1 Production

6. All sectors are assumed to operate under constant returns to scale and cost

optimization. Production technology is modeled by a nesting of constant-elasticity-of-

substitution (CES) function.

7. In each period, the supply of primary factors — capital, land, and labor — is

predetermined by initial conditions or dynamic transition (population, investment, etc.)

equations discussed below. The model includes adjustment rigidities. An important

feature is the distinction between old and new capital goods. In addition, capital is

assumed to be partially mobile, reflecting differences in the marketability of capital goods

across sectors.3 Once the optimal combination of inputs is determined, sectoral output

prices are calculated assuming competitive supply conditions in all markets.

1 See e.g. Meeraus et al (1992) for GAMS. The technical structure (equations) of the BEAR model are fully documented in Roland-Holst: 2015. 2 The present specification is one of the most advanced examples of this empirical method, already applied to most US states and over 50 individual countries or combinations thereof. 3 For simplicity, it is assumed that old capital goods supplied in second-hand markets and new capital goods are homogeneous. This formulation makes it possible to introduce downward rigidities in the adjustment of capital without increasing excessively the number of equilibrium prices to be determined by the model.

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2.1.2 Consumption and Closure Rule

8. All income generated by economic activity is assumed to be distributed to

consumers. Each representative consumer allocates optimally his/her disposable income

among the different commodities and saving. The consumption/saving decision is

completely static: saving is treated as a “good” and its amount is determined

simultaneously with the demand for the other commodities, the price of saving being set

arbitrarily equal to the average price of consumer goods.

9. The government collects income taxes, indirect taxes on intermediate inputs,

outputs and consumer expenditures. The default closure of the model assumes that the

government deficit/saving is exogenously specified.4 The indirect tax schedule will shift to

accommodate any changes in the balance between government revenues and

government expenditures.

10. The current account surplus (deficit) is fixed in nominal terms. The counterpart of

this imbalance is a net outflow (inflow) of capital, which is subtracted (added to) the

domestic flow of saving. In each period, the model equates gross investment to net saving

(equal to the sum of saving by households, the net budget position of the government

and foreign capital inflows). This particular closure rule implies that investment is driven

by saving.

2.1.3 Trade

11. Goods are assumed to be differentiated by region of origin. In other words, goods

classified in the same sector are different according to whether they are produced

domestically or imported. This assumption is frequently known as the Armington

assumption. The degree of substitutability, as well as the import penetration shares are

allowed to vary across commodities. The model assumes a single Armington agent. This

strong assumption implies that the propensity to import and the degree of substitutability

between domestic and imported goods is uniform across economic agents. This

assumption reduces tremendously the dimensionality of the model. In many cases this

assumption is imposed by the data. A symmetric assumption is made on the export side

where domestic producers are assumed to differentiate the domestic market and the

export market. This is modeled using a Constant-Elasticity-of-Transformation (CET)

function.

2.1.4 Dynamic Features

12. The current version of the model has a simple recursive dynamic structure as agents

are assumed to be myopic and to base their decisions on static expectations about prices

4 In the reference simulation, the real government fiscal balance converges (linearly) towards 0 by the final period of the simulation.

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and quantities. Dynamics in the model originate in three sources: i) accumulation of

productive capital and labor growth; ii) shifts in production technology; and iii) the

putty/semi-putty specification of technology.

13. In the aggregate, the basic capital accumulation function equates the current capital

stock to the depreciated stock inherited from the previous period plus gross investment.

However, at the sectoral level, the specific accumulation functions may differ because the

demand for (old and new) capital can be less than the depreciated stock of old capital. In

this case, the sector contracts over time by releasing old capital goods. Consequently, in

each period, the new capital vintage available to expanding industries is equal to the sum

of disinvested capital in contracting industries plus total saving generated by the

economy, consistent with the closure rule of the model.

14. The substitution possibilities among production factors are assumed to be higher

with the new than the old capital vintages — technology has a putty/semi-putty

specification. Hence, when a shock to relative prices occurs (e.g. the imposition of an

emissions fee), the demands for production factors adjust gradually to the long-run

optimum because the substitution effects are delayed over time. The adjustment path

depends on the values of the short-run elasticities of substitution and the replacement

rate of capital. As the latter determines the pace at which new vintages are installed, the

larger is the volume of new investment, the greater the possibility to achieve the long-run

total amount of substitution among production factors.

2.1.5 Profits, Adjustment Costs, and Expectations

15. Firms output and investment decisions are modeled in accordance with the

innovative approach of Goulder and co-authors (see e.g. Goulder et al: 2009 for technical

details). In particular, we allow for the possibility that firms reap profits from events such

[@@fix this] as free permit distribution. Absent more detailed information on ownership

patterns, we assume that these profits accrue to US and foreign residents in proportion

to equity shares of publicly traded US corporations (16% in 2009, Swartz and

Tillman:2010). Between Oregon and other US residents, the shares are assumed to be

proportional to GSP in GDP (3% in 2009)

2.1.6 Dynamic calibration

16. The model is calibrated on exogenous growth rates of population, labor force, and

GDP. In the so-called Baseline scenario, the dynamics are calibrated in each region by

imposing the assumption of a balanced growth path. This implies that the ratio between

labor and capital (in efficiency units) is held constant over time.5 When alternative

scenarios around the baseline are simulated, the technical efficiency parameter is held

5This involves computing in each period a measure of Harrod-neutral technical progress in the capital-labor bundle as a residual. This is a standard calibration procedure in dynamic CGE modeling.

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constant, and the growth of capital is endogenously determined by the saving/investment

relation.

2.1.7 Modelling Emissions

17. The BEAR model captures emissions from production activities in agriculture,

industry, and services, as well as in final demand and use of final goods (e.g. appliances

and autos). This is done by calibrating emission functions to each of these activities that

vary depending upon the emission intensity of the inputs used for the activity in question.

We model both CO2 and the other primary greenhouse gases, which are converted to

CO2 equivalent. Following standards set in the research literature, emissions in

production are modeled as factor inputs. The base version of the model does not have a

full representation of emission reduction or abatement. Emissions abatement occurs by

substituting additional labor or capital for emissions when an emissions cost is applied

from (e.g.) fees, taxes, etc. This is an accepted modeling practice, although in specific

instances it may either understate or overstate actual emissions reduction potential.6 In

this framework, emission levels have an underlying monotone relationship with production

levels, but can be reduced by increasing use of other, productive factors such as capital

and labor. The latter represent investments in lower intensity technologies, process

cleaning activities, etc. An overall calibration procedure fits observed intensity levels to

baseline activity and other factor/resource use levels. In some of the policy simulations

we evaluate sectoral emission reduction scenarios, using specific cost and emission

reduction factors, based on our earlier analysis (Hanemann and Farrell: 2006).

18. The model has the capacity to track 13 categories of individual pollutants and

consolidated emission indexes (listed below). Our focus in the current study is the

emission of CO2 and other greenhouse gases, but the other effluents are of relevance to

a variety of environmental policy issues. An essential characteristic of the BEAR approach

to emissions modeling is endogeneity, allowing emission rates by sector and input to be

exogenous or endogenous, and in either case the level of emissions from the sector in

question is endogenous unless a cap is imposed. This feature is essential to capture

structural adjustments arising from market-based climate policies, as well as the effects

of technological change.

Table 1: Emission Categories

6 See e.g. Babiker et al (2001) for details on a standard implementation of this approach.

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Air Pollutants

1. Carbon Dioxide CO2 2. Suspended particulates (PM2.5) PART

2. Sulfur dioxide SO2 3. Nitrogen dioxide NO2 4. Volatile organic compounds VOC 5. Carbon monoxide CO 6. Toxic air index TOXAIR 7. Biological air index BIOAIR Water Pollutants 8. Biochemical oxygen demand BOD 9. Total suspended solids TSS 10. Toxic water index TOXWAT 11. Biological water index BIOWAT Land Pollutants 12. Toxic land index TOXSOL 13. Biological land index BIOSOL

2.2 Scenarios

19. The primary objective of this project is to assess prospective Cap and Trade

regulation, taking account of its leading design characteristics and interactions with other

policies. To elucidate these complex issues, the Inception Meeting agreed to the general

categories of scenarios in the following table. The table summarize the main features of

each scenario category, but within categories it was agreed to explore more detailed

features for preliminary assessment, even if all these are not included in the final analysis.

20. Detailed variations of the core scenarios (Table 2) will generate intermediate results

and support further consultation with CPO counterparts to refine relevant Cap and Trade

design features and assessment of their detailed economic effects.

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Table 2: General Scenario Categories to be Evaluated

Scenario Description

1 Baseline A "Business as Usual" or Reference Scenario with only existing policies in force over the scenario period. Key existing policies include the Renewable Portfolio Standard, “Coal-to-Clean”, and Clean Fuels program.

2 Core Cap and Trade The basic mechanism: Placing an annual cap, provided by the Oregon CPO (Figure 2), on total state GHG emissions and required covered entities to obtain permits through auctioning for the emissions they contribute to the cap. Revenues are returned lump-sum after factoring in constraints of the State Highway Trust Fund.

3 C&T Design Variations Here we examine alternatives for detailed characteristics of the policy.

3.1 Variable cap

profiles Constant incremental annual reductions in the cap starting in 2021 and declining to 80% below 1990 levels by 2050. Constant percentage annual reductions.

3.2 Variable

sectoral coverage

Core scenario includes full coverage of electric power sector, natural gas sectors, transportation fuels, and industrial entities with emissions greater than 25,000 mtCO2e. Sensitivity scenarios may include phasing in of sensitive sectors such as transportation or emissions-intensive, trade-exposed industries.

3.3 Offsets Offsets for qualified alternative GHG mitigation, including out-of-state GHG reduction, sequestration, etc. Up to 8% regulated entity’s compliance burden.

3.4 Alternative

allowance allocations

Core scenario includes full allowance auctioning. Sensitivity scenarios could include concessional allowance allocation for targeted transition assistance, social objectives, etc. Details for alternatives are described below.

3.5 Alternative revenue allocation rules

Core scenario accounts for State Highway Trust Fund constraints and returns excess revenue as a lump-sum payment to Oregonians. A variety of alternative experiments with permit revenue disbursement/investment, such as allocations to rural communities,

3.6 Linkage to regional and other markets

What would be the costs/benefits of Oregon having access to a larger trading system? Consider effects of WCI price controls (floor and ceiling) for Oregon.

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4 Cost control mechanisms Auction price mechanisms that can limit price escalation and address equity considerations., e.g. banking.

5 Interaction with Existing Energy/Climate Policies and Initiatives

Leading existing and prospective policies will be considered, including RPS, LCFS, EV incentives, and

Figure 1: Oregon’s Progress and Goals for Greenhouse Gas Reduction

Source: Oregon Carbon Policy Office

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3 Description of the literature and data to be used

3.1 Source Material

21. For background, in addition to our own long experience, this project will draw upon

the most salient contributions to Cap and Trade policy and research literature. Globally

and with special reference to Oregon. The draft and final reports will contain detailed

literature surveys, and we are continuing to develop these sources in consultation with

our official Oregon counterparts, other stakeholders and independent researchers. For

the present, suffice to say that we have received and continue to review the leading recent

contributions to Oregon’s Cap and Trade Policy dialog, will draw upon our own extensive

research and publication on related climate policies across the United States and

internationally, bringing a strong and diverse set of precedence and experience to support

CPO’s deliberations and recommendations to state agencies, the Legislature, and the

Governor’s Office. The key existing studies on Oregon’s proposed cap-and-trade

programs include:

- “Considerations for Designing a Cap-and-Trade Program in Oregon” (2017) State

of Oregon Department of Environmental Quality. Available at

https://www.oregon.gov/deq/filterdocs/ghgmarketstudy.pdf

- “Economic and Emissions Impacts of a Clean Air Tax or Fee in Oregon (SB306)”

(2014) Prepared for the Legislative Revenue Office by Portland State University’s

Northwest Economic Research Center (NERC). Available at

https://www.oregonlegislature.gov/lro/Documents/RR%204-

14%20SB%20306%20Clean%20Air.pdf

- “Oregon Cap-and-Trade: An Economic Impact Analysis of SB 1574” (2017) FTI

Consulting. Available at https://www.fticonsulting.com/insights/reports/oregon-

cap-and-trade

22. Source material for the literature review in the report will include, but not be limited

to, the materials cited in the References section below. From our own experience, we will

draw upon findings and research reporting in the following table of links to ten more

prominent examples our own relevant prior work.

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Table 3: Links to Relevant Policy Research Completed by Berkeley Economic Advising and Research

Project Title Link

1 Economic Assessment of California’s Long-term Energy Scenarios (LTES)

http://bearecon.com/portfolio- item/cec-ltes/

2 Economic Assessment for California’s Senate Bill 350 http://bearecon.com/portfolio- item/caiso-sb350/

3 Cap and Trade and Structural Transition in the California Economy

http://bearecon.com/portfolio- item/ef-cap-and-trade/

4 Options for Cap and Trade Auction Revenue Allocation http://bearecon.com/portfolio-item/next10-options/

5 Carbon Emission Offsets and Criteria Pollutants http://bearecon.com/portfolio-item/ucs-offsets/

6 How Will Florida’s Economy Be Affected By A Federal Cap-and-Trade System?

http://bearecon.com/portfolio-item/edf-florida/

7 Clean Energy and Climate Policy for U.S. Growth and Job Creation

http://bearecon.com/portfolio-item/nrdc-aces/

8 Western Horizons for U.S. Climate Policy http://bearecon.com/portfolio-item/ef-wci/

9 Climate Action for Economic Growth: An Economic Assessment of California’s Global Warming Solutions Act

http://bearecon.com/portfolio-item/carb-action/

10 Economic Memorandum on Sustainable Development for the People’s Republic of China

http://bearecon.com/portfolio-item/prc-wb-cem/

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3.2 Data Resources for the Project

23. In the 2016 base year, BEAR is calibrated to a comprehensive economic and

emissions dataset for the Oregon economy and it includes highly disaggregated

representation of firm, household, employment, government, and trade behavior (Table

1). The core data on economic structure are taken from IMPLAN and the US Bureau of

Economic Analysis, while emissions data come from Oregon’s own official emissions

inventory. The model’s 2016–2030 baseline is calibrated to official economic and revenue

forecasts from the Oregon Department of Administrative Services7. Baseline labor force

statistics are drawn from the US Bureau of Labor Statistics, and population estimates are

obtained from the US Bureau of the Census.

Table 4: BEAR 2013 - Current Structure

1. 195 production activities (tentative)

2. 195 commodities (includes trade and transport margins)

3. 31 factors of production

4. 22 labor categories

5. 7 fuel/energy sources

6. Capital

7. Land

8. 10 Household income groups

9. Enterprises

10. Federal Government (7 fiscal accounts)

11. State Government (27 fiscal accounts)

12. Local Government (11 fiscal accounts)

13. Consolidated capital account

14. Trade with WCI Members

15. Trade with the Rest of the United States

16. Trade with the Rest of the World

24. For preliminary assessment the BEAR model has been aggregated to 60 economic

sectors (Table 2), and electric power sector was disaggregated by 8 generation types in

7 See e.g. https://www.oregon.gov/das/OEA/Pages/forecastecorev.aspx

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order to be consistent with the detailed characteristics of the conventional and renewable

energy portfolio. Jobs are detailed the model by both sector and 22 occupational

categories from the US Bureau of Labor Statistics (USBLS: 2018, see Table 3).

Table 5: BEAR Sector Aggregation

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Table 6: The BEAR Model tracks jobs with detailed occupational and wage characteristics

25. Economic impacts include the usual statewide aggregates for real income,

employment, etc., but more importantly the BEAR model provides both structural and

spatial detail, including the following:

Aggregate Real GDP, Employment, Emissions, Permit Price and Revenue

Sectoral Output, Employment, and Emissions by County

Employment and Wages by Occupation and County

Household Real Incomes and Consumption by Decile and County

Energy and other commodity/service costs

Spatial downscaling of results relies on IMPLAN’s county-level detailed database, which

with implement after selective ground-truthing from local information (see Figure ).

1. Management occupations 2. Business and financial operations occupations 3. Computer and mathematical science occupations 4. Architecture and engineering occupations 5. Life, physical, and social science occupations 6. Community and social services occupations 7. Legal occupations 8. Education, training, and library occupations 9. Arts, design, entertainment, sports, and media occupations 10. Healthcare practitioners and technical occupations 11. Healthcare support occupations 12. Protective service occupations 13. Food preparation and serving related occupations 14. Building and grounds cleaning and maintenance occupations 15. Personal care and service occupations 16. Sales and related occupations 17. Office and administrative support occupations 18. Farming, fishing, and forestry occupations 19. Construction and extraction occupations 20. Installation, maintenance, and repair occupations 21. Production occupations 22. Transportation and material moving occupations

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Figure 2:Spatially Detailed Economic Impacts

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4 Structure for the Draft and Final Report and Executive Summaries

4.1 Detailed Report Structure

26. The impact report will offer detailed economic assessment for scenarios agreed in

consultation with CPO and other interested parties they may designate. As indicated in

the model description (above), we have the capacity to evaluate and present results on

all traditional economic indicators (GSP, employment, incomes, demand, production, and

trade) in aggregate and detailed by sector/commodity, occupation, income decile, county,

and census tract. The model also tracks detailed fiscal linkages and accounts, including

cap and trade permit revenues, as well as emissions detailed by source (sector, final

consumption category, and fuel type). This level of detail is unprecedented for Oregon,

but it captures essential heterogeneity that will support more effective policy targeting and

stakeholder engagement.

27. In addition to economic and other impacts of the basic Cap and Trade program, our

final report will evaluate a diverse range of scenarios representing design options for an

Oregon C&T framework, representing “key policy elements” whose individual and

interactive effects CPO wants to elucidate. The “core scenario” will attempt to reflect as

closely as possible the cap-and-trade program that is expected to be considered by the

Oregon legislature, while sensitivity scenarios will consider alternative design features

that may deviate from this core scenario. This will help elucidate tradeoffs that are specific

and relevant to the Oregon context. We will continue to develop these scenarios in

cooperation with CPO, and they can be revised during the early and intermediate

(between draft and final report) stages of the project as needed. Meanwhile, we review

them briefly below in terms of our relevant experience and recommendations for

incorporation into this assessment.

4.1.1 Business-as-Usual Scenario

Existing state-level GHG emissions reduction policies will be included in the baseline, or

business-as-usual, scenario in order to accurately reflect the marginal effect of

implementing the cap-and-trade program. In Oregon, there are three primary policies that

will be incorporated into this baseline, including the State’s (1) 50% by 2040 Renewable

Portfolio Standard (RPS) (2) Coal-to-clean transition from coal electric power generation

by 2035, and (3) the Clean Fuels program for reducing the carbon intensity of

transportation fuels. Taken together these policies have the potential significantly reduce

the carbon intensity of both the electricity and transportation sectors in the state, reducing

the burden of the cap-and-trade program.

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4.1.2 Covered Sectors

The proposed Oregon cap-and-trade policy is expected to cover approximately 84% of

the State’s GHG inventory, with full coverage of the electric power sector, natural gas

sectors, and transportation fuels. Agriculture, forestry, and landfills (with emissions under

25,000 metric tons of CO2e) are expected to be initially exempted from the policy.

The program will cover the State’s 3 investor-owned utilities and the numerous consumer-

owned utilities. Many of these utilities rely on out-of-state generation resources, which will

also be covered under the program for the portion of their generation that is imported into

Oregon. The natural gas sectors include natural gas distribution companies, direct

consumption by approximately 30 industrial entities (assuming their emissions exceed

the 25,000 mtCO2e threshold), and other natural gas marketers. In the transportation

sector, the is no in-state petroleum product refining capacity, however, all imported

transportation fuels will be covered under the cap.

While the core scenario will assume full compliance in these sectors, sensitivity scenarios

may explore various phasing-in options for certain sectors. These will be developed in

collaboration with the CPO.

4.1.3 Allowance Allocation

Auctioning the “right to pollute” generates a royalty from the common resource of air

quality. Cap and trade permit proceeds are generally recognized as “new money” for the

public sector, although they are of course ultimately diverted from other economic activity,

and governments must decide what to do with these revenues. Depending on the

stringency of the cap and other factors, these revenues can be substantial and arouse

significant public and private stakeholder interest. For this reason, careful ex ante

assessment of alternative allowance allocation rules is essential to regulatory diligence

for cap and trade. BEAR has long experience with this issue, including its contributions

to a comprehensive assessment ten years ago for the California Legislative Budget

Office. In this report (http://bearecon.com/portfolio-item/next10-options) BEAR used its

state model to compare over 20 alternative permit revenue distribution/reinvestment

strategies, dynamically identifying detailed growth, equity, and efficiency characteristics

of each approach over a 40 year time frame. This work remains the most definitive

available for California, and it has played an essential role in design of the state’s

allocation strategies.

For this assessment the core scenario will assume that all allowances are allocated via

an auctioning system. Sensitivity analysis will consider alternative allocation

mechanisms, such as free allocations to the electric power sector over a limited time

period in a manner that limits ratepayer price increases and free allocations in early years

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of the program to energy-intensive, trade-exposed (EITE) industries. We will work with

CPO to continue refining the parameters of the allowance allocation sensitivities.

Our recommendation would be to evaluate a diverse set of general allocation rules,

including the main categories: returning the money to the public (transfers, tax relief, or

other rules), investing in further mitigation, and offsetting adjustment costs. Given that

Oregon’s initial conditions are unique, it may be desirable to consider more specifically

targeted transition assistance and other measures. These options can be reviewed in the

scenario development consultations with CPO.

4.1.4 Considerations for Emissions Intensive and Trade Exposed (EITE) Sectors

As indicated above, heterogeneity is an essential characteristic of technology adoption

policies generally and mitigation policies in particular. In the present context, some

sectors may face relatively high adjustment costs from uniform application of cap and

trade and related policies. These costs can undermine competitiveness in these

industries and those sectors, workers, communities, and other stakeholders linked to

them, making their adjustment needs a matter of public interest. CPO has commissioned

a study to identify such sectors, and the economic assessment should include a focus on

them too.

Fortunately, our experience with cap and trade research already includes assessments

of such adjustment challenges and policy options to deal with them. For example, we

have conducted detailed research on offsets, a primary mechanism for firms to avert or

defer infeasible direct adoption costs (http://bearecon.com/portfolio-item/ucs-offsets/ ).

We have also intensively studied schemes for low or no cost permit allocation, a hallmark

concession to utilities that facilitated passage of California’s landmark AB32 legislation.

Beyond this, we have done studies of technology subsidies in the transportation and

industry, as well as international work on securitization of GHG mitigation.

BEAR’s proprietary economic forecasting model is instrumented to study offsets, targeted

permit price interventions and other measures of this kind, year-by-year, sector-by-sector,

etc. This will permit assessment of a diverse set of interventions that recognize temporary

or more sustained adjustment needs.

It should also be noted that traditional EITE sectors may not be the only appropriate

candidates for special attention when it comes to mitigation policy. From experience,

other states and regions have learned that small business, community organizations, and

an array of other stakeholders can assert particular interests related to compliance costs,

local emission standards, distributed renewables, and other issues. We have experience

with many of these additional dimensions of the climate policy dialog, and our assessment

tools and advisory support are well equipped to help our client’s address them.

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4.1.5 Stringency of the Cap and Cap-decline Rates

Because our model forecasts at the full level of disaggregation on an annual basis, we

can specify a detailed time profile of emissions caps, for the whole economy, sub-groups

of covered entities, or even different caps for different groups. This flexibility permits policy

makers to more accurately anticipate adjustment costs and potential compliance

bottlenecks. Because we have done official assessments for California since the inception

of AB328, while California has changed its intermediate emissions targets, we have

unique experience assessing and comparing alternative mitigation pathways for a large

regional economy.

Based on input from the CPO, the report will analyse an allowance budget that begins in

2021 with 53.9 million tonnes of CO2 equivalent (mmtCO2e) and declines by in constant

annual increments to 8.9 mmtCO2e in 2050. The compliance path is shown in Figure 2.

A potential alternative compliance path that may be considered as a sensitivity scenario

is a constant annual percent decline, rather than constant annual incremental declines.

While the final mitigation goal remains unchanged, the constant percentage decline shifts

the compliance burden to the earlier years of the program.

Our forecasting model is also designed to simulate permit banking and some forms of

securitization. It is important to see how these financial instruments can facilitate

adjustment but also create risks depending on the scope of resale markets. It is widely

acknowledged that California’s C&T experiment has succeeded where Europe’s failed

because of the way permit ownership and resale issues were handled. Oregon needs its

own evidence to respond to financial sector stakeholders on these issues.

For this key policy element, at a minimum we recommend evaluating a set of realistic

alternative mitigation pathways, even if the terminal year goal is the same. This will help

elucidate adjustment challenges, the role of technology cost assumptions/expectations,

and opportunities for interstate arbitrage.

4.1.6 Linkage with the Larger Western Climate Initiative and Regional Markets

The issue of interstate arbitrage mentioned above takes two forms. Firstly, Oregon has

the option to source renewable energy from outside the state, where wind and solar may

have lower costs. More significantly, however, regional initiatives to integrate emissions

trading systems enlarges the universe for sharing adjustment burdens. Like insurance

markets, where a larger and more diverse pool of industries/technologies can lower

emission “premia” or permit prices, this can offer at least temporary relief to higher

8 BEAR model results were the only economic analysis cited in the Governor’s Executive Order implementing AB32.

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mitigation cost industries and facilitate their low carbon transition by liberating resources

for technology investment.

BEAR developed its first multi-state model of the WCI over ten years ago

(http://bearecon.com/portfolio-item/ef-wci/ ) and has been contributing to this regional

policy dialog ever since. Once we complete our updated Oregon CGE model, we can

incorporate it into this framework and evaluate scenarios for the state’s participate in a

regional framework. To keep results distinct from the Oregon only C&T assessment, we

recommend this be done as a dedicated sub-task of the project, evaluating a baseline

with full WCI integration, Oregon and California combining their carbon markets, and

Oregon allowing offsets to be purchased in regional markets. Specific scenarios can be

agreed upon project inception.

4.1.7 Interaction with Existing Energy/Climate Policies and Initiatives

Like Oregon, state governments making substantive commitments to emission reduction

recognize that C&T is only one of a suite of related policy tools, including mobile source

and appliance efficiency standards, renewable energy promotion, policies toward fuels,

agriculture, forestry, etc. Linkages between such policies can be complex, however, and

making sure they act in synergy requires careful coordination and assessment. For

example, Oregon’s commitment to expand its renewable energy portfolio could

significantly lower permit prices for other firms that need time or are financially

constrained in their efforts to reduce process emissions.

For practical purposes, we recommend including Oregon’s other leading climate

initiatives, ongoing and prospective, in a dedicated set of scenarios to be specified at

project inception. For general C&T assessment, ongoing policies would be part of the

Baseline scenario, but in this exercise we would try to decompose the individual, additive,

and/or potentially redundant or even conflicting effects of these efforts with C&T.

4.1.8 Investment of Allowance Proceeds

As mentioned above, C&T auction proceeds are a new public revenue source that can

arouse interest among many stakeholders. While some advocate returning these funds

to the public, others believe they should be invested in the public interest. A primary

category of such investment is to finance GHG mitigation, leveraging income from

permitted emissions to reduce them elsewhere. California, for example, set up a

Greenhouse Gas Reduction Fund (GGRF) to allocate a significant percentage of what is

currently about $2 billion in annual permit revenues to approved public and private

projects that promise GHG reductions and “green job creation.” Other investments might

include (e.g.) forest management strategies to mitigate fire risk, infrastructure investments

for climate adaptation, etc.

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In Oregon, any cap-and-trade revenue collected from the transportation sector must be

invested in the State Highway Trust Fund.9 This somewhat limits the revenue allocation

options for the State’s cap-and-trade program; however, this reality should be built into

the core mitigation scenario. For the core scenario, we will assume that any revenue

raised from other (non-transportation) sectors will be returned to residents through a lump

sum transfer. In sensitivity scenarios, we will explore alternative revenue allocation

schemes. Additional revenue allocation schemes will be developed in collaboration with

CPO.

BEAR worked for two years with the California Air Resources Board on GGRF

assessment, developing the prototype jobs assessment tool they use to evaluate

applicants for funding. While we developed a relatively simple multiplier tool for this

purpose, we learned much about the diverse purposes to which proceeds can be

targeted. Moreover, the sector and spatial detail of our forecasting model can assess a

much wider range of investment options.

Based on this experience, we would suggest that in addition to the two sensitivity

scenarios outlined above, the impact report include at least the primary categories of

mitigation investment envisioned by CPO and its allied institutions. These would include

clean public transit, support for EV adoption/diffusion, green infrastructure investments,

and others on a list developed at project inception. The constraint of the State Highway

Transportation Fund should be considered as fixed under these alternative revenue

allocation schemes. It is hoped that indicative findings in this area can support

development of Oregon’s policy toward revenue allocation.

4.1.9 Cost Control Measures

Direct and indirect costs of climate policies, usually arising from technology adoption, are

a primary concern for promoting socially effective emissions reduction. While the ultimate

objective may be transition to lower carbon growth pathways, this process could be

facilitated by a broad array of cost control measures, including (e.g.) concessional permit

allocation, offsets, carbon market integration, and targeted assistance like cost and

financing subsidies or tax preferences.

BEAR’s economic assessment framework already includes most policy instruments like

this, and we can work together with CPO to develop scenarios representing the cost

control options under active consideration or discussion in Oregon. Because we have

detailed sector, fuel, and technology cost data incorporated into our model, these results

can directly inform negotiations to address the adjustment needs of relevant stakeholders.

9 For a detailed overview of this issue, see ECONorthwest (2018) “Cap-and-Invest Issue Paper: Oregon Highway Cost Allocation Study”

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Our research in the past on the incentive effects of transitional permit concessions to

utilities were instrumental in securing their support for the state’s C&T program.

4.2 Presentations

A final responsibility in this project is to assist CPO with results communication. Robust

and transparent stakeholder engagement is essential to effective environmental policy.

Throughout our long experience in state agency advisory work, we have delivered such

communication services for our projects on an end-to-end basis, extending from initial

stakeholder consultation to detailed results communication and engagement with diverse

audiences. As mentioned above, we believe that ex ante assessment offers important

opportunities for constructive policy dialog, leading to more informed, adaptable policy

design and sustainable implementation. Taking full advantage of this requires careful

attention to communicating with three main constituencies: public decision makers (our

clients), enterprise interests, and community stakeholders. Most of our larger state

projects (see firm experience above) have entailed sustained client support in this area.

Following the three steps set forth below, we propose to develop dedicated messaging

for a variety of audiences designated by our client, to be presented in person by our senior

staff and (as approved) made available on electronic media. All communication strategy

and content will be subject to state consultation and approval.

Develop General Presentation Materials

Identification and engagement of stakeholder and peer reviewers

Stakeholder Engagement via Targeted Live Presentations

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