Carbon Pricing in PJM: Are State Policies at Risk?

Stakeholders in PJM may decide on Thursday to initiate a process to study and potentially price CO₂ emissions in its energy market.

PJM, the regional grid operator for parts of the Midwest and the Mid-Atlantic, includes some of the most coal-heavy U.S. states, along with states with CO₂ policies. The proposed stakeholder process would investigate how a pricing mechanism could leverage the markets to select the least-cost zero or low emissions resources in the states that have CO₂ policies while reducing crossborder impacts between states.

Such a process would provide a forum for much-needed detailed discussion and analysis on what could be a critical link between CO₂ emissions policies and efficient markets. However, key stakeholders have been concerned that pricing CO₂ in PJM could take carbon regulation out of state control.

While the mechanism discussed is commonly referred to as “carbon pricing,” it’s only intended to bring a CO₂ price established by another entity into the market. This distinction suggests sensible differentiated roles for environmental regulators, legislatures and the Federal Energy Regulatory Commission (FERC), which oversees PJM.

Concerns about carbon leakage

Some PJM states have CO₂ policies individually or as part of the Regional Greenhouse Gas Initiative (RGGI), a program that caps CO₂ emissions and allows fossil generators to trade emissions allowances.

Now that more states are seeking to tackle climate issues, some stakeholders are worried about “leakage.” For example, polluting generators outside of RGGI states could bid at lower prices because they don’t face the same compliance costs. These generators could then produce and emit more, and thus leakage would create an uneven playing field and thwart emissions goals.

Leakage concerns have now spurred interest in seriously considering carbon pricing. PJM published a white paper examining ways to implement carbon pricing and address leakage in 2017, but received no interest from its member states.

The foremost concern has been that carbon pricing implemented through PJM and approved by FERC could take CO₂ regulation out of state control, potentially through federal preemption. The federal preemption concern is a heavy one, but CO₂ policy and carbon pricing could be allocated between traditional legislative and environmental regulator roles and FERC.

How carbon pricing could work in PJM

The term “carbon pricing” sounds all-inclusive, but the conceptual framework floated in PJM is a mechanism into which a policymaker would input the price on CO₂ emissions. It’s not a CO₂ policy by PJM, but a way for the energy markets to interface with another entity’s CO₂ policy, whether at the national or state level.

Suppose as a CO₂ policy we had a national “carbon tax” at the social cost of carbon (~$50/ton CO₂ emitted). This is the cost to society that consumers and suppliers of energy impose through CO₂ emissions and wouldn’t otherwise account for absent the tax.

In economic terms, the CO₂ emission is an externality because the buyers and sellers in the transaction are imposing costs on non-market participants, and a tax set at the social cost of carbon would help internalize the externality. Emitting generators would pay the tax in proportion to their emissions to a relevant authority (e.g., the U.S. Treasury) and then factor that cost into their PJM energy market bids per carbon pricing requirements.

Because the energy market selects the least-cost resources needed to meet demand, the carbon tax would make offers from higher emitters more expensive and less likely to be selected. The market price that all selected generators receive would increase, and if demand were elastic, the quantity consumed would decrease.

The price and amount of energy consumed with the carbon tax adjustment would be efficient because this is what consumers and suppliers are willing to transact while compensating non-parties to the transaction harmed by the externality (i.e., society bearing the impacts of climate change).

How non-parties would be made whole would be determined legislatively and could involve offsetting the emissions that would impose those harms, such as energy efficiency improvements or solar panels for those who could not otherwise afford them.

Instead of a national carbon tax, CO₂ policies only exist at the state and regional level in the U.S. For example, two states in PJM have a price on CO₂ emissions at ~$5 per ton through RGGI. Generators located in RGGI states pay for their CO₂ emissions, but emitting generators outside of RGGI states can sell into RGGI states without paying for compliance and thus have a competitive advantage.

The conceptual framework floated in PJM would help ensure, albeit imperfectly, that generators importing into RGGI states pay for compliance obligations. PJM’s framework would not set the price on CO₂ emissions, and the mechanism by itself is not a CO₂ policy and thus cannot replace one.

Could FERC act to establish a price on emissions?

Some stakeholders are wary of PJM or FERC taking a further step from simply building a market interface to actually setting a price on CO₂ emissions. And if FERC were to accomplish this through its Federal Power Act authority to ensure just and reasonable wholesale market rates, the fear is that states could be preempted from setting that price themselves.

While FERC has an obligation to identify and address market distortions (e.g., leakage), the predicate finding that certain emissions are an environmental externality and a quantification of their cost have traditionally belonged to other agencies and/or legislatures. Legislatures also have the taxation and spending authority needed to collect and distribute carbon taxes and revenues. These could be at the state or federal level.

For example, the U.S. Environmental Protection Agency has the authority to determine that CO₂ is a pollutant (which to a market regulator would be an externality). It did so with the “endangerment” finding but has not yet promulgated regulations, which would implicitly quantify CO₂ emissions costs. Separately, the Interagency Working Group had provided an estimate for the social cost of carbon, but it is a guidance and doesn’t have a mechanism for collecting and redistributing carbon revenue.

If FERC were to insert the social cost of carbon into PJM’s suggested framework without a carbon tax or other means of charging the generators for their emissions, it would move money from consumers to generators, who wouldn’t be paying a tax, and thus would not make whole non-market participants harmed by the externality.

However, this would help prioritize zero- and lower-emissions resources in energy markets, and the grid operator could return some of the carbon revenues to wholesale consumers so that the net impact is largely to reshuffle supply to dispatch lower emitting resources first.

This would help reduce emissions but not fully internalize the externality because non-market participants are not compensated for bearing its cost and consumers would consume more than is efficient because the tax is diluted from their perspective. A partnership between FERC, environmental regulators and legislatures would therefore be more effective than FERC acting by itself.

CO2 emissions only the first step

While a price on CO₂ emissions is a good first step to addressing one type of greenhouse gas produced from combusting fossil fuels for electricity, it is blind to more potent greenhouse gases like methane or other externalities. It also does not consider the life-cycle emissions of resources that appear to have zero or low CO₂ emissions at the point of generation but still impose greenhouse gas emissions through fuel extraction and transportation.

And although energy efficiency is the most climate-friendly resource, carbon pricing in the energy market is blind to energy efficiency’s steady stream of “negawatt-hours” because the resource only participates in PJM’s capacity market.

Pricing CO₂ emissions, for these and other reasons, cannot be a substitute for a state’s more comprehensive climate policy or ability to promote specific non-emitting technologies.

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Jennifer Chen is senior counsel for federal energy policy at Duke University's Nicholas Institute for Environmental Policy Solutions.