California Institute for Energy and Environment (CIEE)

The regulation of greenhouse gas emissions from the electricity sector within a cap‐and‐trade system poses significant policy questions on where to locate the point of compliance and how to allocate tradable emission allowances. The point of compliance addresses where, in the supply chain linking fuel suppliers, generators, the transmission system and retail local distribution companies, should the obligation for measurement and compliance be placed. This problem is examined in the specific context of California’s legislative requirements and energy markets, and different policy options explored. The conclusion offered is that one particular approach to regulating the electricity sector—the first‐seller (first deliverer) approach—would be best for California. How to allocate emission allowances is important because allocation conveys tremendous value and can have efficiency consequences. This research uses simulation modeling for the electricity sector to examine different approaches to allocation and how it affects prices and other aspects of the electricity sector, as well as implications for the overall cost of climate policy for the California economy. An important issue that influences both questions about point of compliance and method of allocation is the opportunity for emission reductions in California to be offset by emission increases in neighboring regions that supply electricity to the state. This study finds the amount of emission leakage (i.e. an increase in CO2 emissions outside of California as a result of the program) varies with the regulatory design of the program.