Regional Cap and Trade Systems

Economists often point to carbon taxes as the most efficient and effective method for reducing greenhouse gas emissions, but new taxes are exceptionally difficult to enact. An alternative, achievable strategy is through cap and trade systems. Cap and trade programs have helped to reduce emissions, improve local and regional environments, and protect public health. A national cap and trade system for greenhouse gases is unlikely in the near term, but several multistate partnerships are having a positive impact. These programs can have a significant effect on pollution at the regional level that, when aggregated, can influence the performance of the country as a whole.

One of the most notable programs is the Regional Greenhouse Gas Initiative (RGGI, pronounced “Reggie”), which began as a collaboration between ten Northeastern states to cut their carbon dioxide (CO₂) emissions. The partnership initially included Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, and Vermont, but New Jersey Governor Chris Christie removed his state from RGGI in November 2011. Starting in 2009, RGGI became the first market-based regulatory program in the United States to reduce carbon dioxide emissions from the power sector, focusing specifically on fossil fuel–based electric power generators with a capacity of 25 megawatts (MW) or greater. In the program, a cap is set representing the regional CO₂ limit. Participating states sell emission allowances through quarterly regional auctions, and the proceeds are directed towards energy efficiency, renewable energy, and other programs that benefit consumers. Each state has the flexibility to develop its own allowance proceeds plan. In the first two years of the program, the 10 states allocated 52 percent of proceeds to improve energy efficiency, 11 percent to accelerate the deployment of renewable energy technologies, 14 percent to provide bill payment assistance, and 1 percent for a variety of greenhouse gas reduction programs (RGGI, 2011, 4).

Under the RGGI program, states unanimously chose to distribute more than 90 percent of allowances through an auctioning process (Union of Concerned Scientists, 2007). Some policy analysts and industry experts advocate giving away some allowances for free (often as a method to get industry to support the program), but establishing and maintaining a market for the allowances is key to a program's long-term success. To ensure prices are in line with what buyers can pay, the RGGI program established a cost containment reserve, a fixed additional supply of allowances available only if prices exceed certain levels, which increase each year. To ensure program effectiveness, a tracking system is used to record data on both CO₂ emissions and allowance transactions. For transparency, reports and program data are available on the RGGI website.

Each RGGI state is allocated a percentage of the total allowances. In 2014, New York had the highest allocation (39 percent of allowances), and Vermont had the lowest (only 1 percent). The individual state budgets for allowances are based upon their own regulatory schemes. One of the benefits of a multistate partnership is that power plants can ensure compliance by meeting the CO₂ allowance established by any RGGI state. Another benefit is that several state programs comprise a single regional compliance market, which creates a greater level of efficiency in operations and flexibility for participants.

The program has been successful at both auctioning its allowances and meeting its cap. The cap is designed to decrease over time, lowering regional emissions. From 2009 through 2011, the cap was 188 million tons of CO₂ per year; this was lowered to 165 million tons per year for 2012 and 2013. In 2011, emissions were 44 million tons below the cap (Burtraw and Woerman, 2012, 9).

In 2012, the states conducted a review of the trading program, which resulted in a new 2014 RGGI cap of 91 million tons, a 45 percent reduction. The revised program is designed so that the CO₂ cap declines 2.5 percent each year from 2015 to 2020. In addition, states have agreed to work to address emissions from electricity imports, which is significant considering that imports make up between 10 and 52 percent of electricity consumption in these states (Welton, 2013).

An economic assessment by the Analysis Group concluded that this market-based carbon control mechanism has delivered positive economic benefits, helped states reach other environmental policy goals, and reduced payments for out-of-state fossil fuels (Hibbard et al., 2011, 6). Through June 2013, allowances generated $1.4 billion in revenue that, through reinvestment in energy efficiency programs, will generate $2.4 billion in the states' economies over the next decade, leading to an additional 23,000 job years of employment (ENE, 2013, 1). Over the next decade, RGGI's efficiency measures will save customers $1.3 billion in reduced energy costs.

There are economic and job losses in some industries, especially those most affected by the carbon reduction regulations in fossil fuel–related industries. For example, powerplant owners could experience a $1.6 billion reduction in net revenue over time because of reduced demand, but, overall, regulation can bring substantial benefits. One study showed that more than $765 million remained in the local economy defined by the RGGI states because of reduced fossil fuel consumption (Hibbard et al., 2011, 4, 6). By investing proceeds locally in efficient and renewable energy programs, states are generating jobs in these industries and encouraging innovations in technology and processes to reduce emissions. They are also saving people money on their energy bills, which can be spent elsewhere in the economy.

Establishing a regional system of cap and trade signals to small businesses and clean-tech entrepreneurs that the Northeast is serious about the green economy, and its member states represent good opportunities for growth. A regional partnership, like RGGI, and strong incentives within the participating states establish a positive investment landscape, encouraging businesses to establish operations in the region.

Not every regional effort has proven so successful. Another regional cap and trade-based initiative, the Midwest Greenhouse Gas Reduction Accord (MGGRA), was signed in November 2007 by the governors of six Midwestern states and one Canadian province, with the goal of reducing greenhouse gas emissions between 60 and 80 percent below 2007 levels through a multisector cap and trade program. However, after 2010, states were no longer collectively pursuing the goals under the accord (although some have their own plans for reducing GHG emissions).

Another regional effort, the Western Climate Initiative (WCI), began in February 2007 with a non-binding agreement between the governors of five western states: Arizona, California, New Mexico, Oregon, and Washington. These states developed a regional target for reducing greenhouse gas emissions based on existing efforts (specifically, the West Coast Global Warming Initiative and the Southwest Climate Change Initiative). The plan eventually expanded to include Utah, Montana, and four Canadian provinces, in addition to other state “observers” (WCI, 2014). First in 2008 and again in 2010, WCI released program designs that states could use to develop their own reduction strategies, and called for the program to be implemented by 2012 with a second compliance period to begin in 2015. However by 2011, only California and Quebec had adopted any regulations based on the recommendations.

Why was RGGI successful when the Western and Midwestern initiatives failed? In a survey of stakeholders involved in developing these three regional programs, interviewees said the main reason for starting a cap and trade program was political. States saw a need for response to climate change due to federal inaction. Katia Biendenkopf, an assistant professor at the University of Amsterdam, who studied the impact of the European Union's GHG emissions trading scheme on the development of the U.S. regional systems, found that “demonstrating that GHG emissions trading was feasible and successful as well as building pressure on the federal government to act were dominant drivers, both in RGGI and WCI” (Biedenkopf, 2012, 15).

The failed MGGRA agreement was slightly different because it was developed at a time when federal policy was seen as likely to happen, and the program was shaped to specifically reflect the concerns of the Midwestern states so they could stay ahead of the curve (Biedenkopf, 2012, 16). The Midwestern states eventually lost the political will for their own trading program. And even though the Western Climate Initiative failed, California continued its aggressive pursuit of climate mitigation through its own statewide system.

Case Study: California's Cap and Trade

In 2006, California passed the Global Warming Solutions Act, which required a 25 percent GHG reduction statewide by 2020, which is the equivalent of taking 3.5 million cars off the roads (EDF, 2014). The law spelled out a range of measures to expand energy efficiency programs, achieve a renewable energy mix, and develop a cap and trade program.

The California cap and trade program went into effect on January 1, 2013, with a cap on the largest polluters in the electricity and industrial sectors, applying to plants emitting 25,000 metric tons of CO₂ equivalent or more annually. At the program's start, this applied to approximately 300 plants throughout the state. The plan will gradually cover ground transportation and heating fuels, and come to include 85 percent of the state's GHG emissions (Burtraw and Woerman, 2012, 8). When fully implemented, California's program will be twice as large as the RGGI program, as measured by the size of the state's economy and the number of sectors covered (Bifera, 2013). The cap itself decreases by 2 percent annually before 2015, and will decrease 3 percent annually between 2015 and 2020. Based on the amount of emissions covered, the program is currently second in size only to the European Union Emissions Trading System (EU ETS) (C2ES, 2014a, 2).

All rules and market mechanisms are implemented and enforced by the California Air Resources Board (CARB). According to the cap and trade scheme, regulated companies must hold enough allowances to cover their total emissions, and can buy and sell allowances on the open market. Allowances are both given for free and sold at auctions. In contrast to RGGI, CARB gave a significant number of free allowances to electrical utilities in order to ensure that businesses remained competitive, facilitate a smooth transition, and prevent emissions leakage (Hsia-Kiung et al., 2014, 5). Leakages refer to increases in GHG emissions outside the state to compensate for reductions within the state.

The remaining allowances are auctioned off. Each auction has a floor price that increases every year; in 2012 it was set at $10 per metric ton. There are two types of allowances auctioned: (1) current-year vintage, which can be used in the year of their auction, and (2) future-year vintage, which can be banked by companies for later use. The first auction was held in November 2012 when close to 29 million allowances (including current and future vintages) were sold to more than 600 approved industrial facilities and electricity generators. The allowances were sold for $10.09, near the minimum price of $10, indicating initial demand was modest and that participants were confident they would meet the cap (EIA, 2012a).

The first year generated $525 million in auction revenues (C2ES, 2014a, 8). Similar to RGGI, investment of the auction proceeds is vital for the program to achieve its climate change mitigation goals. Two laws establish guidelines for the dispersal of this revenue; the first requires that it be spent for environmental purposes, particularly concerning air quality, and the second requires that at least 25 percent be spent on programs to help disadvantaged communities.

At the end of each compliance period, companies must return allowances to the California government to cover their compliance obligation. Those that do not meet the compliance requirement must pay a penalty through the purchase of four times the number of outstanding allowances (Bosworth, 2013). Regulated entities can also meet up to 8 percent of their obligations using offsets. Offsets are reductions of greenhouse gas emissions that compensate for an emission made elsewhere. This allows companies to reduce emissions by funding reduction activities that would otherwise not occur, such as improving forest management or capturing and destroying methane from livestock manure.

The standards used for the California offsets were carefully developed with input from a number of stakeholders and experts. For example, for forestry-based offsets, the standards require that carbon must stay out of the atmosphere for 100 years, ensuring long-term sustainable forest management.

The use of offsets is not without controversy. Two public interest groups—Citizens Climate Lobby and Our Children's Earth Foundation—filed a lawsuit against CARB, arguing that the offset program violated the requirements under the Global Warming Solutions Act. In their suit, they claim that the offsets do not represent any additional greenhouse gas reductions as required by law, but are preexisting activities. They fear that offsets provide a mechanism for oil refineries to buy their way out of cleaning up pollution without providing any actual environmental benefit.

In January 2013, a state trial ruled in favor of California's Air Resources Board. Our Children's Earth Foundation appealed the decision, but as of this writing a hearing date has yet to be scheduled (Hsia-Kiung et al., 2014, 18). It is important to remember that success with offsets (and many other features of environmental initiatives) depends on how a program is designed. In California's case, it includes some of the strictest rules in the world, giving most participants confidence that offsets represent activities that would not have happened without the program.

Beyond offsets, there are other criticisms of the California cap and trade program. The fossil fuel industry and its lobbyists criticize the complicated nature of the program and its vulnerability to fraud. However, according to an analysis by the University of California, Los Angeles, the program is unlikely to suffer from manipulation and fraud because California's government uses third-party verifiers to check reported emissions and tracks allowances to prove authenticity (Cutter et al., 2011, 8).

A number of environmental justice groups opposed the program early on, arguing that it focused on gases that are released high in the atmosphere, and overlooked the release of heavier pollutants, like fine particles from oil refineries, that are most likely to harm low-income communities (Barringer, 2011). While the groups were supportive of the Global Warming Solutions Act generally, they opposed the cap and trade program as the primary mechanism to achieve reductions. One critic stated “our communities are opposed to a trading scheme because of the inherent inequities for communities of color and low income communities, and the missed opportunities for real localized emission reduction” (Conant, 2012, 32).

Despite these criticisms, the program continues to progress and expand. In January 2014, the California program linked with Quebec, Canada's program so that allowances and offsets issued in one jurisdiction could be used for compliance purposes in the other—the first international carbon market in North America.

California's program also continues to evolve. In October 2013, CARB released a set of amendments to the program based on public meetings and comments, economic analysis, and administrative insight. According to Thomas Reuters' Point Carbon, policymakers still need to address the state's reliance on complementary measures, such as the Renewable Portfolio Standard and the Low Carbon Fuel Standard, so that the demand for allowances doesn't drop to the floor price and stay there (2013).

Renewable Portfolio Standards

While cap and trade programs are growing, their application is still limited in the United States. Cap and trade programs work by directly limiting the amount of greenhouse gas emissions in a given region, but the remaining policies we discuss here limit emissions indirectly by encouraging the use of renewable energy, reducing reliance on fossil fuels, and enhancing efficient use of energy. Renewable portfolio standards (RPS) are one of the primary mechanisms to encourage the uptake of renewable energy in the United States. A renewable portfolio standard is a performance requirement for electric utilities that mandates a certain amount of electricity be generated from eligible renewable sources. As of 2013, 29 states plus Washington, DC, had some kind of enforceable renewable portfolio standard, and 8 other states have non-binding renewable portfolio goals (DSIRE, 2013c). Figure 4.1 provides a map of states that have RPS standards and goals as of 2012.

Some states also include carve outs, requirements that a portion of their electricity portfolio comes from a specific source, such as solar. The first renewable portfolio standard was established in 1983 when Iowa passed the Alternative Energy Production Law (requiring that 2 percent of the state's energy be renewable), although most states passed their standards after 2000.

Massachusetts and Connecticut were among the first states to enact mandatory renewable portfolio standards. After it was clear that many states in the Northeast were considering these standards, the region decided to establish a coordinated system to track both renewable energy and emissions (Cory and Swezey, 2007, 10). Most renewable portfolio standard programs also allow renewable energy generation outside a state to qualify, so that non-renewable portfolio states can benefit from renewable energy policy in a nearby state. For example, Wyoming contains wind farms that participate in the Oregon RPS, even though Wyoming itself does not require renewable energy in its energy mix (Leon, 2013, 4–5). The Clean Energy States Alliance points out some of the key strengths and weaknesses of the renewable portfolio policy as compared to other types of clean energy policies. Some of the strengths of a renewable portfolio standard include:

• A straightforward and easy-to-understand concept;
• A market-based approach that leads to cost efficiency;
• A relatively long-term policy with clear future targets;
• Flexibility for each state;
• Compatibility with federal tax policies to support renewable energy; and,
• Modest costs (Leon, 2013, 8–11).

Weaknesses include:

• Volatility in the price of renewable energy certificates;
• Potential free riders who receive payments for projects that would be profitable without incentives; and,
• Need for modifications over time when revisions can be difficult (Leon, 2013, 13–15).

Each state sets its own standard, so policies can vary considerably. States differ on the level of the requirement, what they define as a renewable source, how it is measured, and how the requirement is enforced (Heeter and Bird, 2012). For example, California's renewable standard requires 33 percent from renewables by 2020, while Texas requires 5,880 MW of new renewable energy generation to be built by 2015 (Cory and Swezey, 2007, 1, 22). Minnesota requires 25 percent from renewable sources by 2025 plus 1.5 percent solar by 2020 (DSIRE, 2013a). Different states have different requirements depending on their capabilities and resources.

While political support for renewable portfolio standards is growing, there are also influential opponents. The American Legislative Exchange Council (ALEC) drafted model legislation in 2012 pushing for a complete repeal of renewable portfolio standards (Goldenberg and Pilkington, 2013). In this case, state legislators introduced versions of the model legislation in a number of states, though most didn't make it beyond an introductory stage. The Council's perspective is that a renewable portfolio standard is a tax on consumers and that it mandates utilities use sources that are expensive and unreliable, increasing the cost of doing business (ALEC, 2012).

In North Carolina, Ohio, and Kansas conservative groups sought unsuccessfully to reverse clean energy regulations. They argued that renewable portfolio policies have too great an impact on electricity rates, give an unfair advantage to certain energy technologies, and that a requirement for a type of energy source interferes with the free market (Leon, 2013, 20–21).

The effectiveness of state renewable portfolio programs can depend on federal policies, and the lack of a national framework makes it harder for businesses to develop separate models for each state. The state-by-state approach also increases regulatory uncertainty, and creates jurisdictional inconsistencies (Gallagher, 2013, 60). These standards permit states to determine what should be included, and these definitions vary widely and can cause confusion.

Increasingly, states are using alternative resources, such as energy efficiency, thermal, and even non-renewables, in their renewable portfolio policies (although non-renewables are typically capped). Michigan, Ohio, Pennsylvania, and West Virginia permit the use of non-renewable resources such as coal, natural gas, and nuclear. In fact, West Virginia's standard does not require a minimum contribution from renewable energy sources at all (DSIRE, 2012).

Energy Efficiency Resource Standards

An energy efficiency resource standard (EERS) or energy efficiency target is a policy tool developed to encourage more efficient generation, transmission, and use of electricity. These are long-term, binding energy savings target for utilities, expressed as a percentage of energy sales or specific energy units over a certain period of time (ACEEE, 2014c, 1). These are similar to renewable portfolio standards in that they require utility providers to reduce energy use by a specified amount that increases each year or so. An energy efficiency resource standard is like a renewable portfolio standard for energy efficiency.

In 1999, Texas was the first state to establish an energy efficiency resource standard, but the top five scoring states in energy efficiency are Massachusetts, California, New York, Oregon, and Vermont. A report by the American Council for an Energy Efficient Economy found that most states are on target to meet their goals (Sciortino et al., 2011). The policy advantages of this tool include simplicity, specificity, and economies of scale. States also often coordinate their renewable portfolio standards with energy efficiency standards to achieve higher energy savings. Eight states include energy efficiency as an eligible resource in their renewable portfolio policies. Authors of one publication found that states use the maximum amount of energy efficiency allowed when possible, making the specified level extremely important in policy design (Heeter and Bird, 2012, 10).

As of February 2014, 26 states have adopted an energy efficiency standard. These states represent 62 percent of electricity sales in the nation (ACEEE, 2014c, 1). The strongest energy efficiency standards are in Massachusetts, Rhode Island, and Vermont, which require nearly 2.5 percent annual savings (ACEEE, 2014b). Not surprisingly, the success of these types of programs depends on the clarity of the regulatory framework, the time frame allotted, and the commitment of resources of those involved (Sciortino et al., 2011).

Building Codes

States can help reduce energy consumption through requirements and incentives in their building codes. Buildings are a major source of greenhouse gas emissions (second only to the transportation sector). Nearly 5 million commercial buildings and 114 million residences in the United States account for approximately 40 percent of the nation's total energy use (US DOE, 2008, 4).

McKinsey & Company estimates that energy improvements in the building sector could reduce annual electricity consumption by 23 percent, thereby reducing consumer energy bills by $130 billion annually (Granade et al., 2009, 7–8). A major advantage of building codes is that they can be designed around local needs and climate—the most efficient and sustainable practices will vary from Wisconsin to Arizona. States can take full advantage of local distinctions that might be lost at the national level.

The first energy efficiency standards for U.S. buildings were adopted in 1978. After a relatively slow initial adoption phase, use of these tools expanded dramatically in the early 21st century. Building codes mandate materials, construction, engineering and related processes. New code provisions can enhance: sustainability and energy efficiency through minimum energy efficiency requirements; use of sustainable, energy efficient materials; and requirements for periodic reviews and updates. Future energy savings can also be locked in during times of new construction or renovation.

While there are federal requirements for building codes, many states have codes that are more stringent to yield greater benefits. Building efficiency codes can reduce peak energy demand, air pollution, and greenhouse gas emissions. Codes can also target building use—industrial, commercial, residential—size, and type of occupancy.

More than 275 American cities, counties, tribes, and states have created green building codes in order to conserve energy, water, and other resources, and to reduce power and water costs (EPA, 2014c). Building energy codes typically include insulation requirements, heating and cooling equipment standards, and lighting requirements. A cutting-edge code provision pertains to roofs, which can decrease power and cooling demand, and lower citywide air temperature in warm weather. Projections indicate that if all states adopted the most recent and stringent state codes and focused more on code enforcement, the United States could avoid construction of 32 new 400 MW power plants by 2020 (EPA, 2006, 4–37).

Massachusetts was named the most energy efficient state in 2013 by the American Council for an Energy-Efficient Economy. One reason is the 2008 Massachusetts Green Communities Act, which advises on best practices in sustainable building code design. The act requires that all commercial buildings in Massachusetts must be in full compliance with the national model building code within a year of any code update. Massachusetts also has an optional stretch code, which is up to 20 percent more stringent than the baseline state energy code. In Massachusetts, jurisdictions that adopted the stretch code as of 2013 house 50 percent of the state's population (Massachusetts' Businesses for Clean Energy, 2014). The state's lead-by-example program, which applies to all state agency new construction and major renovations over 20,000 square feet, has a LEED Plus green standard that is 20 percent more energy efficient than the state energy code.

Washington is another state that is using code compliance as an effective tool for sustainability. Its 2012 State Energy Code is one of the most stringent U.S. state codes, and elicits the highest compliance rate in the nation (ACEEE, 2014a). A residential cost compliance study by the Northwest Energy Efficiency Alliance from 2013 shows compliance rates of 96 percent (Cadmus Group and NEEA, 2013, 32).

California, another leader, has had energy standards for buildings since 1978. In response to a legislative mandate to reduce the state's energy consumption, the California Energy Commission approved new energy standards for both residential and commercial buildings more than 35 years ago. Currently, California's 2013 standards are the most stringent and among the best enforced in the nation (ACEEE, 2014a). California is moving toward zero-net-energy (ZNE) buildings, in which annual energy consumption will equal the production of renewable energy. All new residential buildings will reach ZNE by 2020, and all new commercial buildings by 2030. California is also committed to achieve ZNE for 50 percent of its existing state buildings by 2025 (Roth, 2013).

California's strict energy efficiency standards have helped keep the state's per capita electricity rate stay flat over the past 30 years, while rates in other states rose by 50 percent on average (Horowitz, 2012). Californians saved more than $65 billion on energy costs, and an additional 1.5 million jobs were created (Bacchus, 2012).

Despite these many efforts to improve U.S. building energy efficiency, a 2013 analysis by the Institute for Market Transformation found high rates of noncompliance in most states (Stellberg, 2013). Noncompliance can occur due to lack of resources, education, or political will. Improving enforcement of codes that are already developed could have a significant impact on energy efficiency. One analysis found that bringing just one year's worth of new construction up to full compliance with current energy building codes would save between $63 and $189 million in annual energy costs (Stellberg, 2013, 3).

Compliance can be supported by other state and federal programs, including tax credits and rebates, green banks, public benefit funds, and other financial mechanisms that enable individuals and business to finance energy upgrades. We see the importance of offering not only regulatory requirements but also other innovative programs using public policies to leverage and encourage individual initiatives. Combining code reform and financial incentives can multiply the overall impact on efficiency and sustainability.

Grid Standards

Grid standards are requirements for connecting solar or other electrical generation systems to the electric grid, applicable to both utilities and customers (SEIA, 2014a). These standards encourage the connection of clean, distributed generation systems to the electric grid by establishing standard technical requirements and uniform procedures for utilities. This reduces the uncertainty and delays that these systems sometimes encounter.

For example, net metering enables residential and commercial customers who generate their own renewable energy to feed back into the grid the electricity that they don't use onsite (EPA, 2006, ES-17). It defines application processes and technical requirements for smaller projects and requires that electric utilities buy unused electricity back from customers at retail rates. With net metering, the meter runs backwards when a residential solar panel produces more electricity than is being used.

As of 2013, 44 states have some kind of net metering policy, whether through a law, regulation, or voluntary effort by utilities (Yim, 2013). While participation is increasing rapidly, the percentage of participating customers remains well below 1 percent (EIA, 2012b). Utility-industry trade associations and fossil fuel interests see net metering policies as lost revenue. They even argue that solar customers do not pay their share of electricity costs. The American Legislative Exchange Council (ALEC) recently proposed a resolution to weaken net metering policies. With the help of the Edison Electric Institute, they drafted model legislation outlining a fixed grid charge that would recover grid costs, and argued for the need to update net metering policies and restructure crediting mechanisms so that everyone who uses the grid pays to maintain it (ALEC, 2014). The Arizona Public Service Company took a similar position when it proposed that customers who install solar panels on their rooftops should pay an extra $50 to $100 on their monthly bill to cover the system's maintenance costs (Elsner, 2013). The final ruling was a lot lower than this—about $5 per month for customers; nevertheless, Arizona is the first state to charge customers for installing solar panels (Goldenberg and Pilkington, 2013).

Feed-In Tariffs

Feed-in tariffs (FITs) require electric utilities to pay pre-established, above-market rates to generators of renewable power that is fed onto the grid over a guaranteed period of time. The goal is to make renewable energy sources cost-competitive with fossil fuel–based technologies, by making the price of renewable energy known and reliable. Tariffs provide renewable generators with a set stream of income from their projects. They also reduce the payback period, that is, the time it takes to accumulate enough annual or monthly savings to recoup the original investment.

Feed-in tariff programs have been slow to emerge in North America, but they are widely used in Europe and other countries. California, Hawaii, Vermont, and Washington were the first states to establish systems of feed-in tariffs. Although only seven states have feed-in tariff programs as of 2013, a number of utility providers offer programs. For example, in 2013, a voluntary program started in Virginia, where residential and commercial owners of solar photovoltaic generators can receive 15 cents per kilowatt-hour (kWh) for five years (EIA, 2013).

Feed-in tariff programs were first introduced in Germany in 1991, followed by Denmark and Spain, and they are now the most widely popular policy to promote renewable energy worldwide (Zhang, 2013, 2). In the 1990s, project costs remained high due to fluctuating electricity costs, but in 2000, Germany and Denmark switched to a cost-base, fixed-rate model. This change was a “catalyst for the dramatic renewable energy growth witnessed by Europe, particularly Germany and Spain, over the past decade” (Institute for Building Efficiency, 2010).

In 2005, China introduced the first resource-based wind tariff outside of Europe. In 2012, Japan introduced a feed-in tariff for solar energy. The implementation of the Japanese program contributed to a 75 percent increase in clean energy investment; 97 percent of that was spent on solar (Pew Charitable Trusts, 2012, 21).

Feed-in tariff policies reduce the environmental impact of electricity generation, stabilize electricity rates, and facilitate economic development and job growth (NREL, 2013). The most effective of these programs set rates above the retail cost of electricity. In the United States, most feed-in tariff programs use a cost containment mechanism—they have a program and/or annual limit, to cap the dollar amount available (EIA, 2013).

Feed-in tariffs typically stimulate significant growth in the generation of renewable energy—some estimates credit them with stimulating approximately 75 percent of global solar photovoltaic and 45 percent of global wind capacity (Zhang, 2013, 2). Another study by the World Bank looked at wind feed-in tariff policies in 35 European countries to determine cost effectiveness. The researchers concluded that two main actions can increase wind investment: (1) extending the contract agreement and (2) providing guaranteed grid access (Zhang, 2013, 2).

Feed-in tariff policies work best in areas where the cost of retail electricity is low and cost of electricity from solar systems is high (The California Majority Report, 2013). In Germany, a country that led the way with these policies, there is now a contraction in the market, and other European countries have experienced FIT market turmoil (Trabish, 2014). With feed-in tariffs, solar customers sometimes build large systems to maximize their return, which can be unsustainable in markets where solar costs continue to drop. Net metering on the other hand, ensures that system size matches customers' electricity usage (Trabish, 2014). Some argue that feed-in tariffs remain beneficial to drive commercial and community-scale renewables, while net energy metering is more appropriate for residential scale projects.

Tax Credits, Rebates, and Subsidies

Like the federal government, states can implement a range of tax credits, rebates, and subsidies to encourage businesses and consumers to take part in sustainability initiatives. According to the National Governors Association, every single U.S. state has created some kind of financial incentive to promote clean energy (2013, 2). These incentives range from deductions for renewable energy production and energy conservation, to deductions for wood-burning heating systems, biomass, geothermal, and bio heating oil use. Other incentives are offered for things like greater use of electric vehicles. These programs are important in making renewables as cost-effective as fossil fuels.

In 2013, California enacted the Green Tariff Shared Renewables Program, through which three major utilities will make renewable energy available to a whole new market of customers (e.g., renters, businesses that lease their spaces, low-income residents, and those with poor credit scores). Customers receive a credit on their utility bills for clean energy they buy at off-site renewable energy facilities (without shifting costs to customers who do not participate). This program has the potential to create $2 billion in economic activity from the 500MW of solar facilities that will be constructed, generate $60 million in tax revenue, and create 7,000 jobs (Wolk, 2014).

Nebraska supports wind-farm development with tax incentives (C2ES, 2013b). A tax exemption for the purchase of wind-farm components like turbines and towers enables wind projects to stay competitive in the regional electricity industry.

Colorado provides tax incentives to support electric vehicle (EV) adoption. Their Innovative Motor Vehicle Income Tax Credit makes available up to $6,000 in tax credits for electric vehicle purchases/lessees until 2021. The Colorado Special Fuel Tax & Electric Vehicle Fee established an annual, flat fee for registration of plug-in vehicles, at a price lower than other states (C2ES, 2013a). New York State has also enacted three programs to expand financial incentives for solar energy projects, including tax credits to homeowners for the cost of solar installation equipment.

Public Benefit Funds

Public benefit funds (PBFs) are pools of public resources invested in clean energy supplies and programs. Public benefit funds are created by enacting a small fee, typically called a systems benefit charge (SBC), on customers' electricity bills.

Public benefit funds became popular in the late 1990s after the restructuring of the electrical industry. New York, California, and Massachusetts were among the first states to develop public benefit funds. California's was established in 1998 and generates more than $135 million per year for clean resources and consumer education (EPA, 2013a). In 1997, Massachusetts created a renewable energy and energy efficiency fund. The Massachusetts Renewable Energy Trust focuses first on identifying barriers to renewable energy growth and second on maximizing public benefit by creating high-tech jobs in clean energy.

Public benefit funds help states meet their long-term energy goals and may help them design a more cohesive energy strategy. They complement other clean energy policies at both the state and federal level and enable states to secure resources to meet their energy goals. The EPA has developed a number of best practices—ranging from establishing working groups and publicizing achievements, to designing complementary energy programs and drafting supporting legislation—from states that have such clean energy funds (EPA, 2009).

As of 2010, 30 states and the District of Columbia had public benefit funds (Glatt, 2010, 1). These programs are administered through state energy offices (California), through quasi-public agencies (Connecticut and Massachusetts), by public regulatory agencies (New Jersey), through nonprofit organizations (Pennsylvania), or through utility companies (Arizona). Public benefit funds have a number of advantages, they:

• Narrow gaps between market price of electricity and the costs of clean energy technologies;
• Lower regulatory and market barriers for emerging technologies;
• Help develop infrastructure needed for the success of clean energy; and,
• Promote awareness of clean energy to the public.

Utilities benefit from energy reductions, lowered customer electricity rates, and reductions in peak energy demands. Public benefit funds are often set up to provide assistance to low-income residents. For example, in 2007 in Illinois, $72 million of the state's $80 million public benefit fund went to low-income energy assistance (Glatt, 2010).

Case Study: New York Systems Benefit Charge

New York is widely recognized as a leader in energy efficiency and renewable energy development (Morris and Stutt, 2012, 1). The New York Systems Benefit Charge (NYSBC) was one of the first of its kind established in 1996 by the New York State Public Service Commission. Originally funded from 1998 to 2001 at $78 million per year, NYSBC is administered by the New York State Energy Research Development Authority (NYSERDA), a public benefit corporation whose mission is to help New York meet its energy goals.

Two public power authorities not under the jurisdiction of the Public Service Commission—the New York Power Authority and Long Island Power Authority—offer their own programs funded by systems benefit charges. New York's Systems Benefit program, branded the New York Energy $mart program, was designed to generate funding for public policy initiatives not adequately addressed by New York's electricity markets. The program contains specific initiatives across four core areas: energy efficiency, research and development, programs for low-income customers, and environmental protection programs.

New York's Systems Benefit program was extended in 2001, with funding increased to $150 million annually, and an added goal of achieving peak load reductions to increase the stability of the electric supply. Extended again in 2006, funding was increased to $175 million annually. More specific goals and objectives were also set at that time: 54 percent of funding was specified for peak load, energy efficiency, and outreach and education programs; 23 percent to research and development; and 24 percent to low-income energy affordability programs (NYSERDA, 2010, 4).

The most recent extension of the program in 2011, through 2016, set total funding for the five-year period at $469 million (NYS PCS, 2014). In addition, some of the funding is provided to utilities that are also required to implement energy efficiency programs. This expansion also committed funds to power supply and delivery, building systems, and clean energy infrastructure. The portfolio of programs is designed to increase energy innovation through scientific research, market analysis, technology development, and clean energy technology adoption, more rigorous standards in codes, and promotion of a clean energy economy through business and market development. In 2012, programs in workforce development and combined heat and power were added (NYSERDA, 2013a, 2–1).

The fund's technology and market development investments serve to realize policy objectives in the energy efficiency portfolio standard (EEPS) and renewable portfolio standard (RPS) (NYSERDA, 2013a, ES-2). These initiatives help new or underused technology move into the marketplace and serve as feeders to help achieve energy efficiency and renewability goals (NYSERDA, 2010, 2). The fund is widely considered successful in moving New York to become a leader in the nation in this field (Morris and Stutt, 2012).

Green Banks

State green banks are relatively new financial tools for sparking clean energy investment. Green banks use public debt to leverage private sector investment. Renewable energy technologies have great potential to meet the challenges of a low-carbon energy infrastructure, but require substantial amounts of capital and are often competing against government-subsidized conventional energy industries. Green banks bring elements of predictability and aggregation that reduce overall pricing, eliminating a significant market barrier that has long slowed the development of new clean technology (Hendricks and Bovarnick, 2014).

According to the Center for American Progress, national green banks have been successfully undertaken in Germany, the United Kingdom, and China. In the United States, New York, Connecticut, Hawaii, Massachusetts, and California all have or are in the process of establishing similar financial entities (although they are not all called banks). The Connecticut Clean Energy Finance and Investment Authority (CEFIA), established in 2011, was the first green bank in the United States. It provides a combination of loans, grants, and other credit in support of the state's clean energy industry. In 2013, Hawaii enacted a law to authorize the establishment of a renewable energy loan fund.

New York State Governor Andrew Cuomo called for the establishment of a $1 billion New York Green Bank, and in December 2013, the New York Public Service Commission approved funding for the bank from clean energy ratepayer funds, combined with funds from Regional Greenhouse Gas Initiative (RGGI) allowances for initial funding of $210 million. The green bank partners with financial institutions, energy service companies, project developers, and equipment manufacturers to support clean energy projects (NYSERDA, 2014).

Green banks can help overcome market barriers such as lack of capital markets and federal policy uncertainty. These institutions partner with private sector by providing credit enhancement, loan loss reserves, and loan bundling, in order to encourage private sector support of clean energy projects. Models show that these banks can double the amount of capital for clean energy markets within 5 years, and create ten times more capital within 20 years (New York State, 2013).

On-Bill Financing

One of the barriers to introducing energy efficient retrofits is the high upfront costs these projects require. On-bill financing (OBF) can help overcome this barrier by leveraging the relationship between utilities and customers. Rather than directly paying the upfront cost to install an energy-saving project, on-bill financing enables customers to invest in energy efficiency improvements through a loan or tariff, and customers pay for upgrades over time as a charge on their utility bill. The utility or program administrator generally provides the loan funds, so they also hold the repayment risk. Many programs allow the utility to suspend service to those who do not make their loan payments. If the costs and benefits of energy efficiency measures are aligned properly, sometimes this can be bill neutral for customers, meaning the energy savings of the improvement make up for the charge; in fact, some programs require bill neutrality.

The earliest on-bill finance program was piloted in 1993 in Wisconsin. Today there are 23 states with on-bill financing programs, though not all have legislation to support it and many tend to have different provisions (ACEEE, 2012, 1–2). On-bill financing has a number of benefits including eliminating upfront costs for customers, generating positive cash flow for utilities, increasing the value of property, and creating new jobs. These types of programs are designed such that they can operate concurrently with other programs like rebate offers.

Importantly, on-bill financing can be tied to a property, often through a meter, so that debt can transfer between owners and tenants. This way if a customer paying the financing charge moves, the new occupant (not the building owner) must take on the payment obligation.

“In many buildings, without an OBF structure, the cost of utility services are borne by tenants, either directly with separately metered space, or indirectly with the owner passing charges on to tenants on the basis of square footage or some other formula. The owner typically bears the cost of improvements, such as a new boiler or better water pumps, but the tenants realize the benefits in the form of lower utility bills. This works to discourage the owner from making sensible investments in efficiency” (Henderson, 2013, 2).

On-bill financing can help encourage building owners to take part in energy efficiency projects, if both owner and tenants agree to improvements that reduce the total monthly bill (Henderson, 2013, 5). It also broadens the number of customers that can participate, having fewer eligibility restrictions than traditional loans; however, on-bill financing faces a number of barriers. Utility companies need the expertise and resources to act as lending institutions. Questions of equity may arise when programs are paid out of public benefit funds, which everyone pays into, while only some benefit from on-bill financing. There is also a risk that some borrowers will be unable to pay, especially because bill neutrality doesn't necessarily mean that individual customers will have lower payments (Henderson, 2013, 4).

Property Assessed Clean Energy

Property assessed clean energy (PACE) financing is a similar tool to overcome the barrier of high upfront costs and encourage renewable energy installations or energy efficiency retrofits in buildings. It also spreads the cost of the system over a longer time period than other types of energy financing (DSIRE, 2014). With property assessed clean energy, property owners borrow money from a local government to pay for energy improvements and repay the amount through a property tax assessment. What is unique about this type of financing option is that it attaches the loan obligation for these technologies to the property rather than the individual borrower, which encourages investment, even in projects with a long payback period (DSIRE, 2014). Homeowners who know that they may only be in their house for a few years may not want to invest in a solar photovoltaic system, for example, that has a payback period of 10 years. With the loan attached to the home, it transfers to the next homeowner, who receives the benefits of that energy upgrade, and continues making the payments.

As of March 2014, 31 states plus Washington, DC, had legislation that allowed for property assessed clean energy programs (Tweed, 2012). In 2012, California launched a program, allowing non-residential property owners in 14 counties and 126 cities to finance energy efficiency, renewable energy, and water efficiency projects. However, recent legal uncertainties have slowed down the growth of property assessed clean energy financing for residential programs.

The Federal Housing Finance Agency (FHFA) put residential property assessed clean energy programs on hold in 2010, claiming that the assessments violated securities agreements. They argued that since many of these programs are financed as the senior lien on a property, they create unacceptable risk of default on mortgages (FHFA, 2010). This means that property assessed clean energy loans rank higher than mortgages, giving them preferential right to foreclosure proceeds. In other words, the government that issued the PACE bond gets paid first. The FHFA advised Fannie Mae and Freddie Mac to avoid buying mortgages with property assessed clean energy loans. Lawsuits against FHFA came from Florida, New York, and California. A federal district court judge in the state of California ruled in favor of the state, saying that FHFA violated federal law by taking action without public notice or opportunity for stakeholder comment (US District Court, 2012). However, the Ninth Circuit Court of Appeals overturned this ruling, stating that FHFA could not be legally pressured into changing its opinion (Friedrich, 2013). Fannie Mae stood by its policy in a note to clients in November 2013.

The legal uncertainty may make some governments hesitant to start or restart property assessed clean energy programs, although some states and municipalities have found innovative ways to continue them. Vermont, Oklahoma, Maine, and Rhode Island chose to make property assessed clean energy loans a junior lien with lower priority than mortgage payments. A number of cities in California take part in the state's HERO Program, which provides disclaimers for homeowners enrolling in programs. According to PACENow, an advocacy organization, property assessed clean energy retrofits increase the value of homes, and evidence thus far shows that they may actually reduce the risk of default by making energy more affordable. In California, the default rate for mortgages of three of these programs has been less than 1 percent (Friedrich, 2013).

Despite the possibility that the bonds could suffer losses due to the risk that Fannie Mae and Freddie Mac might challenge the priority status of the liens, investors are moving forward in securitizing property assessed clean energy bonds. In March 2014, Deutsche Bank AG sold the first securities backed by these bonds. The Western Riverside Council of Governments in California issued the underlying bonds, which were given AA grade by Kroll Bond Rating Agency. The sale totaled $103.8 million and carried a 4.75 percent coupon (Shenn, 2014).