Trade-Offs in Trade: Examining the Impacts of Interstate Cooperation under Alternative Clean Power Plan Compliance Scenarios

It is generally understood that allowance or credit trade under first-best policies that limit carbon dioxide (CO2) emissions reduces the overall cost of compliance. However, using the trading options available under EPA's Clean Power Plan (CPP) as an example, we demonstrate that the magnitude and direction of costs for individual states participating in trade depends heavily on design of the compliance strategy, as well as on market conditions. Using a simple two-state electricity model, we analyze interregional cooperation through emissions credit/allowance trade impacts state costs and emissions, and we identify the conditions under which cooperation decreases costs for both states under the three main CPP compliance options: tradable fuel-based (coal and natural gas) rate standards, tradable state-based rate standards, and cap-and-trade with three different revenue-recycling schemes for allowance auction revenue. We find that cooperation tends to lower costs for both states, and that cost decreases are greater in magnitude, when electricity transmission is constrained, and compliance costs (as measured by renewable energy costs) are heterogeneous across states, however, we also identify conditions under which an individual state's costs rise despite a net gain from trade across the 2-state region. Furthermore, for the fuel-based standards, we show that cooperation can result in increased CO2 emissions, and the increase in emissions becomes larger as renewable energy costs diverge across the states. For the state-based standard policy, we demonstrate two counteracting effects of cooperation created by a requirement of the CPP. For the cap-and-trade policy, we show that lump-sum rebating back to the states on the basis of their initial caps will benefit both states.