Though ongoing legal challenges have delayed the timeline of the U.S. Clean Power Plan, states are continuing to make decisions about how to approach eventual compliance. Among these decisions is whether to pursue market-based approaches—multi-state or regional markets that trade carbon allowances or emission rate credits. This paper offers a primer for regulators, setting forth approaches and best practices for designing a carbon market that are drawn from lessons learned by more than 50 jurisdictions around the world, including the Regional Greenhouse Gas Initiative (RGGI) in the Northeastern United States.
A transparent and open process is the foundation of good market design. Starting with such a process, regulators can use stakeholder input to help them decide, for example, whether to pursue a statewide or regional approach. Most carbon trading systems to date have followed “mass-based” approaches, which regulate total emissions under a cap and rely on a system of tradable allowances—allowing for more design flexibility than “rate-based” approaches. The authors also consider how to use the auction process, initial allocations, and ownership rules to encourage the development of a secondary market. This can keep costs and price volatility in check while increasing liquidity, or the availability of allowances in the market. Regulators should also consider issues of future risk and put in place measures that limit the opportunity for market manipulation. Finally, just as transparency is a key part of setting up a carbon market, it remains equally important in matters of implementation and program review.