Upstream, Downstream, or Midstream – Where to Place the Cap?

Implementing a cap-and-trade system to rein in greenhouse gas pollution will be complicated. Where the cap is "placed" will go a long way to determining how complicated.

Upstream, Downstream

In a cap-and-trade system designed to reduce global warming the government places a declining limit — a "cap" — on total greenhouse gas emissions and allows emitters to trade emissions amongst themselves to meet the cap. (A carbon tax, on the other hand, means a tax on the use of anything that contains fossil fuel carbon.)

While cap-and-trade appears to be favored in DC, many argue that among other things it would be too complicated to implement. (See here, here, here, and here.) A big part of the complication factor depends on an important design decision that must be made before implementation: where in the fuel stream between extraction, production, distribution, and consumption to place the cap.

Upstream regulations mean capping near extraction while downstream regulations occur closer to the consumer.

Upstream Simplest?

It seems to me that by far the simplest, most straightforward approach is to regulate as far upstream as possible, namely, at the point of extraction or importation. This would include coal mines, natural gas wells, oil wells, and oil tankers.

All that would have to be monitored are data we already carefully monitor:

• the amount of fuel produced or imported and
• its carbon content.

However, behavioral economists criticize upstream caps because the price signal from the cap is far removed from the consumer who makes the decision to purchase. While traditional economists often argue that upstream costs from the imposition of a cap will travel through the system to affect consumer prices, others argue that placing the regulation at the pollution point gives direct incentive to those in control of the emissions to reduce them.

Why? Because the consumer can see a direct, obvious financial benefit to choosing the product with less fossil fuel carbon. For example, choosing between two types of gasoline at the same gas station, one with standard petroleum at say $2.00 per gallon and another from biofuels at $1.50 per gallon, is a no-brainer. Much more complicated would be trying to suss out the carbon price signal of gasoline with mixtures of petroleum and biofuels.

Moving Downstream Is Problematic

But while moving downstream may provide a better price signal, it can also add complications because

1) there tend to be more entities to regulate and

2) the carbon content of the products becomes more variable.

At its most extreme, a downstream system would apply the cap at the point of consumption — a nightmare scenario that would amount to rationing usage across the populace — clearly a non-starter. Two quick examples.

• Can you imagine finding yourself at a gas station miles from home and realizing you don’t have enough ration cards to fill up your tank?
• What about a pair of socks? Let’s follow the chain. Because the carbon content of all marketable products would have to be determined — not an easy task — a downstream cap on a pair of socks would have to factor in how much fossil fuels were used in growing the cotton, the carbon-content of all the processes that turn the cotton into socks, and the fossil-fuel footprint of getting the socks to your local store. And because those socks can come from a variety of cotton growers and suppliers, the socks' carbon content would have to be constantly recalculated. So in a system that caps consumption, the number of socks the store can sell or that you can buy will vary.

Midstream for Electricity — Often a Good Compromise

Between all-the-way upstream and all-the-way downstream are a variety of midstream options.

A highly favored regulatory approach for fossil-fuel based electricity is to cap at the point of production — the power plants. This was the approach adopted to regulate acid-rain producing emissions of sulfur and nitrogen oxides.

For global warming, each power plant would have to keep track of the carbon content of its fuel and the amount of fuel it uses. Straightforward, relatively easy and what seven Northeastern states are implementing through their Regional Greenhouse Gas Initiative to cut global warming pollution.

Midstream for Transportation — A Not-So-Good Fit

A good approach for one sector is not necessarily a good one for a different sector.

The carbon emissions from the transportation sector are determined by two highly variable factors: fuel economy and the fossil-fuel content of the fuel. (Not to mention car maintenance and driving style.) So how to regulate?

1. An industry-wide cap on the fuel economy of cars sold would not necessarily translate into a cap on carbon emissions from transportation since cars can become less fuel-efficient over time and the carbon content of the fuel we use is not constant.
2. Addressing fuel economy doesn’t address variable amounts of driving and so capping gasoline use through a low-carbon fuel standard would be required. But this would mean that the actual carbon content of our gasoline be well-defined — much more precisely than it is now.
   
   But is that feasible? Since gasoline can contain varying amounts of biofuels and the fossil-fuel content of biofuels can change — depending upon such diverse things as the farming practices of the corn grower that supplied the feedstock to the ethanol refinery — accurately assessing the carbon content of gasoline in the aggregate would be, in my opinion, virtually impossible.

Better Caps for Transportation Should Look Upward

For these reasons, I think we must look upstream in the case of transportation. The cap should be applied to the extractors and importers or to the refiners. Additional midstream and downstream measures such as Corporate Average Fuel Economy (CAFE) standards and low-carbon fuel standards  can act as backstop measures (sort of icing on the cake), but the action must be focused upstream.

Such upstream or downstream decisions are but part of a multitude of issues that will have to be resolved by Congress before passing a climate bill. And by the way these same issues would have to be worked out for a carbon tax too.

I predict getting a climate change bill passed is going to be a long, hard slog.