Your Personal Climate Exchange—A Commentary by Ian Ayres ’86 and Barry Nalebuff
The following commentary was published in Forbes on November 24, 2008.
Your Personal Climate Exchange
By Ian Ayres ’86 and Barry Nalebuff
The Chicago Climate Exchange is an unusual free market experiment in which companies that want to demonstrate a true commitment to reducing their greenhouse emissions pledge to lower them by 1% a year. If they surpass that goal, they end up with permits they can sell to others. If they fail, they are penalized by having to buy permits.
What is unusual is that no one forces anyone to join the exchange. Participation is voluntary. But once a business has signed up, it is contractually obligated to buy or sell permits based on its performance. A company that beats the 1% goal gets both good publicity and a financial reward, and the specter of the potential penalty helps it reach that goal.
Why not offer the same opportunity to individuals? You could contract to reduce your home energy consumption by 1% a year for each of the next ten years. When you beat that target, you'd get permits to sell. When you miss, you'd pay a penalty by buying unused permits from others. As a result, your incremental price of fuel would go up. Every extra Btu you use would mean fewer permits to sell or more to buy.
This incremental price shift is like a self-imposed tax on energy consumption. It creates an incentive to conserve. But it's different from an ordinary tax in that you may not have to pay anything. If you hit your target, you won't owe a dime. Thus the scheme gives you an incentive without hitting you over the head.
Creating such a market might seem difficult, and the transaction costs could outweigh the benefits. Therefore we propose that utility companies set it up and do all the trading for you. When you sign up, the utility company will give you permits equal to 99% of your previous year's consumption. To the extent that you beat that 99% target, you'll get credit for the value of your extra permits, with a minimum price of 5 cents per kilowatt-hour. That 5 cents is our estimate of how much utilities are already spending, per kwh saved, on programs to help consumers conserve energy, and it's enough to provide a big incentive. It's about 75% of the average price for electricity in the U.S., not including transmission and distribution costs. When you miss the target, the utility will buy the extra permits and bill you, up to a maximum price of 10 cents per kwh. Utilities should be allowed to buy renewable energy credits from one another, too, if it makes for a cheaper way of obtaining them. So someone turning down the air conditioner in San Diego might be paid a fee by an energy squanderer in Atlanta.
Many consumers already buy offsets for their auto emissions or jet travel. That's noble, but it doesn't reward people who insulate their houses or find other ways to conserve energy at home. Joining our Community Climate Exchange would offer them specific targets and financial rewards.
Of course, some people might fail to hit the targets through no fault of their own. If a winter is especially long or a summer hot, energy consumption might rise despite any attempt at conservation. A solution would be to tie the 99% target to heating and cooling degree days, which measure how far the temperature varies from 65 degrees. The target could be adjusted up or down based on the weather experience.
If every household managed to beat its goal, the utility company would end up in the hole. But many utilities are under mandates from their state regulators to find ways to help consumers use less power. Others are limited in their ability to build new plants. If energy conservation reduced their need to come up with extra generating capacity, they'd benefit greatly. Moreover, while there has been much conservation effort focused on gasoline consumption, residential electricity use may be an even greater environmental problem, since it relies heavily on coal-fired power plants.
We finally propose that folks who join the Community Climate Exchange get to proclaim their greenness with a distinctive decal they can put on their door and by having their house highlighted on a Google map. Thus all their friends and neighbors can know who has joined and who hasn't, just as their neighbors already know if they drive a Prius.
Like the Chicago Climate Exchange, this all would be entirely voluntary. Let Americans who want to reduce energy consumption put their money where their outlet is.
Ian Ayres and Barry Nalebuff are professors at Yale Law School and Yale School of Management. Ayres’ latest book, Super Crunchers, was published in August. Visit their homepage at forbes.com/whynot.