What Have I Learned?

This is my last planned post on the RFS point of obligation. Here are my observations from the previous eleven posts plus some thoughts not directly covered in those posts. Some of these observations should be applicable to regulating CO₂ and other greenhouse gases.

1. The regulation should be consistent and treat similarly situated entities similarly. This applies regardless of whether a market is part of the regulatory structure. Regulation should solve environmental problems without placing disproportionate compliance cost on any particular entity or class of entities. No one paying for compliance should have to compete with those getting it for free. While all refineries might be similarly situated, all refinery parent companies are not. A company having two compliance options, i.e., buy credits or perform to the standard, is not similarly situated with a company having three degrees of freedom: buy credits, perform to the standard or sell credits.
2. The regulated universe should be as broad as possible and cover all entities similarly situated with respect to the environmental problem. This is particularly significant when a compliance market is involved. Broader applicability means more market participants and increased probability of finding the least cost path to compliance.
3. Assign the compliance obligation to the entity best positioned to solve the problem. This is a textbook management principle, “If subordinates are to be successful, they must have as much authority as they need to accomplish the tasks assigned to them.” Whetten and Cameron, Developing Management Skills, p. 468 (8^th 2011). Assigning the compliance task to those not well situated necessitates restructuring, in this case, the entire transportation fuel supply industry. If all merchant refiners are to blend and, therefore, also be transportation fuel marketers, all refiners will then be vertically integrated, and merchant refining will disappear as a business model. This is a drastic transformation for the sole purpose of blending renewable fuels, a service marketers are already providing. The current industry mix of business models exists because it is efficient. Why needlessly destroy that efficiency?
4. Government must be decisive and set a bright-line standard defining compliance. A tax or fee, for example, is not a bright line standard since it does not dictate the environmental performance deemed acceptable, but, rather, coerces regulated parties toward an unquantified goal using financial pressure. A regulator once told me about the “rock game” in which industry is told, “Go find a rock and bring it back.” Industry returns with a rock. The regulator says, “Nope, wrong rock. Go find another.” This process iterates until the regulator’s subjective standard regarding rocks is met. Specifying the concentration or mass of a pollutant allowed per unit of activity creates a bright line standard.
5. In keeping with the principles of consistency and breadth, the activity to which the standard is applied must be common to all regulated parties. Commonality is not always the case. For example, sulfur dioxide regulations are not uniform across all emitting industries. Petroleum refineries generally adhere to a standard of 162 ppm of hydrogen sulfide in process fuel gas. Power plants, however, generally measure sulfur dioxide concentrations directly in their stacks. It is difficult to see how beating a refinery standard based on volumes of consumed fuel gas can create emission credits salable to a power plant where the standard is based on stack gas flows. Basing compliance on a common activity ensures each industry bears a fair share of the national compliance cost.
6. Likewise, regulated party performance needs to be quantifiable and measurable. Under a standard requiring periodic equipment inspections, for example, the number of inspections can be quantified, but the resulting emission reductions cannot be measured. No tradable credits can be created in this situation. Generally, the performance needs to be measured in volume or mass terms such as gallons required to be blended or tons allowed to be emitted.
7. Compliance trading should be based on over-compliance and under-compliance. No entity should be forced to pay for all activity related to the regulated pollutant unless the standard is zero. If 10 pounds of emissions are allowed but 12 are emitted, 2 pounds of credits, not 12, should be purchased. Meeting the standard is par for the course, for everyone; no rewards or penalties for making par, only for being above or below.

Best,

Bob