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The Right Route for Cap and Trade

Written by Super User.

The United States continues to try and shift towards greater energy efficiency and greenhouse gas reduction, both voluntarily and by tugging along those reticent to change. The high spike in energy costs over the last several years has sparked a boom for conservation and alternative fuel sources movements, while at the same time has forced oil and energy companies to find a way to soften their public image as villains.

The major issues of the modern era have become global warming, the burden of foreign oil, the exploration of how to develop renewable energy sources and how to curb pollution. Even more important as the country trudges past the eye wall of the economic maelstrom is how to attack all of these issues profitably and without hamstringing industry with higher costs. At the end of June, the House passed Representatives Henry Waxman (D-CA) and Edward Markey’s (D-MA) “American Clean Energy and Security Act of 2009” (ACESA), which has the principal focus of reducing and regulating greenhouse gas emissions through economic incentives and efficiency programs. The cap and trade centerpiece of the bill has received considerable attention for its potential impacts in international trade, while the U.S. Department of Agriculture (USDA) has praised the legislation for offering billions of dollars in additional revenue opportunities for farmers.

“Congress has an unprecedented opportunity right now—in these next few months—to put the American economy on a strong footing for the 21st century,” said Nathaniel Keohane, Ph.D., director, Economic Policy and Analysis, Environmental Defense Fund (EDF). He added last month the House took the first crucial step and “Now it’s the Senate’s turn.”

A standard provision of any climate change legislation is a cap on greenhouse gas emissions, and the Waxman-Markey bill is no different. The bill requires a 17% reduction by 2020, striving for an 83% reduction by 2050. In the cap and trade system, caps are placed on carbon dioxide emissions and companies must have permits to emit greenhouse gases. These permits, or allowances, have emerged as the key debate because many see them as a new valuable commodity, worth tens of billions of dollars. The question then becomes should the government freely give away the permits, should it auction them or should it be a combination of the two.

“Allowances will have significant value,” said Senate Finance Committee Chairman Max Baucus (D-MT) during a recent Committee hearing. “In 2012, the first year of the program in the House-passed bill, the Congressional Budget Office puts their value at $60 billion. For the period of 2010 to 2019, they amount to more than $870 billion.”

As it stands, the Waxman-Markey bill would have the government freely allocate 85% of emission allowances, with 40% of that going to consumers via local power distribution companies and 15% to what are referred to as “trade-exposed” industries—those that would be hurt by trade with countries that did not have their own carbon programs. The remaining percentage would be split among states, refineries, energy research entities and others.

“The environmental effects of cap and trade with free allocations are similar to those of a carbon tax or a cap and trade program with auction of allowances,” said Alan Viard, resident scholar, American Enterprise Institute (AEI). “Unfortunately, economic consequences are much less benign.”

According to Viard, if the market price of allowances under cap and trade is $20 per ton, every firm would have an incentive to reduce emissions at a cost less that amount, while providing no incentive to reduce emissions that would cost more. “The incentive is clear-cut for a firm that has no allocated allowance to cover the emission and must therefore pay $20 to buy an allowance from someone else,” explained Viard. “Although it may be less obvious, a firm that was allocated more allowances that it needs faces the same incentive. If such a firm emits an additional ton, it must use an allowance that it otherwise would have sold to another firm for $20.”

The major concerns from AEI’s and Viard’s standpoint is that the costs of the cap and trade system will be shouldered by consumers, with some estimates indicating consumers could be stuck with 85% of the bill.

To better serve consumers, Dallas Burtraw, senior fellow, Resources for the Future, believes that the government should use a simple per-household rebate of allowance revenue raised through auction, known as a cap and dividend. That would also allow for some tweaking in allocation to correct for regional differences in costs.

“The allocation approach in HR 2454 is complex, but nonetheless leaves the distributional outcome largely undetermined,” said Burtraw. “State public utility commissions will play the determining role in how households are affected, not Congress, and this will be done in 50 different ways. In fact, there is great uncertainty about how the allowance value directed to local distribution companies will flow back to customers.” He believes that free allocation of allowances will raise the costs for consumers, a matter widely agreed upon, while free allocation to local distribution companies on behalf of energy consumers would increase electricity producers’ profits in competitive regions of the country by $2.5 billion per year during 2015-2020. The electricity sector is the primary target of the legislation and would be the most impacted, representing between 80-88% of total reduction in energy-related carbon dioxide emissions by 2030.

Whether the allowances are freely given away or auctioned, some take a broader view of the bill.

“Despite all the attention it has received, the split between auctioning permits and giving them away turns out to be a red herring,” stated Keohane. “Although it might seem counterintuitive at first, the bottom line is clear: whether the allowances are auctioned off or freely allocated doesn’t affect the environmental efficacy or cost-effectiveness of the program.”

According to the Energy Information Administration (EIA), though the ACESA legislation would raise energy prices, the cost effects to consumers on electricity and natural gas are mitigated through 2025 by free allowances to distribution companies. In 2020, the effect would be around 9.5 cents per kilowatt hour, while by 2030, the effect could be anywhere between 11.1 cents to 17.8 cents because of the planned phase-out of free allowances between 2025 and 2030.


There were plenty that felt the proposed legislation needs more tweaking before it will be successful.

“The House approach relies on a flawed distribution of free allowances that picks winners and losers as the nation transitions to low-carbon sources,” Jack Gerard, president, American Petroleum Institute (API). “The House plan would hold refiners responsible for 44% of emissions but only allocate to them 2.25% of allowances.” Gerard recommended that the Senate should scrap the House approach and start over with a more equitable system.


Matthew Carr, NACM staff writer. Follow us on Twitter @NACM_National


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