Friday, March 23, 2007

Cap and Trade Gaining Favor

Congress taking up business-friendly proposals to reduce global warming

[From the San Francisco Chronicle:]

As environmental activists and politicians, including Al Gore [see image at right], descend on Capitol Hill this week to urge action on global warming, nearly all are touting a business-friendly solution -- as are California regulators who are drawing up the state's new system to curb greenhouse gas emissions.

It's called emissions trading, or cap and trade, and it has won support from corporations and lawmakers who worry that strict global warming limits could damage the U.S. economy.

"There's a lot of education needed in Congress that global warming legislation isn't going to hurt the economy, and (cap and trade) is a big part of this," said Lexi Schultz, a Washington representative for the Union of Concerned Scientists.

But the track records of similar programs in Europe and Southern California are mixed, experts say.

"What California is doing on this issue is brave and encouraging, and for that reason the state and Congress should heed Europe's lessons," said Yvo de Boer, secretary-general of the U.N. Framework Convention on Climate Change, the world body that oversees the Kyoto Protocol and the negotiations for a successor pact after Kyoto expires in 2012.

Former Vice President Gore is scheduled to testify today to the House and Senate, capping a series of rallies and hearings that demonstrate the pent-up momentum behind Democratic leaders' promises to take action on climate change after years of Republican resistance.

In Congress, all five bills on global warming being debated -- with two more expected to be introduced soon -- rely heavily on the creation of an emissions trading system, in which companies are given limits for their emissions of carbon dioxide and other greenhouse gases and then are allowed to buy and sell their excess or deficit emissions as if they were financial securities.

California regulators are drawing up plans for an emissions trading system under a state law enacted last year calling for the reduction of greenhouse gas output to 1990 levels by 2020, a cut of about 25 percent. And California recently signed agreements with Oregon, Washington, Arizona and New Mexico -- as well as with British Columbia -- to form a cross-border emissions market.

"California is really establishing a de facto national standard, and it's likely to heavily influence the shape of whatever action Congress eventually takes," said Blas Perez Henriquez, executive director of the Center for Environmental Public Policy at UC Berkeley's Goldman School of Public Policy.

Many environmentalists had long supported traditional forms of top-down government regulation, especially what is known as a carbon tax, which would levy a tax on energy sources that emit carbon dioxide.

"Most people believe that the two big alternatives out there are a carbon tax or cap and trade," said Sen. Dianne Feinstein, D-Calif., speaking at a climate change conference at UC Berkeley last month. "I fall into the cap and trade thing, largely because I don't see a carbon tax ever getting enacted in the United States."

In recent months, big-business interests have rushed to jump on the cap-and-trade bandwagon. In January, companies with large emissions outputs such as GE, Alcoa, DuPont, Caterpillar and Duke Energy came out in support.

Last week, the chief executives of GM, Ford, Toyota and Chrysler did the same in testimony before Congress.

And on Monday, a coalition of institutional investors, including Merrill Lynch and California's two giant pension funds, the Public Employees' Retirement System and the State Teachers' Retirement System, threw their weight behind cap-and-trade legislation.

Schultz said one of her key selling points is the argument that emissions trading "will spur technological innovation" as businesses seek to reduce their greenhouse gas output and sell the emissions credits that they no longer need.

Backers cite the national cap-and-trade system created by the 1990 Clean Air Act to fight smog. This program -- which regulates the particulates and sulfur dioxide that create conventional air pollution, not the nine greenhouse gases such as carbon dioxide that cause global warming -- governs power plants nationwide and is generally viewed as successful.

But greenhouse gases are more complicated to regulate than smog, traders say.

"Setting up a market for greenhouse gases is tremendously tricky," said Mark Trexler, director of global consulting services for EcoSecurities, a London consultancy and broker in carbon credits.

One danger, Trexler said, is that companies will be granted too many credits -- which, in effect, gives them permission to keep polluting. This mistake has severely shaken the European Union Emission Trading Scheme, set up to comply with the Kyoto Protocol, as prices have collapsed from about $38 per ton of carbon dioxide in 2004 to Tuesday's closing average of $1.40.

"A mistake very clearly made in Europe was to allocate too generously, so companies did not need to make an effort to reduce emissions," De Boer said. "This created significant distortions and windfall profits."

"Setting credits should be about who gets gored," said Josh Margolis, managing director of Cantor Fitzgerald Brokerage, a financial services firm for energy markets. A properly designed program is one that "is going to affect you like no other you have ever imagined," he added.

Experts point to a similar mistake made in 1994 when the Los Angeles area's air quality management authority -- which regulates pollutants other than greenhouse gases -- replaced its system of fixed quotas with a cap-and-trade program.

Under this new program, known as the Regional Clean Air Incentives Market, or RECLAIM, the area's formerly rapid pace of air-quality improvement slowed to a crawl because utility companies were granted overly high limits for emissions of nitrogen oxides and sulfur dioxide.

Some environmentalists also warn that these trading systems hurt minorities and the poor.

"We're skeptical of how efficient and just a cap-and-trade system can be because RECLAIM resulted in the concentration of pollution in low-income communities," said Philip Huang, a staff lawyer for Communities for a Better Environment, a statewide group that represents working-class and poor urban areas.

Huang noted that the older industries that are frequently located in poor communities tend to have high emissions of both greenhouse gases and conventional pollutants. As a result, he said, a trading system would allow large industries to reduce their emissions in newer factories located in more affluent areas while maintaining the high emissions in their older facilities.

Officials at the California Air Resources Board, the agency that is drawing up the state's new rules, say they won't repeat the mistakes of Europe and Southern California.

"Yes, there are environmental justice issues to consider with RECLAIM, and there's no shortage of other possible issues that have to be worked through," said Chuck Shulock, climate change coordinator for the agency. "But we're confident that a market-based system can be created successfully."

I've been encouraged by the recent testimony from business leaders in support of 'cap and trade' programs to limit global warming pollution. This should help cap and trade policies gain traction in the senate and go along way towards convincing Congress that reining in our global warming pollution won't wreck the economy, as President Bush has maintained.

Businesses know regulation is imminent, and they have a strong incentive at this point to see that regulation enacted sooner rather than later. Regulatory uncertainty is the stuff that keeps investors up at night, as the global warming policy framework that is eventually enacted will have profound effects on how companies do business in the United States in a carbon-constrained economy. Business leaders need to know what to expect so they can plan accordingly, and investors are keenly interested in what plans they come up with to operate their businesses in the coming carbon-constrained economy. That can't happen until policy-makers give the business community some regulatory certainty by enacting legislation. Tough legislation is probably even preferable to unknown legislation at this point.

The discussion of the environmental justice issues of cap-and-trade programs in the Chronicle article is a bit misleading, as greenhouse gas emissions differ from other air pollutants. Whereas other air pollutants like mercury, benzene, nitrous oxides and sulfur dioxide have localized effects, global warming pollutants have a global effect. It largely doesn't matter where carbon dioxide or methane are emitted - each pound of CO2 in the atmosphere will contribute to global climatic change, not localized effects (to be more specific, any localized climate change effects will be driven by global concentrations of CO2, not local emissions).

It is true that cap and trade programs do not result in equitable geographic distribution of emissions reductions. In the case of programs dealing with pollutants will localized effects, this means cap and trade programs have serious environmental justice consequences (see this previous post for an example).

But in the case of global warming pollutants, carbon dioxide and methane, what is important is global atmospheric concentrations of these pollutants, not localized concentrations. In this case, a cap and trade program is very appropriate and can operate largely without environmental justice effects.

(Or at least not direct environmental justice - the inadvertent reductions in other pollutants as coal-fired power plants back off to reduce CO2 emissions may be unequally distributed, bit given the frequent placement of these power plants near low-income and disenfranchised communities, this inadvertent effect of a global warming cap and trade program may in fact help remedy existing environmental injustices.)

[Image source: Associated Press]


Dan said...

Cap-and-trade proponents, such as the United States Climate Action Partnership, have provided a real service in moving Congress and the country toward accepting that action on climate change is imperative and that putting a price on carbon is essential. Cap-and-trade will not be the ultimate solution, however; because of its complexity and the delays inherent in its development and implementation.

The Carbon Tax Center ( strongly endorses a carbon tax. We begin with the principle that charging businesses and individuals a price to emit CO2 is essential to reduce U.S. emissions quickly and steeply enough to prevent atmospheric concentrations of CO2 from reaching an irreversible tipping point. The transformation of our fossil fuels-based energy system to reliance on energy efficiency, renewable energy and sustainable fuels won't happen without carbon taxes sending the appropriate price signals into every corner of the economy and every aspect of life.

We have serious questions about the efficacy and equity of a cap-and-trade program and believe that a carbon tax is the most transparent, universal, equitable, understandable and immediate measure for creating incentives to reduce carbon emissions. For a comparison of a carbon tax to cap-and-trade, see the issue paper on our website.

WattHead said...

Thanks for the comment Dan. I'm undecided personally about what policy option is better. At this point, I think I'm happy with either, as long as something is enacted soon (something effective that is). I'll check out the information on your site (I've been meaning to look a little closer at the problems/difficulties/drawbacks of cap and trade for a while). Thanks.

Heiko said...

I completely agree with Dan. Cap and trade has many serious problems, it's complicated and prone to manipulation and profiteering.

The word "trade" sounds market based, as if this was about capitalism versus socialism.

Actually, trading only makes sense, if the polluters are given free rights to pollute. A cap doesn't necessitate any trading at all. Simple auctioning will do fine and would in effect be a variable carbon tax.

Polluters like cap and trade, because of the free rights to pollute they get.

Given 1000 tonnes of CO2 emissions, of which 100 can be cut at $5 per tonne, a carbon tax of $10 will cost the emitter $9500 ($9000 in tax, and $500 to reduce emissions).

In cap and trade, with emissions rights selling for $10 per tonne, the emitter will make $500, if they manage to get 1000 tonnes of free allowances.

If the emitter can reduce emissions at a cost of 0 (say because they are shutting down an uneconomic power plant), they can make $10,000 by selling their free allowances for $10 per tonne.

You can easily see why this would create perverse incentives. To earn the allowances, it would be worthwhile to keep decrepit, inefficient old plants in operation, and the owner would then be rewarded for supposedly reducing emissions, when in truth they kept an uneconomic plant emitting for longer than they would have otherwise.

Heiko said...

Let me expand a bit more.

Carbon taxes, a simple cap with auctioning or cap and trade (with free emissions allowances) all bring about a price for carbon and that creates an incentive to cut emissions. The incentive is the same for all three systems and depends primarily on the price of carbon (and also on how certain that price is in the future).

What's different is solely the redistributional aspect. Redistribution is really all about justice, who deserves to be rewarded or punished, who ought to pay the costs of emission reductions or the costs of climate change. Secondarily it's also about economic efficiency, ie the kind of incentives to work and innovate that are created.

Carbon taxes raise revenue, punish the polluter for emissions they cannot easily reduce and put all the cost of emissions reduction on the polluter.

The main justice isse is whether it's fair that emitters are asked to bear all the burden. You may not care when the emitter is some fat cat, but when it's the working poor trying to get to work?

To address this issue, the tax money can be used to help those unfairly affected.

Domestic industry may also make the case that they are in competition with much dirtier foreign producers not subject to a carbon tax (or cap), and therefore are deserving of exemptions or subsidies, because otherwise, the business would go to their higher emitting competitors abroad.

With cap and trade, none of the external costs of the emissions are born by the emitters, they are born by society at large. Emitters merely carry the cost of emissions reductions. Is this just?

Furthermore, it's not all emitters that bear the cost, it's those where emissions reductions are hardest. In the extreme, where half of emitters can achieve their cuts at 0 cost, and half cannot cut at all and a small price setting minority in between can cut at $10 per tonne, the scheme degrades to a wealth transfer from some emitters (quite possibly the working poor) to other emitters (quite possibly factory owners reducing production when it would be economic to do so anyway).

Now is that just?

And is it surprising that GM would prefer cap and trade? ... preferably with its emissions based on 1990 levels ;-)