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Energy & Climate Change 

Cap-and-Trade: The Triumph of Politics Over Economics, Science 

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By Michael G. Frodl and John M. Manoyan 

The cap-and-trade bill that Congress is debating has been designed not so much to address the challenge of climate change or even put a good economic model in place to solve emissions reductions, but mainly to overcome political resistance.

Some critics question why the legislation won’t embrace a more transparent and predictable carbon tax. The energy sector, overwhelmingly, favors a carbon tax over cap-and-trade.

But the “t” word is why the politicians are not going along. Tax, they fear, has horrible connotations, while cap-and-trade seems innocent and fuzzy by comparison.
So what exactly is cap-and-trade?

It was a solution developed 20 years ago to deal with the problem of “acid rain” in a region downwind of coal burning utilities in the Midwest. The acidified rain was burning and killing trees in the eastern United States and Canada. Instead of setting a regional cap for sulfur emissions that contribute to acidification of rain, the United States created a permitting system. At the beginning, everyone received just enough permits to allow the emissions as they were occurring.

As time would go on, the permits would be traded at auction and resold. But the growth in the emissions would be capped. Since the market as a whole could not exceed the aggregate emissions cap, the permits would rise in value over time.  

The system worked better and faster than anyone had expected. Upgrades were adopted speedily, permits traded effortlessly, and targets met faster and for much less cost than forecast.

The legend of cap-and-trade was born.

Some advocates such as NASA scientist James E. Hansen, who was one of the pioneers in warning about global warming, still argue for a carbon tax. Cap-and-trade as pitched to politicians and voters alike may get some confused reactions at first, but it does not get any of the negatives associated with the words carbon tax. Although in essence, once all the numbers are sorted out, cap-and-trade is in effect a tax.

The really troubling part is that the system may not lead to any improvement in the campaign to reduce carbon dioxide (CO2) emissions. A less politically popular tax might do more.

The original cap-and-trade was the solution to a regional problem: a U.S.-Canada cross-border issue. Only two players needed to agree to the rules and play by them. The problem with the cap-and-trade for CO2 is that global warming is a worldwide problem. That means that unless and until every nation agrees to play its part, it really doesn’t matter for the sake of the future of the planet if the United States adopts this solution or not.

Not only was the original problem a regional one, it also affected only specific industries. CO2 cap-and-trade, on the other hand, will reach well beyond just a few industrial and national boundaries. It will also clamp restraints on the U.S. economy while other countries do what they please.

If the United States agrees to a draconian schedule of targets for CO2 emissions reductions through a cap-and-trade domestic plan, it will not save the planet if India, China and other nations allow industry to relocate and operate without CO2 limits.

Also, the original cap-and-trade was designed when proven technology was already available to remove sulfur from emissions. CO2-extractive technologies are still in their infancy.

Sulfur cap-and-trade worked quickly because industries could retrofit, upgrade, capture or just pay to keep emitting. There was an economic choice, supported by affordable technology that is largely absent now with CO2 cap-and-trade.

While the original cap-and-trade spurred quick and cheap deployment of tested sulfur-capturing scrubbers, the new cap-and-trade is coming out before many CO2-capturing technologies have been tested and proven. Above all, retrofitting existing carbon emitters is still an expensive proposition that is not even doable in every instance. This is going to cost the end user, the consumer.

The quick and cheap example of the first cap-and-trade should therefore not be relied on for predicting the future of this CO2 retread.

Another precedent for what can happen with cap-and-trade is the European Union. And it’s been a dismal failure.

The EU originally was suspicious of cap-and-trade. European global warming activists were pushing a carbon tax. Eventually, they were worn down by the push back from the United States and opted for cap-and-trade just to get something done.

The EU in its first pass handed out permits for free, since it was so hard to get European industry to agree to a self-limiting increase in energy prices when the United States and Asia were dragging their feet.

The result was entirely predictable — no reduction in CO2 outputs. Europe even ran ahead of its targets, and would still be running ahead of them if it weren’t for the worst global recession since World War II that simply cooled off the European economy and killed emissions the old fashioned way.

The bureaucrats in Brussels were nevertheless cornered by angry global warming activists and promised them a second pass at the problem. This time the permits would actually cost something to industries. But the key to getting European industries on board was Brussels giving them reason to believe that there soon would be a U.S. cap-and-trade law passed and that U.S. companies unwilling or unable to reduce their CO2 emissions would soon be bidding up the value of the permits European companies had bought.

There is a sense that the Obama administration has to go to the climate summit in Copenhagen later this year with something substantial in hand, if only to show it has left the Bush years behind.  A giant new demand for EU carbon permits by the end of the year would be much appreciated at the summit, but would set a deadline that is neither desirable nor convenient for the U.S. economy.

The struggle in Washington is between a Congress that wants to follow the first European pass at the problem and simply hand out permits for free to all industries, and the administration that wants to see the maximum number of permits sold at auction in the minimum amount of time.

On top of that, there is the problem that the revenues from a cap-and-trade scheme are looking mighty appealing to members of Congress and the White House in need of government revenue sources. Early U.S. industrialist supporters of the cap-and-trade scheme that promised to direct proceeds from auctioning permits to the industries adopting new CO2 capture technologies are alarmed at the prospect of those funds being now instead going to the Treasury general revenues fund.

Assuming that the proposed cap-and-trade legislation gets through, what can be expected?

One certainty is that the original objective of reducing emissions enough to slow global warming will not be met for many years. The head of the International Energy Administration warned in June that unless carbon permits were trading at $180 a metric ton by 2030, the nation would not meet greenhouse gas reduction targets. That’s a big jump in the price of emissions from the amounts of under $20 a ton that are being bandied about by Congress and the administration.

Even allowing for inflation, $180 a metric ton by 2030 is the equivalent in today’s dollars of much more than $20.

Economically punitive measures are no solution. The way to reach emission targets requires better and more efficient technologies, as well as disruptive ones.

The costs of this cap-and-trade program will be significant for U.S. consumers.

Based on the kilowatts consumed per capita by Americans — assuming a cap-and-trade that charges for permits from $20 to $200 — the direct and indirect cost per year for a three-person family would range from $3,000 to $5,000. That’s already 10 times what the White House and Congress say it will cost per family. If the IEA chief is right about what it will take to slow global warming by 2030, costs could go up to $8,000 to $10,000 for that family.

Cap-and-trade will cost most carbon energy intensive industries a bundle. Industries such as aluminum that consume great amounts of electricity will just pack up and leave. The winners will be industries that are carbon energy light (including nuclear) and those companies that have the better lobbyists in Washington.

Even with the creation of a host of new energy jobs that other legislation will foster, the net effect could be a loss of millions of jobs.

Also, carbon energy intensive industries in developing countries will benefit if the United States in the future agrees to provide funds for Beijing and New Delhi to upgrade their industries and release less CO2. That means industries that left the United States and went over to China or India will have U.S. taxpayer monies following them and paying for whatever upgrades they have to adopt.

The U.S. defense industry base is going to be affected even more severely than most other industries. Most of that sector is still in heavy manufacturing. Its energy costs in the next decade will skyrocket under cap-and-trade.

Something needs to come out of Washington to deal with global warming. It should not be a politically opportunistic cap-and-trade scheme, but a carbon tax. A tax that starts out modestly, whose implementation schedule is known well in advance to industry, and whose administration is fair and transparent and which doesn’t allow for one industry to gain unfair advantage over another. 

If the nation’s leaders show some courage and make the case to the American people for a carbon tax, people will follow.     

John M. Manoyan is a chemical engineer, nuclear physicist and is now an investment advisor in San Francisco. Michael G. Frodl is a tax attorney and co-founder of the Forum for Environmental Law, Science, Engineering and Finance. Their personal views do not represent those of FELSEF.

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