CAP-AND-TRADE, THE LESSONS LEARNED

Cap-and-trade is coming.

Representatives of the U.S. Green Party say the lesson of the European Union (EU) Emissions Trading Scheme (ETS) is: Don’t do it. Both NASA’s James Hansen, the foremost U.S. climate scientist, and Rex Tillerson, the CEO of ExxonMobil, agree.

The President is nevertheless intent on doing it.

President Barack Obama, before a joint session of Congress, February 24: “…to truly transform our economy, protect our security, and save our planet from the ravages of climate change, we need to ultimately make clean, renewable energy the profitable kind of energy. So I ask this Congress to send me legislation that places a market-based cap on carbon pollution and drives the production of more renewable energy in America…”

There are several keys to designing a successful cap-and-trade system, most especially making it effective, equitable and resistant to tampering. Some say the EU ETS is none of the three. The evidence suggests something more intriguing.

From NationalWildlife via YouTube.

Scott Boyd, a finance and markets writer skeptical of cap-and-trade: “By definition, a “market-based cap” increases the costs faced by any form of manufacturing or production that emits carbon dioxide gas. Naturally, businesses are not in the habit of taking on extra expenses without passing the cost on to consumers…no one can argue against the merits of pollution reduction, but how can pollution be reduced without pricing goods and services out of the reach of a large segment of the population?”

EU power prices went up under cap-and-trade...(click to enlarge)

Boyd points out that during the first few years of the EU ETS (2005 to 2008), European electricity prices escalated. He neglects to consider the impact on EU power prices of Russia's stranglehold on natural gas supplies. In addition, he neglects to mention that during the same time period the U.S. - which, of course, did nothing to limit emissions - also saw significant increases in power prices. Last, but definitely not least, he neglects to mention the massive EU build-up of emissions-free New Energy capacity to which increased EU power prices contributed.

...But so did U.S. power prices without cap-and-trade. (click to enlarge)

The brilliance of the Obama admimistration’s plan is that instead of attempting to elaborate the EU ETS model to prevent energy rates from rising in the short term, the Obama plan calls for simply returning the revenues from the system to taxpayers in other forms that more than make up for power price increases. Peter Orszag, Obama's Director of the Office of Management and Budget, recently discussed the plan with George Stephanopoulos on ABC’s This Week.

“STEPHANOPOULOS: …you do concede that this capping of carbon emissions is going to increase energy rates for just about everyone in the country? And that is the equivalent of a tax, isn't it?
ORSZAG: Well, I think we have to be -- let's be fair about this. Either you're going to look at what -- what is collected through the tax code and what's returned through the tax code.
And on that basis, there's a tax cut for 95 percent of Americans, or you have to go all in. Let's also count the benefits that families get through Pell Grants, the benefits that they'll receive through constraining health care costs, the benefits that they get from weatherizing their homes, and so on. All in, this budget makes the vast majority of American families much better off.
STEPHANOPOULOS: So you're not -- you're not disputing that this package -- the cap-and-trade on its own will increase prices for -- for most Americans, but they're going to be getting other benefits in the budget?
ORSZAG: Absolutely.”

Van Jones calls this “the new math.” By ”the old math” it is cheaper to feed kids pizza and soda. By new math it is cheaper to spend money on healthy, high quality food in the short run and avoid the long term costs of diabetes and heart disease.

By old math, it is expensive to institute a cap-and-trade system. It makes using fossil fuels seem costly. It will be almost impossible to prevent major generators of GhGs like coal companies, oil companies and the utilities that refuse to move away from fossil fuels from passing those costs to consumers in the form of higher utility bills and gas pump prices.

By new math the plan simultaneously puts a price on emissions from which ratepayers will be motivated to reduce energy consumption, reimburses ratepayers for short term price increase burdens and shifts the cost-burden of emissions to the big emitters, motivating them to find New Energy sources.

Here's how: Because the Obama plan calls for the auctioning of 100% of emission allowances, the cap-and-trade system will generate massive revenues. GhG emitters will be forced to pay for their emissions. Those revenues, by new math, will pay for subsidized electric vehicle programs and cash-for-clunkers programs so drivers can start getting much better mileage and remain unharmed by higher gas pump prices. The revenues will also pay for home and building weatherization programs and subsidized efficiency programs so consumers' energy bills will be lower and they can remain unharmed by higher power prices.

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All those programs will generate jobs, so the money spent in the short term on increased utility costs (the “energy tax”) will drive economic growth, increasing the quality of life the way economic growth lifted all boats during the Clinton era expansion, adding revenues to the federal budget which will pay for health system and education system and infrastructure improvements. And all those programs will add revenues to the federal budget.

Scott Boyd, finance and markets writer: “…[President Obama’s] budget plan released last week even assumes $78.7 billion in new revenue from the sale of greenhouse gas emissions by 2012.”

The Greens are right, however, that for all this to add up, even with the new math, the cap-and-trade system must be designed well. Fortunately, the EU ETS has been experimenting with cap-and-trade since 2005. Much has been learned.

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In its initial phase, the EU ETS seduced participants into the system by excessively giving away permissions to emit (called European Union Allowances, EUAs). This made the price of emitting too cheap and caused the first 18 months of the process to produce poor results. When the EU began tightening caps and auctioning EUAs, the price rose and stabilized.

The Obama administration’s decision to initiate its cap-and-trade system by auctioning 100% of U.S. emissions allowances demonstrates a clear recognition of EU ETS experiences. That recognition should make it possible for the U.S. to avoid the worst of the growing pains, though some early market volatilty is likely.

Nothing can prevent a cap-and-trade market system from following larger market trends but the guaranteed, system-wide cap on emissions, regularly ratcheted down to prevent the gaming of the market, will continue to spur investment in New Energy even in recessionary periods.

Overall, EU emissions went up 1% per year during the ETS rollout. Some take that as an indication of failure. Clearly, the system did not reduce emissions absolutely. But it is hard to know what emissions might have been in this early and volatile phase of the system in the absence of caps and trading. U.S. emissions went up more than EU emissions and emissions in China and India went up dramatically more. So it would seem that even an inadequate cap-and-trade system tends to help slow the growth of GhG spew.

Furthermore, the EU experience reinforces the premise that it is important to ratchet caps down as hard as the system will bear. Since the design of the Obama system provides for more revenues from tighter caps, there should be no problem and improved emissions reductions from it.

During the 2005 through 2008 period of experimentation, the EU discovered a serious weakness. The high cost of spew drove emitting businesses to move emissions-intensive production to emerging economies and drove others to import goods that were cheaper only because they were manufactured in undeveloped nations where there was no price on the spew or in countries where incentives supported production.

A form of this “emissions rendition” is being used by biofuels producers in third-world countries. Using a strategy dubbed “splash and dash,” biofuels from Brazil and Indonesia are sent to the U.S. and diluted with 1% of U.S. biodiesel, qualifying the entire shipment for a U.S. subsidy unavailable to European biofuels producers. The shipments then go to Europe where, because of the subsidy, they can be sold at prices that undercut EU producers.

Emissions trading is complicated. Most big markets are. (click to enlarge)

The EU is working on fixes, in the form of import tariffs, for these loopholes. The real fix, however, is an international agreement on the price of GhGs. Because sooner or later the world’s nations will realize GhG-spew is an international problem, this real fix will eventually come. Hopefully, it will come sooner rather than too late.

Clearly, the Obama administration recognizes this need for international cooperation, which is why it has signaled a willingness to participate in the December 2009 world summit in Copenhagen, where the successor agreement to the Kyoto treaty will be finalized.

A sense of urgency about global climate change is what turns NASA's James Hansen away from the slownesses and vulnerabilities of cap-and-trade. At the other end of the political spectrum, ExxonMobil CEO Rex Tillerson's opposition is more suspect. Does he object because cap-and-trade will be ineffective or because it will be effective at shifting costs to companies like his?

The problem is that the "simple" and "ready to implement" flat emissions tax they both favor is neither simple nor ready to implement. Many, including the very politically pragmatic President Obama, do not believe a tax is politically viable either. In this way, the Hansen-Tillerson ideal becomes the enemy of the Obama reality.

If the EU ETS were persisting in its mistakes, that would be a reason to think about a better alternative. But to insist on an unlikely "perfect" instead of working to improve a real "good" does not seem the wisest choice at this crucial moment in the world's fight against global climate change.

Since the financial crises have been rolling through world markets, the EU ETS has discovered a new flaw. With demand in everything slowing, emitters have begun anticipating less activity and, thereby, less GhGs. They have been dumping EUAs on the EU ETS for cash. The price has again fallen.

The net result is price volatility making business planning difficult. On the other hand, business planning in the U.S., absent an emissions market, has been no piece of cake either. It is a difficult time and markets everywhere are tempestuous.

Dumping EUAs is a perfectly smart short term strategy and cash-strapped companies may have no other choice. The system, however, remains in place. Emissions now are limited by reduced demand. Later, when demand rises, there will still be a cap and a price on emissions and companies will have to adjust their strategies accordingly.

These market fluctuations and hesitations did not prevent players from scoring big in the ETS during the rollout. The European Climate Exchange (ECX), Europe’s biggest, had 68% volume growth in 2008 and a $90 billion value. Is that an inherently bad thing? Or is it a good thing because it draws participation and raises awareness? There can be no doubt some traders cleaned up on the price volatility and little doubt there was some price manipulation. Any system requires regulation.

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The New York Stock Exchange, the world’s biggest stock trading market by dollar value, traces its origins to 1792 and was formally constituted in 1817. Yet recent events prove a system with more than 200 years of experience at protecting itself is not impervious to the nefariousness of smart, greedy people intent on doing their worst. Perfection is not the object. Excellence is the object.

In the case of cap-and-trade, the definition of excellence is easy to define mathematically. If atmospheric GhG concentrations are near 350 parts per million in 2050, it's an excellent system.

The EU is working to make the system excellent. Idealists and cynics do not like the effort. President Obama, a pragmatist, wants to join the fight to make cap-and-trade work.

2008 was the U.S. year of decision. In 2009, there will be some even more important decisions.

From SACEcleanenergy via YouTube.

Carbon Capping – What the U.S. Can Learn From Europe’s Experience
Scott Boyd, March 2, 2009 (FXTrade InfoCenter)
and
Greens speak out on Obama's plans for carbon emissions trading…
March 3, 2009 (Green Party of the U.S.)
and
Electric Power Industry 2007: Year in Review
January 21, 2009 (Energy Information Administration of the U.S. Department of Energy)

WHO
US President Barack Obama; Canadian Prime Minister Stephen Harper; Budd Dickinson, energy engineer/co-chair, U.S. Green Party (Budd Dickinson, energy engineer/co-chair); Peter Orszag, Director, Office of Management and Budget (OMB); George Stephanopoulos, host, ABC’s This Week; Lars Josefsson, CEO, European utility Vattenfall/ key advisor to German Chancellor Angela Merkel; Colette Lewiner, energy consultant, Capgemini; Scott Boyd, finance and markets writer

WHAT
The Obama administration wants to fight global climate change with a cap-and-trade system that would cap emissions and offer a marketplace to facilitate the changeover to New Energy. The U.S. Green Party, like many hardcore environmentalists, opposes cap-and-trade.

WHEN
- January 2008 to January 2009: ECX grew 68% on $90 billion trading value.
- Internationally, Green Parties want developed countries to cut GhGs to 30% below 1990 levels by 2020, 80% below 1990 levels by 2050 and, subsequently, mover to zero emissions.
- The Obama administration is calling the for the U.S. to cut its GhGs 20% by 2020 on the way to 80% by 2050.
- In December 2009, a summit in Copenhagen will decide the paramenters of the agreement that will replace the Kyoto pact.

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WHERE
- The EU ETS has been developing mandatory caps and a 27-nation, Europe-wide marketplace for EUAs.
- Cap-and-trade appears to be on its way for the U.S. but the real question is whether the December meeting in Copenhagen will result in some kind of international commitment involving the U.S. and heretofore uncommitted emerging economies like China, India, Brazil and Indonesia.

WHY
- In a cap-and-trade system, emitters are allotted a specific amount of emissions in tons (or tonnes, the metric equivalent but 10% larger). That’s the capping part.
The intial allotment of emissions can be given or auctioned or partially given and partially auctioned by the regulating board (the EU or the U.S. federal government’s regulator). It generates revenues via the auction.
- To do business while spewing beyond that amount of tonnage, the emitter must purchase permits (in the EU ETS called European Union Allowances, EUAs, and in the U.S. like to be called credits or allowances). If an emitter can do business with fewer emissions that it is allotted (by becoming more efficient or by installing/accessing emissions-free New Energy), it can sell excess permits (and use the money to buy New Energy or become more efficient). That’s the trading part.
- The regulating board ratchets down the caps as time goes by and auctions off more and more permits to emit, generating more and more revenues. It also generates revenues by fining bad actors who exceed their caps but do not buy permits. The fines are designed to be so high as to make it preferable to simply purchase permits.

From ChangeDotGov via YouTube

QUOTES
- Budd Dickinson, energy engineer/co-chair, U.S. Green Party: "The failure of emissions trading in Europe over the past three years proves cap-and-trade plans are full of loopholes, are vulnerable to widespread abuse, and threaten the air quality in communities near industries that buy credits. The solution must involve drastic cuts in greenhouse gases, reduction of fossil fuel consumption (especially car traffic), carbon taxes, energy conservation, and new jobs in conservation, retrofitting, and cultivation of safe, clean energy sources. There is no way to solve the global warming crisis without profound changes to our economy and way of life…"
- Lars Josefsson, CEO, European utility Vattenfall/ key advisor to German Chancellor Angela Merkel: “…[H] high electricity prices are] the intent of the whole exercise – if there were no effects, why should you have a cap-and-trade system…”
- Colette Lewiner, energy consultant, Capgemini: “When the price [of EUAs] is so low, it plays no role in investment decisions concerning lower CO2-generating power plants. But when prices are too high, it doesn’t provide an impetus to go green as it is simply cheaper to pollute.”
- Scott Boyd, finance and markets writer: “…[T]his commentary is not an argument against the need for emission controls or a denial of climate change. There is no question that the US – indeed the entire planet – must do more to reduce greenhouse gas and pollution in general…the US can learn from Europe’s implementation of a cap-and-trade system…Despite the urgency, simply rushing ahead with an ill-conceived and poorly-executed approach that fails to address the root problem is unacceptable…”