Brave New World

While lobbyists and other Congress-watchers await the reconciliation of the conflicting energy bills passed earlier this year in the US House and Senate, a piece of legislation with the prosaic title of "America's Climate Security Act" (S.2191) has begun the long process of committee review and revision. If passed by both houses in its present form--an unlikely proposition--it would trump many of the hotly-debated energy bill provisions, such as the renewable electricity standard, biofuels mandates, and higher fuel economy. The greenhouse gas "cap and trade" restrictions of "Lieberman-Warner", as the bill is also known, would mandate reducing US emissions by roughly 70% from current levels by mid-century. On a scale well beyond that of the cap-and-trade system introduced by the EU in pursuit of its commitments under the Kyoto Protocol, Lieberman-Warner would reorganize large segments of the US economy, along with those of some countries with which we trade. We stand at the threshold of a new world.

I don't have space here to provide a line by line analysis of the bill. If you're interested, the full text is available at http://www.thomas.gov/, entering S.2191 in the search box. (I apologize for many past broken links to thomas.gov, before I discovered that it doesn't retain search criteria.) For now, I'll cover the bill's key provisions and expand on them in later postings, as appropriate.

Since critics of emissions trading frequently cite the shortcomings of the EU Emissions Trading Scheme (ETS), it's important to state up front that Lieberman-Warner diverges from the former in scope, intent, and execution, sharing little more than the basic notion of a cap on covered emissions and the issuance of tradable allowances to enable those facing high costs of reduction to benefit from cheaper excess reductions by others. Most significantly, unlike the EU's focus on large industries and utilities, this bill covers the majority of US greenhouse gas emissions, whether from stationary sources or motor vehicles. The ETS also relied heavily on "grandfathering," furnishing free allowances for most of a firm's current emissions. That created a windfall for some companies and undermined the after-market for these permits, which has been highly volatile.

Lieberman-Warner limits grandfathering to 20% of emissions and then gradually phases it out entirely. In particular, oil companies would receive no free allowances, from day one. (More on this in a moment.) Instead, most allowances would be auctioned, with the proceeds allocated to fund a variety of activities, including alternative energy, carbon sequestration, and low-income energy cost relief. These benefits would be augmented by handing out some of the allowances themselves to states and a variety of other organizations. While this would ensure broad participation in the emissions market, it also appears vulnerable to criticisms of patronage.

One of the key arguments against US participation in efforts to reduce GHG emissions has been that it would result in the offshoring of our emitting industries, with Americans simply importing products and effectively exporting the associated emissions. Lieberman-Warner tackles this directly by requiring importers to purchase allowances for the intrinsic emissions of most products--effectively a GHG-equalizing tariff. We would presumably discover later whether that is permissible under the WTO.

So what would this mean for energy consumers? By requiring producers of fuel and electricity to obtain allowances or offsets for their direct emissions and for the downstream emissions of their products, and by severely limiting grandfathered emissions--to zero for petroleum products--it would drive up the price of fuel and electricity, as surely as if the price of oil, gas or coal had gone up. In other words, because Lieberman-Warner covers petroleum products at the wholesale, rather than retail level, it spares consumers the need to get involved in emissions trading, but does not spare them from the financial consequences. Now, an economist would point out that market conditions will determine whether 100% of the cost of allowances would be passed on, or something less. I think it's prudent, given the tightness of these markets today, to assume 100%. If an emissions allowance costs $10/ton of CO20-equivalent, then we should expect gasoline prices to rise by 10 cents per gallon, and coal-fired electricity by about 1 cent per kWh (less, initially, due to 20% grandfathering.)

This isn't the first such bill to be introduced in the Congress, and its prospects are uncertain. Lieberman-Warner is a bit more aggressive than the antecedent "Lieberman-McCain" (S.280), while somewhat less so--and decidedly more market-friendly--than "Sanders-Boxer" (S.309.) None of the previous cap-and-trade bills passed, but then none enjoyed centrist, bi-partisan support going into an election year in which climate change could emerge as a major campaign issue. For planning purposes, anyone potentially affected by this legislation--and that is effectively everyone except small businesses--ought to assume that something similar will be enacted within the next 2-3 years. And if a Democrat or Senator McCain wins the Presidency next year, it would stand a good chance of being signed into law. In the meantime, we can choose between taking voluntarily steps in this direction, or enjoying the final years of the no-cost emissions era.