Thursday, June 25, 2009

A Funny Thing Happened on the Way To Cap and Trade

How much of an unappetizing jumble can you put into a dog's breakfast, before the dog refuses to eat it? That is the question that the authors of the Waxman-Markey "climate bill" appear intent on testing, before it goes to an expected vote of the entire House of Representatives tomorrow. Aside from addressing truly momentous, economy-altering matters--a cap & trade system for greenhouse gas emissions and a national renewable electricity standard to promote green power even more than cap & trade would, anyway--this bill includes more than its share of tenuously-related add-ons, some of which might be nearly as significant as the provisions that have garnered the headlines. Nor has last week's Congressional Budget Office analysis settled all the questions about the bill's likely cost to the public, except to raise suspicions that if it truly amounted to only $175 per household per year, there wouldn't be so much fuss about it.

Let's start with those costs, before we come back to the miscellaneous provisions that begin on page 808 of 1092. The CBO examined the cap & trade provisions of Waxman-Markey and its issuance of free emissions permits to various sectors and groups. They then allocated the costs among all American households by quintile of income. That's an important detail, because of the bill's provisions for rebates and other assistance to lower-income families, the lowest-earning of which would actually come out ahead in their analysis. For the rest of us, I believe the key figures to focus on are not the estimated $235-340 per year "net cost", but the range of $555-1,380 per year in expected "gross costs" before "direct relief to households"--which if you read the bill doesn't look very direct at all. It consists mainly of those free emissions permit allocations that go to utilities and various other industries and groups, not consumers.

The other aspect of the CBO analysis to focus on is its assumptions, explicit and implicit. The key explicit one is the emissions permit price of $28/ton of CO2 from which these costs were derived. While it's certainly possible that permit prices might be that low in 2020--the equivalent of $0.25 on a gallon of gasoline or roughly $0.03/kWh on coal-fired electricity--in the long run they would likely rise much higher, in order to cover the cost of deeper, more difficult reductions in industrial and transportation emissions. The CBO's big, implicit assumption relates to the impact of cap & trade on the economy as a whole, which footnote 3 indicates is excluded, along with the impact of the bill's many other provisions. If cap & trade slows growth, as seems very likely, incomes would be lower and jobs less plentiful than otherwise--even if "green jobs" grew--and other taxes would need to increase to service the debt and cover growing entitlement costs. When you factor in these uncertainties, the probability that cap & trade would cost American families no more than a couple of hundred bucks a year looks low.

The other day I described the severe mismatch between actual US emissions and the sectors chosen in Waxman-Markey to receive the lion's share of free emission permits. The bill would also establish an "Emission Allowance Rebate Program" to help energy-intensive industries engaged in international trade. Remarkably, however, it states, "The petroleum refining sector shall not be an eligible industrial sector." So US refineries, which under this bill would be responsible for both their own emissions and those from the subsequent use of their products--in our cars, for example--could not seek relief for the permit costs associated with products they export to the Caribbean and other markets, while other industries could. That would hamper not only refinery profitability, but also their ability to produce a suitable mix of products for domestic consumption. Last year US refineries exported 1.8 million barrels per day of products to balance their operations and meet stringent US fuel specifications. Raising the cost of those exports would ultimately result in fewer US refineries and more petroleum product imports. That would make US fuel prices more volatile, while increasing the average Waxman-Markey premium at the pump, over and above the direct cost of emissions permits.

Now let's consider what else has been included in this bill. Among the surprises I found in its last few hundred pages was another $4 billion of funding for the cash-for-clunkers program I discussed last Friday, along with its extension until next April 1st. Another provision would give the Secretary of Transportation broad powers under an "Open Fuel Standard" to require auto makers to produce large volumes of flexible fuel vehicles--a key enabler for increasing the country's biofuel production above the amount that can safely be blended into ordinary gasoline. According to yesterday's Washington Post, it would also establish and fund a new multi-billion-dollar federal agency, the Clean Energy Deployment Administration, in apparent competition with the Department of Energy.

Moving further afield, Waxman-Markey would also impose sweeping new rules on energy commodity markets to allow the Commodity Futures Trading Commission to regulate derivatives and swaps and limit speculation. The CFTC would decide what constituted a "bona fide hedge" and what didn't, setting limits on how many contracts a non-hedging entity could hold--not just in the US but also on foreign exchanges dealing with US-based commodities. It would also control energy commodity speculation by index funds. And while these measures at least have a connection to energy, that certainly does not hold for Section 355, which would place strict limits on who could buy a credit default swap, and under what circumstances.

I hope you haven't concluded from the above that I am a wide-eyed idealist who is easily shocked by the way the world really works. This is not a case of liking an idea only in its most abstract form. Although I have long supported cap & trade as the best approach for reducing emissions, I always expected a certain amount of horse-trading to get there--and note that the Senate has yet to weigh in on this bill. Unfortunately, the central cap & trade provisions of Waxman-Markey have been sufficiently distorted to cast serious doubt on their likely efficacy in managing our actual emissions, while issues as important as the regulation of energy markets and credit default swaps surely warrant separate legislation that would expose these proposals to the scrutiny and transparency they deserve. This might be the way laws are made these days, but the insertion of a grab-bag of disparate provisions into a bill of this magnitude represents an act of legislative mischief. In the context of the similar process that shaped last year's version of cap & trade, the Boxer-Lieberman-Warner Bill, I have begun to wonder if it's even possible for cap & trade to be implemented effectively under our political system, or whether a simpler carbon tax might be less prone to this sort of excessive creativity.

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