Is the US Ready for a Carbon Tax?

• While the Trump administration seeks to undo CO2 regulations, a group of former Republican officials has proposed a new, market-based emissions plan.
• This "carbon tax" looks simpler than EPA's Clean Power Plan or previous cap-and-trade legislation, but not simpler than the pre-Obama status quo.

The idea of taxing the carbon content of energy--and presumably the goods and services produced with it--is back in the news. A group of Republican "wise men" has floated it as an alternative to the regulation-based approach to emissions that the Obama administration pursued after its preferred "cap & trade" legislation died in the Congress.

Reduced to its basics, a carbon tax is a focused version of a consumption tax, based on usage rather than income or valuation. The level of the tax would be set by law, either as a fixed amount per ton of emissions or at an initial rate with preset future increases. What can't be known with certainty in advance is just how much a given level of carbon tax would reduce actual emissions.

This contrasts with the method of setting a price on carbon preferred by many other economists and environmental groups, called "cap & trade." In this approach, the government sets a cap, or maximum level, on emissions for a designated sector or the economy as a whole, while parties subject to the cap are allowed to trade emission allowances and credits with each other under that cap. Thus policy makers set the level of emission reductions, and allow the market to find the resulting price on carbon. In principal, that ought to be more efficient than the simpler carbon tax, because market forces should drive participants with low costs of cutting emissions to make the deepest reductions and then sell their excess cuts to others, for less than it would cost the latter to reduce by that amount.

From the late 1990s until 2009 or '10 I was convinced that cap & trade was the better approach to pricing emissions. However, the experience of watching the US Congress attempt to design a cap-and-trade system for the US economy cured my certainty. As I have described at length, the inclination of legislators to help favored companies, industries and sectors, combined with the extraordinary temptations created by the sheer scale of the revenue such a system would channel through the government's hands, revealed practical problems that look insurmountable in the real world, at least under our political system.

In fairness, cap-and-trade is currently used to promote emissions reductions in various jurisdictions, including California, the mainly northeastern states participating in the Regional Greenhouse Gas Initiative, and the European Union. From what I have observed, all of them have experienced technical difficulties involving the allocation of free allowances, inadequate liquidity, and other issues. The biggest practical problem is that the carbon prices these systems have tended to deliver might be characterized as the opposite of a Goldilocks price; i.e., they are typically high enough to generate substantial revenue, creating strong constituencies for their continuation, but too low to influence behavior very much.

For example, California's emissions credits currently trade at around $13 per metric ton of CO2, equivalent to $0.10 per gallon of gasoline containing ethanol. Would an extra $1 per fill-up make much of a difference in how much you drive, which car to buy when you replace your current car, or whether to sell your car (or forgo buying one) and take public transportation?

Moreover, California's emissions have been essentially flat since the state implemented cap-and-trade in 2012. However, since 2002 the state's electric utilities--historically the highest emitting sector--have operated and invested under a Renewable Portfolio Standard requiring them to increase the share of renewable energy in their generation mix to 20% by 2010, 33% by 2020, and now 50% by 2030. I suspect that accounts for most of the 7% drop in emissions since 2002, while the impact of a carbon price equivalent to 0.6 cents per kilowatt-hour (kWh) is likely lost in the noise. Of course a carbon tax would create its own political and practical complications.

First, consider how a carbon tax would affect different energy sources. As with cap & trade, a carbon tax should have its biggest impact on the highest-emitting forms of energy. In practice that would compound the current disadvantages for coal compared to abundant, low-priced natural gas and rapidly growing, essentially zero-emitting renewables like wind and solar power. At least on the surface, that seems at odds with the stated goal of the Trump administration to attempt to rescue the US coal industry and the communities that depend on it.

Like cap & trade, a carbon tax would also require a significant amount of new bookkeeping to track the path of "embedded emissions"--the CO2 and other greenhouse gases emitted at each step of a product or service's supply chain--through the economy. Some of this is already done voluntarily by companies participating in various sustainability reporting efforts, but it would be new for many others. The EPA, Department of Energy, and numerous non-governmental agencies have done much work to quantify such emissions, but a carbon tax would require a level of rigor and audit trail consistent with the creation of what amounts to a shadow currency within the economy.

A carbon tax also raises similar questions of how to spend the resulting revenue that have bedeviled cap & trade. At the current US emissions and assuming few sources were exempted, the proposed $40 per metric ton initial carbon tax would raise around $275 billion per year. That's 8% of this year's federal budget. It doesn't take a cynic to guess that the first inclination of any Congress enacting such a tax would be to hang onto this money to fund new programs, reduce the federal deficit, or some combination, rather than returning it to taxpayers as former Secretaries Baker and Schultz and the economists who back them suggest.

Their proposal would require that the proceeds of the carbon tax be rebated to essentially the same people who would be paying it at the gas pump or in their gas and electric bills. This sounds similar to the "Cap and Dividend" approach to cap & trade proposed by Senators Cantwell (D) and Collins (R) a few years ago. Their bill had the great advantage of simplicity, requiring just a fraction of the 1,427 pages of the 2009 Waxman-Markey cap & trade bill, the main purpose of which seemed to be to redistribute vast sums of money outside the tax code. But like W-M, it went absolutely nowhere.

Like it or not, that's my best guess of the fate of the current carbon tax idea, too. The biggest challenge facing a carbon tax today is that it would not be running as a simpler, more market-oriented alternative to prescriptive legislation or complex EPA regulations. After all, the administration's intention appears to be to eliminate the EPA's main emissions-reduction regulation, the Clean Power Plan, not to replace it.

And although the new US Secretary of State, Mr. Tillerson, is on record numerous times in support of a carbon tax, that position seems to have been put forward mainly in preference to cap & trade, rather than on its own merits in the absence of any other strict climate policy.

A carbon tax would raise the effective price of energy commodities in which we appear to have a global competitive advantage, at least for now. The current proposal may rebate the carbon tax on exports, but most economic activity starts and ends within this country. And as noted in the NY Times op-ed by Dr. Feldstein and the other economists backing this measure, the revenue recycling to consumers would be on an equal basis, rather than proportional to usage, so there would be winners and losers as with any redistributive taxation. Lower-income Americans driving older cars seem likelier to come out on the short end of that than wealthier consumers driving new cars that meet rising fuel economy standards.

Ultimately, we must ask why President Trump or his team would want to impose a new tax on US consumers and businesses to address a problem that has probably just become an even lower priority for them than it was. Notwithstanding Mr. Trump's demonstrated unpredictability, the simplest answer seems to be that he wouldn't.

EPA's CO2 Rule and the Back Door to Cap & Trade

• Significant differences in EPA's proposed state CO2 targets for the power sector are reviving interest in cap & trade as a way to reduce compliance costs.
• This compounds the EPA plan's controversy and raises serious concerns about how the resulting revenue would be used.

Earlier this month the US Environmental Protection Agency released for comment its proposal for regulating the CO2 emissions from existing power plants. It follows EPA’s emissions rule for new power plants published late last year but takes a different, more expansive approach.  If implemented, the “Clean Power Plan” would reduce US emissions in the utility sector by around 25% by 2020 and 30% by 2030.

One of its most surprising features is that instead of setting emissions standards for each type of power plant or mandating a single, across-the-board emissions-reduction percentage, it imposes distinct emissions targets on each state. Based on analysis by Bloomberg New Energy Finance, some states could actually increase emissions, while others would be required to make deep cuts. The resulting disparities have apparently triggered new interest in state and regional emissions trading as a means of managing the rule’s cost.

Although emissions trading has become more controversial in recent years, it proved its worth in holding down the cost of implementing previous environmental regulations, such as the effort to reduce sulfur pollution associated with acid rain. It works by enabling facilities or companies with lower-than-average abatement costs to profit from maximizing their reductions and then selling their excess reductions to others with higher costs. The desired overall reductions are thus achieved at a lower cost to the economy than if each company or facility were required to reduce its emissions by the same amount.

Although the Clean Power Plan doesn’t require that states establish such emissions trading markets, its lengthy preamble includes a discussion of existing state greenhouse gas “cap-and-trade” markets in California and the Northeast. It also points out that measures to comply with the new rule may generate benefits in the markets for conventional pollutants, including those for the recent cross-state pollution rule. Administrator McCarthy also mentioned the benefits of multi-state markets in her speech announcing the new rule.

A patchwork of cap and trade markets across the US, including the addition of new states to mechanisms like the Regional Greenhouse Gas Initiative (RGGI), might help mitigate some of the cost of complying with 50 different CO2 targets. However, it would still be a far cry from the kind of economy-wide, comprehensive CO2 cap-and-trade system once contemplated by the US Congress.

Cap and trade was an idea that had gained significant momentum and even begun to appear inevitable, prior to the onset of the financial crisis in 2008. To supporters, it looked like a better way to limit and eventually cut greenhouse gas emissions than through command-and-control regulations. And the price it would establish for emissions would be based on the cost of achieving a desired level of reductions, rather than being set arbitrarily, as a carbon tax would be, without any guarantee of actual emissions reductions. Opponents viewed it as an unnecessary or unnecessarily complicated drag on the economy and a tax by another name, coining the pejorative term “cap-and-tax”.

Although early US cap-and-trade bills were bipartisan, including one co-sponsored by Senator McCain, the 2008 Republican Presidential nominee, the debate over cap and trade took on an increasingly partisan tone in a period of widening polarization on most major issues. The Waxman-Markey climate bill, with cap and trade as a major provision, was narrowly passed when Democrats controlled the House of Representatives in 2009, but various Senate versions failed to attract sufficient support, even when Democrats held a filibuster-proof supermajority in that body. The chances of enacting cap and trade legislation effectively died when a Republican won the vacant Senate seat for Massachusetts in January 2010. However, viewing this as a purely partisan divide is simplistic, at best.

Aside from opposition by key Senate Democrats, including one whose campaign included a vivid demonstration of his stand against Waxman-Markey, the versions of “cap and trade” debated in 2009 and 2010 bore little resemblance to the original idea. Waxman-Markey was a 1400-page monstrosity, laden with extraneous provisions and pork. Its embedded allocation of free allowances strongly favored the same electricity sector now being targeted by EPA’s Clean Power Plan, at the expense of transportation energy, for which low-carbon options remain fewer and more costly. It would have created a de facto gasoline tax, while yielding fewer net emissions reductions than a system with a level playing field. Subsequent bills, such as the Kerry-Lieberman bill in 2010, took this a step farther, removing transportation fuels from cap and trade and effectively taxing them at a rate based on the price of emissions credits.

Along the way, national CO2 cap-and-trade legislation evolved from a fairly straightforward way to harness market forces to deliver the cheapest emissions cuts available, to a mechanism for raising and redistributing large sums of money outside the tax code. In some cases that would have been done directly, such as in the gratifyingly brief Cantwell-Collins “cap-and-dividend” bill, or as indirectly and inefficiently as in Waxman-Markey. It’s no wonder the whole idea became toxic at the federal level.

Although emissions trading for greenhouse gas reduction came up short in the US Congress, it took hold elsewhere. The EU’s Emissions Trading System (ETS) is an outgrowth of the Kyoto Protocol’s emissions trading mechanism, which was included largely at the urging of the US delegation to the Kyoto climate conference in 1997. The ETS is focused on the industrial and power sectors and covers 43% of EU emissions. It has experienced significant ups and downs over the sale and allocation of emissions credits.

Cap and trade also emerged as a preferred approach for some US states seeking to reduce their emissions. California’s emissions market was established via a provision of the 2006 Climate Solutions Act (A.B. 32), and RGGI currently facilitates trading among 9 mostly northeastern states. The relatively low prices of emissions allowances in these systems–particularly in RGGI, which has traded in the range of $3-$5/ton of CO2–suggests that they may still be capturing low-hanging fruit in the early phases of steadily declining emissions caps. Their effectiveness at facilitating future low-cost emissions cuts is hard to gauge, because they also don’t exist in a vacuum.

Except for Vermont, all of the states involved have renewable electricity mandates that by their nature deliver more prescriptive emissions cuts. These markets have also been implemented in a generally weak US economy, which has constrained energy demand, and against the backdrop of the shale revolution, which has yielded significant non-mandated emissions reductions. Nor have these state and regional approaches to cap and trade entirely avoided the debates over how to spend their substantial proceeds that plagued federal cap-and-trade legislation.

For many years my view of cap and trade was that if we needed to put a price on GHG emissions, this was a better, more efficient option than an arbitrary carbon tax, or other top-down method. My experience analyzing more recent “cap-and-trade” legislation left me with serious doubts about our ability to implement a fair and effective national cap-and-trade market for CO2 and other greenhouse gases within the current political environment. Whether on a unified basis or in aggregate across many smaller systems, the enormous sums it could eventually generate are simply too tempting to expect our legislators and government agencies to administer even-handedly.

Whatever its potential benefits and pitfalls, I can’t help seeing cap and trade as a distraction in the context of the EPA’s proposed Clean Power Plan. Even at its most efficient, cap and trade couldn’t render painless the wide disparities of a plan that would require Arizona to cut emissions per megawatt-hour by more than half, and states like Texas and Oklahoma to cut by 36-38%, while Kansas, Kentucky, Missouri, Montana and even California cut by less than a quarter–and under some scenarios might even increase their overall emissions. Cap and trade would merely be a footnote on the scale of transformation the EPA’s plan envisions for the US electricity sector.

A different version of this posting was previously published on Energy Trends Insider.

EPA's New CO2 Rules Create Opportunities for Natural Gas, for Now

• EPA's proposed rule for reducing CO2 emissions from power plants could increase natural gas demand in the utility sector by as much as 50%, at the expense of coal.
• Cutting emissions by regulation rather than legislation entails legal and political uncertainties that could hamper the investment necessary to meet EPA's targets.

Earlier this month the Environmental Protection Agency announced its proposal for regulating the greenhouse gas emissions from all currently operating US power plants. Unsurprisingly, initial assessments suggested it favors the renewable energy, energy efficiency and nuclear power industries--and especially natural gas--all at the expense of coal. However, the longer-term outcome is subject to significant uncertainties, because of the way this policy is being implemented.

EPA's proposed "Clean Power Plan" regulation would reduce CO2 emissions from the US electric power sector by 25% by 2020 and 30% by 2030, compared to 2005. Although it does not specify that the annual reduction of over 700 million metric tons of CO2--half of which had already been achieved by 2012--must all come from coal-burning power plants, such plants accounted for 75% of 2012 emissions from power generation.

It's worth recalling how we got here. In the last decade the US Congress made several attempts to enact comprehensive climate legislation, based on an economy-wide cap on CO2 and a system of trading emissions allowances: "cap and trade." In 2009 the House of Representatives passed the Waxman-Markey bill, with its rather distorted version of cap and trade. It died in the US Senate, where the President's party briefly held a filibuster-proof supermajority.

The Clean Power Plan is the culmination of the administration's efforts to regulate the major CO2 sources in the US economy, in the absence of comprehensive climate legislation. Although Administrator McCarthy touted the flexibility of the plan in her enthusiastic rollout speech and suggested that its implementation might include state or regional cap and trade markets for emissions, the net result will look very different than an economy-wide approach.

For starters, there won't be a cap on overall emissions, but rather a set of state-level performance targets for emissions per megawatt-hour generated in 2020 and 2030. If electricity demand grew 29% by 2040, as recently forecast by the Energy Information Administration of the US Department of Energy, the CO2 savings in the EPA plan might even be largely negated. EPA is banking on the widespread adoption of energy efficiency measures to avoid such an outcome.

Since we have many technologies for generating electricity, with varying emissions all the way down to nearly zero, many different future generating mixes could achieve the plan's goals, though not at equal cost or reliability. Ironically, since coal's share of power generation has declined from 50%  in 2005 to 39% as of last year, it could be done by replacing all the older coal-fired power plants in the US with state of the art plants using either ultra-supercritical pulverized coal combustion (USC ) or integrated gasification combined cycle (IGCC). 

That won't happen for a variety of reasons, not least of which is EPA's "New Source Performance Standards" published last November. That rule effectively requires new coal-fired power plants to emit around a third less CO2 than today's most efficient coal plant designs. That's only possibly if they capture and sequester (CCS) at least some of their emissions, a feature found in only a couple of power plants now under construction globally.

It's also questionable how the capital required to upgrade the entire US coal generating fleet could be raised. Returns on such facilities have fallen, due to competition from shale gas and from renewables like wind power with very low marginal costs--sometimes negative after factoring in tax credits. Some are interpreting EPA's aggressive CO2 target for 2020 and relatively milder 2030 step as an indication that the latter target could be made much more stringent, later.

So while coal is likely to remain an important  part of the US power mix in 2030, as the EPA's administrator noted, meeting these goals in the real world will likely entail a significant shift from coal to gas and renewable energy sources, while preserving roughly the current nuclear generating fleet, including those units now under construction.

If the entire burden of the shift fell to gas, it would entail increasing the utilization of existing natural gas combined cycle power plants (NGCC) and likely building new units in some states. In the documentation of its draft rules, EPA cited average 2012 NGCC utilization of 46%. Increasing utilization up to 75% would deliver over 600 million additional MWh from gas annually--a 56% increase over total 2013 gas-fired generation, exceeding the output of all US renewables last year--at an emissions reduction of around 340 million metric tons vs. coal. That would be just sufficient to meet the 30% emissions reduction target for the electricity demand and generating mix we had in 2013.

The incremental natural gas required to produce this extra power works out to about 4.4 trillion cubic feet (TCF) per year. That would increase gas consumption in the power sector by just over half, compared to 2013, and boost total US gas demand by 17%. To put that in perspective, US dry natural gas production has grown by 4.1 TCF/y since 2008.

EPA apparently anticipates power sector gas consumption increasing by just 1.2 TCF/y by 2020, and falling thereafter as end-use efficiency improves.  Fuel-switching is only one of the four Best System of Emission Reduction "building blocks" EPA envisions states using, including efficiency improvements at existing power plants, increased penetration of renewable generation, and demand-side efficiency measures. The ultimate mix will vary by state and be influenced by changes in gas, coal and power prices.

I mentioned uncertainties at the beginning of this post. Aside from the inevitable legal challenges to EPA's regulation of power plant CO2 under the 1990 Clean Air Act, its imposition by executive authority, rather than legislation, leaves future administrations free to strengthen, weaken, or even abandon this approach.

Since EPA's planned emission reductions from the power sector are large on a national scale (10% of total US 2005 emissions) but still small on a global scale (2% of 2013 world emissions) their long-term political sustainability may depend on the extent to which they succeed in prompting the large developing countries to follow suit in reducing their growing emissions.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Candidates & Energy 2012: Obama

It's curious that energy hasn't been as big an issue in this year's presidential campaign as it was in 2008, the year of "Drill, baby, drill."  The price of unleaded regular gasoline has averaged roughly a dime per gallon higher through September than either last year or the same period in 2008, when prices peaked at $4.11 per gallon in July.  Gas prices are higher this year because global oil prices are also higher, with UK Brent crude averaging $15 per barrel over its 2008 full-year average, though without a similar spike.  One explanation for the reduced focus on energy is that President Obama co-opted his opponents' "all of the above" prescription, while indicators such as US crude oil production and natural gas output and prices have been moving in favorable directions.  The Obama campaign and key administration officials routinely draw a strong causal connection between those two facts, forming the basis of their campaign on energy.  But is that claim true?  Like the Washington Post fact checker's assessment of another frequent presidential assertion about energy, a finding of "true but false" seems appropriate.

Although I had intended to provide a side-by-side comparison of President Obama's and Governor Romney's energy agendas, it quickly became obvious that that was impractical, due to length and complexity.  I'll take a look at the challenger's ideas next week.  Since any re-election bid is fundamentally a referendum on the incumbent, it made sense to start with the record of an administration that came into office with an unusually clear and clearly articulated vision on energy, experienced some notable victories and defeats along the way, and ended up embracing a pair of big, emerging trends that it had done virtually nothing to foster. 

That is readily apparent when it comes to oil production, which must be a core element of any "all of the above" approach, since that "all" implicitly includes fossil fuels along with renewables and efficiency.  Go to the Obama campaign web page on energy and you'll see this chart:

It's a rescaled version of the chart below, which appears on the WhiteHouse.gov site on gas prices:

Aside from the fact that changing the axis scale makes the trend look much more dramatic, what's entirely missing from both these charts and the websites where they appear is any cogent explanation of why oil production is rising.  That requires some context about the industry and oil markets that I've overlaid in the following graphs:

Most oil projects big enough to matter aren't accomplished overnight. The process typically involves acquiring onshore or offshore leases, obtaining the necessary permits, conducting exploration activities that only proceed to the next step based on success, planning the required production wells and processing facilities, competing for internal funding against other company projects, obtaining additional permits, constructing facilities and drilling the production wells. Every step takes time.  Depending on the complexity of the project, the overall timeline can span from three to seven years, and that's if no one sues to block the project.  To see why oil production has been rising since 2009, we need to ask what was happening in 2003-6.  The answer is that after many years of being stuck in a range of $20-30 per barrel--with an excursion down to single digits in the late 1990s--oil prices tripled during that period, mainly due to the combination of global economic growth, especially in Asia, and the lagged effect on oil project investments from that late-'90s price crash.  In other words, production went up mainly because five or six years earlier the financial rewards for drilling suddenly got much bigger.

So at a minimum it's a stretch--mere spin--to claim credit for higher production that is attributable to events and perhaps policies on your predecessor's watch.  However, the picture looks worse when we factor in the policies and attitudes that went into effect when this administration took office in early 2009.  Recall that one of the first energy decisions of the new administration was Interior Secretary Salazar's cancellation of previously awarded oil leases in Utah.  Later that year a senior Treasury official--currently chairman of the President's Council of Economic Advisers--testified before Congress that US policies were promoting the "overproduction of US oil and gas", just as the now-touted production surge was starting.  For at least its first several years, the rhetoric and actions of the Obama White House were generally consistent with that view and with Mr. Obama's portrayal of oil and gas as "yesterday's energy" in his 2011 State of the Union address.  The brief offshore drilling opening signaled in spring 2010 was quickly retracted following the Deepwater Horizon accident, with the imposition of a six-month offshore drilling moratorium and subsequent "permitorium". Those responses--justified or not--resulted in Gulf of Mexico production falling by 22% since mid-2010, a decline that has been masked by the tremendous success of "tight oil" exploration and production in Texas and North Dakota. (The time lag for the moratorium's effects was negligible, because the deepwater projects that were halted had already been planned and permitted.)

In fact, the President's adoption of "all of the above" is fairly recent, making headlines following his 2012 State of the Union. It represents quite an evolution from Senator Obama's 2008 emphasis on renewable energy and climate change mitigation. President Obama certainly pursued those agendas with vigor, incorporating billions of dollars of federal grants and loan guarantees for renewables in the 2009 stimulus, backing the Waxman-Markey cap-and-trade bill, and at both the Copenhagen and Cancun UN climate conferences committing the US to significant greenhouse gas reduction targets and further negotiations. 

It hasn't all worked out as planned, though.  Notwithstanding the high-profile bankruptcies of Solyndra--a colossal failure of due diligence by the administration--and other loan guarantee and grant beneficiaries, the output of wind, solar and other non-hydro renewable energy generation has indeed grown by 55% since 2008, increasing from 3.1% to 4.7% of total US electricity generation, equivalent to 1.9% of total energy consumption.  Yet sadly the wind and solar manufacturing sectors that were to have produced so many "green jobs" are caught up in parallel waves of excess global production capacity that could take years--or wrenching consolidation--to work off.  The overcapacity that has blighted the prospects of many of these companies is largely attributable to the generous incentives provided by the US and other governments from Europe to Asia.  Direct wind and solar jobs accounted for just 54,000 of the US "clean economy jobs" tallied by Brookings and Battelle in their study last year, and they look no more secure than non-green jobs.

Climate policy is another area featuring a big disconnect between effort and results. With control of both Houses of Congress, the President backed a climate bill that exhibited all the worst tendencies of that body: 1,092 pages of bloated regulations and carve-outs for favored constituencies.  Even to someone who had supported the idea of cap and trade for a decade, it was a dog's breakfast, configured mainly as a production-inhibiting tax on the US petroleum sector.  Waxman-Markey failed to pass the Senate, and a more bi-partisan bill died in the aftermath of Deepwater Horizon and the recession. Whatever one's views on the science of climate change, costly climate legislation looked like a bad bet in a weak economy.  Actual emissions have fallen, however, as a result not of policy but of another trend that wasn't on the administration's radar screen until it grew too large to ignore: shale gas.  Emissions are at a 20-year low, mainly due to fuel switching from coal to cheap natural gas in the utility sector.

Another key trend cited as evidence of the effectiveness of the administration's energy policies is the reduction of oil imports that has occurred since 2008.  Yet like the facts on oil production, the causes are only tenuously connected to those policies.  From 2008-11, US net petroleum imports fell by 2.6 million bbl/day (MBD), including refined products.  That goes a long way toward achieving then-candidate Obama's goal of reducing imports by an amount equivalent to what the US imported from the Middle East and Venezuela.  However, the biggest contributor to this reduction was the 1.1 MBD increase in total US petroleum production (including natural gas liquids), followed by a 0.6 MBD drop in demand that had more to do with reduced driving and the weak economy than the early gains from tougher fuel economy rules. Increasing biofuel production associated with the 2007 Renewable Fuel Standard contributed another 0.3 MBD, although that policy now stands in urgent need of reform.

I have watched many elections in my life, and I can't honestly say I'm surprised to see an administration running on something other than its actual energy record, which in this case includes positives such as funding ARPA-E's potentially transformational energy R&D and having enough sense to keep largely out of the way of the shale gas revolution--at least for now. Yet having focused 90% of its efforts on a set of technologies that look important for the future but will still meet less than 10% of our energy needs for some time to come, they have now hitched their electoral wagon to an oil production surge that they didn't help and partly hindered.  I can only imagine that this would be deeply disappointing to those who supported Mr. Obama in 2008 because of his vision for alternative energy and the environment.  Nor does it provide much comfort to those who found large portions of that agenda ill-considered or premature. The President's 11th-hour conversion to "all of the above" creates great uncertainty about the course he would pursue with regard to energy for the next four years, if reelected. 

Secretary Chu Advised on "Prudent Development" of Oil and Gas

A news item concerning last week's release of the National Petroleum Council's "Prudent Development" report referred to a recommendation supporting a national tax on carbon. That caught my attention. Given the NPC's makeup, a consensus on such a controversial issue would be surprising. The actual text of the report proved somewhat less dramatic on the climate policy front, but no less worthwhile for its comprehensive assessment of the abundance of North American hydrocarbon resources, as well as the development approach "necessary for public trust, protection of health, safety and the environment, and access to resources." The report doesn't just focus on macro concerns about climate change and other environmental issues, but also on timely details such as the methane emissions, water and land-use impacts involved in shale gas production and other resource development.

For those not familiar with the NPC, the organization is charged with advising the Secretary of Energy on matters relating to oil and gas, though in practice it looks at a much broader array of energy issues. In 2007 I helped with the renewable energy analysis in the group's previous study, entitled "Hard Truths." The current study is one of two requested of the NPC by Secretary Chu; the other will look at future transportation fuels and is due out in the first half of next year. What makes these reports unusual is that they incorporate the views of academics, government officials, non-governmental organizations, and the legal and financial sectors, along with those of the energy industry. In the current study, just under half the participants represented oil and gas companies, while the Emissions and Carbon Regulation Subgroup included members from the National Resources Defense Council and US EPA, and the Environment and Regulatory Subgroup was chaired by someone from the Environmental Defense Fund. I think we'd all benefit from more such "strange bedfellows" collaborations.

The report's specific recommendation on carbon pricing as a mechanism for addressing greenhouse gas emissions appears in the Executive Summary and originates in an entire chapter on "Carbon and Other Emissions in the End-Use Sectors." Although it's much more generic than the Fuelfix article indicated, it's still noteworthy. It deals with the need to internalize emissions costs into fuel and technology choices, with a carbon tax mentioned as just one option among a range of measures for establishing an explicit or implicit price on carbon. It states,

"As Congress, the Administration, and relevant agencies consider energy policies, they should recognize that the most effective and efficient method to further reduce GHG emissions would be a mechanism for putting a price on carbon emissions that is national, economy-wide, market-based, visible, predictable, transparent, applicable to all sources of emissions, and part of an effective global framework."

It goes on to address non-market mechanisms such as performance standards and clean energy standards, and how a policy on carbon should be phased in. While individual oil and gas companies have supported cap and trade or a carbon tax either individually or within multi-industry groups, I can't recall such a broad cross-section of this industry going along with the idea of carbon pricing, even in this non-specific manner.

The timing of this is interesting. It's hard to envision a comprehensive climate bill passing the Congress between now and the November 2012 election, or even being introduced on anything other than a symbolic basis. The pork-laden monstrosity of the Waxman-Markey bill succeeded only in making cap and trade toxic, and I can't imagine a worse environment for introducing any kind of new tax--a price on carbon is clearly a tax--even if the concept behind cap and trade has a solid bipartisan pedigree. Short of the miraculous materialization of a carbon tax as a compromise revenue solution from the deficit-fighting Supercommittee, carbon pricing in the US looks dead until 2013 and possibly well beyond. I'm also starting to see more comments along the lines of this one from the blog of the Information Technology and Innovation Foundation suggesting that policies promoting innovation might be a lot more important in addressing climate change than any level of carbon pricing that could realistically be implemented here.

So whether you regard this recommendation by the NPC as an attempt to restart a stalled debate on carbon pricing, or merely a tardy entry in a formerly crowded field, I think it also signals that the energy industry isn't oblivious to the fact that its emissions--including the lion's share associated with end-user consumption of their products--must eventually be dealt with. Chances are, that will await a return to economic health and stability, when US consumers, voters and taxpayers might be expected to prove more willing to incur the sacrifices this will entail. The report also includes a good perspective on the considerable North American resource upside that could be unleashed with different policies than the ones now in place, and that might just hasten the arrival of more favorable economic conditions for carbon policy.

The Year of Regulation?

Some new years seem newer than others, bringing major changes rather than just the turning of a calendar page. 2011 is shaping up that way, with a return to divided government in the US and the beginning of national greenhouse gas regulation by the EPA based on that agency's interpretation of the Clean Air Act, rather than as a result of explicit new Congressional legislation. As the ongoing legal battle over this between the EPA and the state of Texas demonstrates, there's a lot at stake, and the final outcome has not yet been determined.

When the US Supreme Court ruled in 2007 that CO2 and other greenhouse gases constituted pollution that was subject to regulation under the Clean Air Act, it set in motion the process that is now culminating with the EPA's proposed rules for regulating these gases. Initially this will take the form of what the agency calls New Source Performance Standards, applying only to new facilities and modifications within existing facilitates, and only for sources emitting more than 50,000 tons per year of greenhouse gases (GHGs). That exempts residential and most business activities using less than the energy equivalent of about two gasoline tank-trucks per day. The first phase of these regulations is specifically targeted at power plants and oil refineries, and over time it could significantly alter the way that electricity is produced and oil refined in this country.

I've argued for years that this is entirely the wrong way to go about reducing emissions, because greenhouse gases are global, rather than local in effect, and a command and control approach applied to point sources of CO2 and other GHGs will miss many of the least expensive emission reduction opportunities while forcing businesses to focus their efforts on some of the most expensive. Cap and trade or some other means of establishing a price on emissions would have been much more efficient, although the version of cap and trade passed by the House of Representatives in 2009 was a miserable excuse for such a system, distorted as it was by preferential treatment for favored groups and sectors.

But this isn't just a question of economic efficiency; it's also a question of effectiveness. Regulating power plant emissions addresses 34% of total gross US GHG emissions, including roughly 92% of the emissions from the coal value chain, while regulating refineries tackles less than 10% of the emissions from the petroleum value chain--and some of the hardest ones to cut, at that. Refineries are already about 90% efficient. Squeezing even more efficiency from them--which would be the net effect of capping their GHG emissions, since most of those are associated with the combustion of fossil fuels--is likely to cost a lot more than the value of any energy savings such changes would yield. That could have a significant impact on states like Texas, which is home to more than a quarter of the country's refining capacity. The result would also increase national energy costs in either of two ways, with higher operating costs at US refineries being passed on to consumers in the price of fuels, or by reducing US refining throughput and capacity and increasing our reliance on product imports. The latter works directly against the widely-held notion that anything that reduces emissions must automatically be good for our energy security.

None of this is set in stone, although I certainly wouldn't bet against some version of it coming into effect. The incoming Republican chairman of the House Energy and Commerce Committee has already indicated his determination to restrain the regulation of GHGs by the EPA, and even without a majority in the Senate the House, which controls the government's purse strings, could make it much harder for EPA to pursue this course. At the same time, several previous sponsors of Senate energy and climate legislation have expressed interest in a new, bi-partisan approach to energy, and it's not inconceivable that watering down the proposed EPA regs could become part of a deal to establish a national low-emission energy standard that would include not just renewables, but also nuclear energy and possibly even natural gas. I will be watching these developments with great interest in the weeks and months ahead.

Big Energy Stories of 2010

Many of the main energy trends of 2010 were predictable at the year's start, including the growing reliance of renewable energy on government assistance in the aftermath of the financial crisis, the debate over US greenhouse gas legislation, the emphasis on green jobs and competition with China, the delayed arrival of cellulosic biofuels, and the anticipation surrounding the product launches of the first mass-market electric vehicles. As interesting as all this was, the year in energy was dominated by two transformative events: the Deepwater Horizon accident and the multi-million barrel leak that ensued, and the less spectacular but no less profound awakening to the possibilities of the shale gas revolution.

The Deepwater Horizon disaster has been the subject of such extensive coverage and investigation that there's little I can add concerning the facts, other than to note that we have not heard the last word on just how much oil actually leaked into the Gulf of Mexico. The consequences of our response to the spill will be with us for a long time, both in terms of reduced offshore drilling activity and the decline in US oil output that must inevitably follow. The impact will reach far beyond the tens of thousands of workers whose livelihoods are directly or indirectly linked to the US offshore industry. Early in 2010 it looked like the industry would finally be offered access to areas that had been off-limits for decades, and by year-end not only has drilling in the central and western Gulf come to a near standstill, but the prospect of leases in the eastern Gulf and the mid-Atlantic coast has been foreclosed, perhaps permanently.

The psychological impact of the event could extend even farther than its physical and economic fallout. Whatever misgivings many people had about offshore drilling before the accident, the industry had built up trust through an impressive string of technical achievements--pushing the boundaries of resource accessibility from depths of a few hundred feet into nearly two miles of inhospitable ocean--and a solid reputation for safety. In the space of one day and the following weeks, that trust was shattered. Coming on the heels of a financial crisis that destroyed the trust of millions of Americans in the nation's largest financial institutions and markets likely amplified the effect. As fickle as we Americans sometimes seem, I wouldn't bet that this trust can be restored quickly, or to the same degree.

The shale gas revolution is a completely different kind of story, though it, too, has arguably been tainted by Deepwater Horizon. As it unlocks a resource that has converted the US natural gas supply outlook from one of scarcity and growing import dependence to expected abundance for decades, the gas industry can't assume it will receive the benefit of the doubt concerning the environmental impact of the drilling techniques that have made this turnabout possible.


Perhaps one reason the impact of cheap natural gas hasn't sunk in yet is that the main market price for gas, the futures price at the Henry Hub in Louisiana, doesn't have much relevance for the average consumer. Residential gas customers don't buy their gas in the million-BTU (MMBTU) lots in which the futures contract is denominated; we buy gas in therms--one tenth of an MMBTU--and by the time we see it on our bills all sorts of handling and distribution fees and mark-ups have been added on. But when you compare the price of traded gas in barrels of oil equivalent (BOE) to the price of West Texas Intermediate crude, the remarkable divergence of the last two years becomes obvious, as shown in the chart above. Between 2000 and 2006 gas and oil tracked each other closely, allowing for the greater seasonal volatility of the former. There were even periods when a barrel-equivalent of gas was worth more than a barrel of oil. Yet while oil and gas prices fell precipitously when the recession and financial crisis burst the various asset bubbles, they have diverged sharply since then, with oil advancing back up to today's $91/bbl and gas settling into the $20-25/bbl range in which we were accustomed to see oil prices a decade ago. Adjust that for inflation and you're looking at an average natural gas price for 2010 equivalent to $20/bbl in 2000.

That might help explain why the developers of renewable electricity sources such as wind have struggled so much this year, despite receiving $3.9 billion in direct cash grants from the US Treasury. They're not competing with $90 oil; the US generated less than 1% of its electricity from petroleum this year, through September. Instead, they're competing with gas at an effective price of $25/bbl or less. But if this is a new obstacle for some renewables, it surely represents a huge opportunity for the country as a whole, as we struggle to find our way out of the fiscal and competitive pit we've dug. Cheap energy has always been a key to growth, and right now, gas is the only energy source offering that without requiring an enormous up-front investment. It's no panacea, and it can't take on every burden without being spread so thin that its price advantage would disappear. But I'd much rather be looking at the possibilities this presents than at the constraints that high-priced oil and natural gas imposed only a couple of years ago.

That's probably as good a note as any on which to end the year. New postings will resume the week of January 3, 2011. In the meantime, I wish my readers a happy holiday season.

Chicago's Climate Exchange Shuts Down

I see that the Chicago Climate Exchange (CCX) will be winding down its CO2 trading operations by the end of the year and laying off staff. This is only surprising considering that the parent company of the CCX was acquired just this summer by the Intercontinental Exchange, though mainly for its successful European emissions trading market. In case you were wondering how long the odds against enacting cap & trade legislation in the US have become, the demise of the CCX is a signpost you can't ignore. If the symbolism of a popular Democratic governor using the Waxman-Markey climate bill for target practice during his recent successful bid for the US Senate wasn't clear enough, it looks like his bullet may have also hit the CCX.

I recall a meeting with one of the founders of CCX at Texaco's corporate headquarters in New York prior to my leaving the company at the end of 2001. At that time, Texaco's management was coming around to the idea that sooner or later emissions of CO2 and other greenhouse gases would carry a price, for the first time in human history. Cap & trade offered a proven way to discover that price, based on the pioneering experience of US markets for sulfur dioxide, a cause of acid rain, and nitrogen oxides. The principles of emissions trading had been embedded in the Kyoto Protocol, largely thanks to the efforts of the US delegation, and European countries were setting up the precursors of the EU Emissions Trading System to manage mandatory carbon reductions. Such developments still appeared to be somewhere over the horizon in the US, which never ratified Kyoto, but they seemed likely to find their way here, eventually. One of the main selling points of the CCX, which was based on voluntary emission reduction commitments by member companies, was that it would provide valuable early experience in a formal market for emissions reductions, giving participants a leg up when such trading was required by law. This argument didn't persuade my former employer, but a number of other companies signed up.

If this scenario now seems like a quaint strand of alternate history--a "what if?" that never materialized--that perspective is quite recent. The prospects for CCX and wider emissions trading looked reasonable for a long time. The value of the CCX contract peaked in mid-2008, when it had become apparent that the ultimate presidential nominees of both major US political parties would be candidates who supported cap & trade, with the Republican even having previously co-authored Senate legislation on the subject. After a severe dip during the worst of the financial crisis, the contract recovered to around $2/ton after the new administration took office, but then swooned again as the Waxman-Markey bill, with its heavily skewed version of cap & trade, neared passage. As the likelihood of parallel Senate action on climate legislation receded, it never really recovered.

In its editorial on the termination of the Chicago Climate Exchange, the Wall Street Journal suggested that the market has delivered its verdict and the idea of national-level cap & trade is now dead in the US. Perhaps, but it certainly doesn't signal an end to all CO2 trading here. Aside from the state and regional programs to which the Journal alluded, companies with global operations subject to emissions caps in other countries will still be active participants in non-US emissions markets, and firms that remain committed to voluntary reductions in the US may continue to trade with each other, via brokers, or with over-the-counter market makers.

For that matter, I can't help wondering whether cap & trade is truly as dead as a Monty Python parrot or just resting. I'm reluctant to let go of an idea I've supported for a long time, but I also still see significant advantages for cap & trade over other means of putting a price on greenhouse gas emissions. Although the idea of carbon pricing may have gone out of fashion in the US, major tax reform for the purpose of deficit reduction could make it much more difficult to provide the monetary incentives for renewable energy technologies that we do today. Without those subsidies or a price on CO2, renewables will have a hard time competing with fossil fuels. And if our only other choices for emissions reduction were mandates or the command-and-control approach for which the EPA is now gearing up, then cap & trade and the emissions trading that makes it work might no longer look quite so appalling to their critics. In that case, the companies that participated in the CCX during the last seven years might not have wasted their time, after all.

FYI, I'll be participating in a webinar on the sustainability aspects of natural gas next Monday at The Energy Collective . To sign up follow this link. In the meantime, I wish my US readers a very enjoyable Thanksgiving. New postings will resume next week.

Energy Implications of Tax Reform

I've been thinking about the implications for energy of a major deficit reduction effort along the lines suggested by the co-chairs of the President's fiscal responsibility and reform commission. Our present approach to providing incentives for various energy sources and technologies, new and old, is embedded in a tax code and taxation philosophy that might not survive the upheaval required to bring the US deficit and resulting federal debt back into a manageable range. This goes far beyond the comparatively minor question of extending expiring grants and tax credits that I discussed the other day; under the most stringent of the proposals from Mr. Bowles and Senator Simpson, such things wouldn't even exist. It's not clear how the Administration or Congress would promote favored energy technologies and strategies without these well-established but costly tools.

Start with renewable energy. We currently promote renewable fuels and electricity generation with a combination of mandates--policies such as the federal Renewable Fuels Standard (RFS) and state Renewable Portfolio Standards--and subsidy payments. Until last year's stimulus bill established the Treasury renewable energy grants, for which eligibility is due to expire in a few weeks, most of those subsidy payments have come in the form of reductions in federal taxes, via either an investment tax credit (ITC) based on the cost of a project or a production tax credit (PTC) for actual energy generated. Both of these measures, which have had a checkered history of expirations and extensions, fall into the broad category of "tax expenditures". The Zero Option proposed by Messrs. Bowles and Simpson would permanently eliminate over $1 trillion of such tax expenditures, in exchange for much lower tax rates.

Even if the renewable energy tax credits were reloaded into a streamlined tax code under the "Wyden-Gregg-style" reform presented as Option 2 from the co-chairs, the value of those credits would be reduced--or at least rendered harder to extract--because the corporate tax rate would be reduced from the current 35% to 26%. That means that a higher proportion of companies would likely not pay large enough taxes to take full advantage of the renewable energy tax credits--or have as much appetite for others' credits via "tax equity" swaps. Compounding that, the likelihood of enacting cash grants to get around this restriction would probably be much lower in an environment in which entire herds of sacred cows were being slaughtered in the cause of averting a looming national deficit and debt crisis.

In the absence of such tax credits, renewable energy developers and manufacturers would be forced to rely even more on state-level mandates or a proposed federal renewable electricity standard. The first test of such a mandates-only approach might come in a few weeks, if the ethanol blenders' credit is allowed to expire, while the annual RFS mandate continues to ratchet up. Or companies might simply conclude that without generous tax subsidies for renewable energy deployment here, their best opportunities would be found in markets that are growing much faster than ours, based on actual energy demand, rather than better incentives. Developing Asia comes to mind. That shift might not be the worst outcome, in terms of both the US trade deficit and global emissions reductions.

Conventional energy firms wouldn't escape unscathed, either. They stand to lose significant tax expenditures as well, in the form of oil & gas depletion allowances, the Section 199 manufacturing deduction, and other benefits. However, the oil and gas industry has been paying an effective corporate tax rate above 40% even after all these credits and deductions. A drop to 26% might more than offset the loss of the other benefits, while more importantly bridging the competitive gap between US firms and foreign competitors that operate under lower tax rates and a territorial tax system, rather than being taxed on worldwide earnings, as US companies are today. Bowles/Simpson also proposed increasing the federal gasoline tax by 15¢ per gallon to restore the Highway Trust Fund to solvency. That's a worthy goal, but as I've pointed out previously the Highway fund faces complex challenges as the US car fleet becomes steadily more fuel efficient and increasingly moves away from liquid fuels taxed at the pump. Raising the gas tax is a stop-gap measure, at best, on the way to a different means of collecting road taxes.

With regard to climate policy, tax reform that eliminated tax credits or reduced their value would also tend to nudge the debate back in the direction of putting an explicit price on carbon, either via cap & trade or with an outright tax. Might that prospect suddenly look more attractive as an adjunct to a fairer and simpler income tax system, than it seemed when it would have come as a further complication to an already enormously convoluted tax system that is widely viewed as unfair by both liberals and conservatives? My guess is not, without something else that motivates us to tackle climate change on a much more urgent basis.

Now let's come back to reality. The proposals of the commission's co-chairs have already received a frosty reception or outright hostility from both sides of the aisle, and they haven't yet gotten the buy-in of the rest of their team; the final report requires the consent of 14 of the 18 members. Their ideas must also compete with a growing number of deficit-reduction alternatives, including a widely-reported plan from another bi-partisan group, plus at least one solo proposal from another member of the President's commission. The chances are low for any of these proposals to gain enough traction to be enacted without first being significantly watered down. However, it is starting to look just as risky to assume that the present tax system--and its cornucopia of energy incentives--will continue unchanged indefinitely. A quick glance at the US debt clock ought to make that abundantly clear.

The Incredible Shrinking Energy Bill

When legislation is introduced in the US Congress, most of the discussion typically concerns its specific provisions. Sometimes, as in the case of the "public option" absent from the final healthcare bill, notable omissions vie for attention. However, in the case of this year's greatly-diminished energy bill released this week by Senator Reid (D-NV), most of the controversy seems to be focused on its long list of missing elements, including but not limited to cap & trade, a national renewable energy standard for electricity, and extensions for various expiring renewable energy incentives. That's not to say that what's left doesn't deserve careful scrutiny, particularly provisions affecting offshore oil and gas drilling. But compared to the energy bill that might have been, this draft looks like a pitiful remnant, even at 409 pages.

Although I can appreciate the frustration of those who expected Congress finally to enact cap & trade this year, I find the convoluted tactical arguments and finger-pointing over its failure to reach consensus on this issue to be mostly "inside baseball" rationalization. The clues adequately explaining its omission from the current bill are on display in the bill's title, "The Clean Energy Jobs and Oil Company Accountability Act of 2010". In other words, what happened to cap & trade this year was the recession and the oil spill. The former made the country less receptive to what is at its core a substantial new tax, while the latter scuttled the best chance for a bi-partisan "grand compromise" based on swapping expanded access to US off-limits oil and gas resources for stronger emissions regulations. Even though the taxation underlying cap & trade is intended to recognize a serious unpriced externality of our energy economy, it still represents a significant redistribution of wealth from energy producers and consumers to the government and the purposes for which the government chooses to spend the proceeds: at best a zero-sum game with frictional losses, and at worst--insert Waxman-Markey--a monumentally-distorting boondoggle.

Then there's the missing national renewable electricity standard (RES), which in clear English is a mandate for utilities to obtain a defined and escalating percentage of the electricity they provide customers from selected renewable sources. The American Wind Energy Association (AWEA), the trade association for the US wind industry, sees this as an absolute necessity for their industry to continue growing and was vexed over its exclusion from the current bill--this in spite of the fact that the wind industry's main federal support, the Production Tax Credit, was previously extended through 2012, along with the valuable option to select an Investment Tax Credit instead. I see two practical explanations for this omission, though it's clear from the efforts of AWEA and other groups that it could still find its way back into the bill. First, the RES is really another tax. Instead of being levied on taxpayers by the government, it would be levied by utilities on ratepayers when the costs of the renewable energy projects or the tradeable Renewable Energy Credits they can buy in lieu of buying green power are passed on to their customers. On a more practical level, with 29 states plus the District of Columbia already having equivalent Renewable Portfolio Standards in place, most of the best US wind and solar resources are already covered by such targets. A national RES might not add a lot more of these energy sources, but it certainly would trigger a scramble for the states with limited renewable resources to line up supplies from elsewhere. That might be good for the renewable energy sector, but it's of questionable benefit to a national economy still struggling to emerge from the recession.

Also absent from this draft are the expiring renewable energy incentives highlighted in yesterday's New York Times editorial. These include the $0.45/gal. ethanol blenders' credit, about which I've blogged extensively, and the Treasury renewable energy grants offering up-front cash for the Investment Tax Credits that would otherwise require waiting for next year's tax return--assuming the recipient company had sufficient taxable income to benefit from the entire amount of the credit. These grants look problematic, as I noted last fall, when reports first surfaced that most of the money paid--approaching $2 billion--had gone to non-US firms. As I discussed at the time, this reflects the reality of a wind energy market in which US firms account for less than half of domestic sales, supported by a thoroughly-globalized supply chain, not unlike many other industries. The arguments pro and con too easily reduce to unappealing sound-bites.

That leaves us with what is currently in the bill, which I have so far only had time to skim. It seems to consist mainly of well-intended but overly-politicized efforts--one section is entitled the "Big Oil Bailout Prevention Unlimited Liability Act of 2010--to hold BP accountable for the Gulf Coast oil spill and to address the liability for future spills, while trying to reduce the chances of another one. That sounds like motherhood and apple pie at this point, but as always the devil is in the details; implementing some of these details would leave the US with a much smaller offshore oil capability. That might appeal to environmentalists but would be catastrophic for energy consumers, our trade deficit, and US energy security. And why would you charge the Secretary of Energy with issuing a monthly report, starting in September or October, on the economic and employment impact of a deepwater drilling moratorium that is only intended to last through November? Interestingly, the bill would also establish a Congressional version of the President's oil spill commission, this time with specific technical criteria for appointment to this body. Alternative, compromise versions of the bill's oil provisions are already emerging from within Senator Reid's own party, and with a lot of luck we could end up with measures that would actually make offshore drilling safer and more responsible without killing it--and the roughly 30% of domestic oil production it provides.

In addition to its oil spill provisions, the bill also offers some generous tax credits for converting heavy-duty trucking to natural gas, along the lines of the Pickens proposals I discussed last Friday, plus similar help for vehicle electrification and infrastructure, yet more energy efficiency measures (this time focused on homes), and funding for an old government program to buy up land and waterways for parks and nature preserves. All of this is notionally paid for ("PAYGO") by raising the Oil Spill Liability Trust Fund fee on all the oil produced and used in the US from $0.08 to $0.45 per barrel, which would directly increase the size of the fund to cover future disasters from $1 billion to $5 billion, while indirectly making all the bill's other provisions appear deficit-neutral. The proposed fee increase has the potential to raise an extra $2.5 billion per year.

It's not clear whether even this slimmed-down bill can garner enough votes to pass in the Senate, let alone do so before the summer adjournment. In any case I'd expect the version that comes up for a final vote--if it does at all--to look somewhat different than this draft. It would almost certainly grow much longer, a malady that has afflicted all major legislation in recent Congresses. Whether it will actually make a meaningfully-positive impact on the serious energy challenges the US faces remains to be seen.

Whither Cap & Trade?

Just a year ago it seemed a near-certainty that the US would eventually adopt some form of cap & trade mechanism for greenhouse gases (GHGs). After repeated failed attempts to pass cap & trade legislation in the Senate, the House of Representatives narrowly passed the Waxman-Markey bill, HR-2454, and the Senate was expected to follow, bolstered by a filibuster-proof Democratic majority and urged on by a popular new President. Then came the divisive debate over healthcare legislation, the off-year election of Republican Scott Brown in Massachusetts, Climategate, and an oil spill that among other things derailed the latest bi-partisan (tri-partisan?) Senate climate bill. Today, the prospects for climate legislation remain highly uncertain, while the clock runs out on the current Congressional session. And if all that weren't enough, the EPA has just issued new regulations covering interstate emissions of conventional air pollutants that could effectively terminate the highly-successful sulfur-dioxide market upon which cap & trade for GHGs was based. Can cap & trade survive these travails, and should it?

Time will tell whether Waxman-Markey represented the high-water mark of cap & trade in the US, or if the hiatus since then has merely been a pause in a long process of refining and ultimately adopting this approach. Heaven knows W-M was a highly-imperfect vehicle for cap & trade, with its allocation of emissions allowances skewed to the highest-emitting sector and with hundreds of pages of extraneous provisions that could set up all sorts of unintended or undesirable consequences. The last year has also seen a proliferation of variations on cap & trade that call into question the original formulation of an economy-wide cap on emissions implemented by means of requiring emitters to purchase allowances from a gradually-shrinking national pool of emissions credits, with the proceeds doled out by Congress for purposes including clean energy R&D and deployment, deficit reduction, and mitigation of the impact on consumers and selected businesses. The Cantwell-Collins bill, for example, proposes returning most of the allowance revenue directly to consumers, while the Kerry-Lieberman bill would exclude the transportation fuels sector from cap & trade, but impose on it a sort of carbon tax based on the price of traded allowances. Both of these approaches have complex pros and cons, and as with original cap & trade their effectiveness at reducing emissions without imposing crippling costs on the overall economy depends critically on their detailed provisions, negotiated exceptions, and how they would actually be implemented.

Cap & trade has also come under fire on more fundamental grounds. Some critics have questioned the desirability of creating a vast new financial market for emissions when the shortcomings of other financial markets have caused so much harm, while others have suggested that investing in innovation to make low-carbon energy and efficiency much more cost-effective has greater potential to reduce emissions in a world in which developed-country emissions are being eclipsed by those in developing Asia.

Against this backdrop EPA Administrator Jackson's repeated assurances that she prefers legislated cap & trade to enforcement under the Clean Air Act have become increasingly divorced from reality. Her agency's determination to proceed with enforcement next year if no bill is passed, coupled with its newly-issued rules for power-plant pollution, serve mainly to remind the market that emissions allowances are not a new form of fiat currency, with intrinsic value backed by fractional reserves and the full faith and credit of the US government, but a fragile construct, the value of which can be eroded or erased at the whim of this and other regulators or the courts. Today's Wall St. Journal describes the impact of the new air pollution rules on the SOx market. Any potential participant who imagines that something similar couldn't happen to a future greenhouse gas allowance market is not paying attention.

So despite the apparent enthusiasm of the majority party's Senate caucus for enacting some kind of comprehensive climate and energy bill this year, presumably including elements of cap & trade, we're left with serious questions about whether this is an idea whose time has come and gone. From my perspective, putting a price on GHG emissions is still an essential step if we're serious about reducing them by more than the amounts that have resulted from the inadvertent combination of the recession, cheap natural gas, and existing incentives for renewable energy and efficiency. Cap & trade still has significant theoretical advantages over an arbitrary carbon tax as a means of imposing such a price, but as we've seen the likelihood of cap & trade being enacted in such a pure form seems low in the messy world of US politics--perhaps as low as the chances of a pure and simple carbon tax.

The odds against cap & trade look long at this point. Realistically, the time left for bringing a full-blown climate bill to a vote in the Senate is measured in weeks, rather than months, before the dynamics of the mid-term election campaign take over. Notions of passing an energy-only bill and then grafting on Waxman-Markey's climate provisions via a House-Senate conference committee seem even less likely to produce a mechanism that could survive the political upheaval that the mid-terms appear likely to produce. Nor should anyone be considering the last-gasp option of trying to pass climate legislation in a lame-duck session after the November election. As the Congressional Budget Office recently determined, any sort of controls on emissions are likely to reduce overall US employment--"green jobs" notwithstanding--so getting this right must be treated as more important than just getting something through before the current window closes. I will be watching developments in the weeks ahead with great interest.