A Specific Response to Global Warming: Let’s Take a Look at Cap-and-Trade

The environmental community may have its differences, but one thing that is gaining universal agreement is that we need to reduce our carbon emissions to address the rising waters and rising threats of global warming. So how do we do this? Three commonly discussed mechanisms include a cap-and-trade regime, a straight carbon tax, or direct carbon regulation (without the ability to trade emissions credits). Of these three, the one being discussed by the Western Climate Initiative—and the one which has gained the most political traction—is the cap-and-trade option. So next question: what is it?

The purpose of cap-and-trade is to reduce greenhouse gas pollution, the most common pollutant being carbon dioxide. And although carbon emissions do occur in nature, human emissions of carbon dioxide have increased astronomically in the past 150 years, due to fossil fuel use in our vehicles, our businesses, and our homes. A cap-and-trade would put a cap on greenhouse gas emissions that result from the burning of fossil fuels, at some agreed-upon level, and then gradually reduce that cap until we reach a sustainable level of carbon emissions that does not endanger the ecosystems we rely on. The State of Oregon has set a goal for itself of reducing carbon emissions to 80% of 1990 levels by the year 2050. As of yet, this goal has no teeth. But the legal enforcement of some carbon reduction goal cannot be far off, if the message of scientists, the interest of political leaders, and the level of general public awareness, are all taken as indications.

Two big issues arise when discussing a cap-and-trade regime:

1) Where, meaning in what sectors of the economy, do we apply it? CUB believes strongly that any effective carbon reduction plan will have to be applied to all affected sectors: the transportation sector; the big industrial sector; and the utility sector. To be even more specific, here are the numbers: 40% of our nation’s carbon dioxide emissions comes from the electricity sector (meaning electric utilities); another 33% comes from the transportation sector; 17% is produced by industrial processes; and an additional 10% from residential and commercial sources. A cap-and-trade could be rather easily applied to the utility sector, because it operates within a relatively finite and mostly regulated system, which would allow for implementation of another layer of regulation without having to recreate the wheel or start from scratch. That said, we think cap-and-trade or complementary regulations must encompass all major sectors, because of the potential for bleeding into one another. For example, if only electricity generation were carbon-regulated, people could just choose to install natural gas for heating rather than electricity; this avoids carbon-regulation cost for the individual, but also avoids carbon reduction in the larger economy. Similarly, a societal shift to plug-in hybrid vehicles is simply moving emissions from one sector (transportation) to another (utility). So CUB thinks carbon regulation must be applied across all major economic sectors.

2) Where do the credits start out? Credits, or allowances, can be auctioned off by the government to companies in the various sectors, and then government can use that money to fund clean energy research and development, and building large renewable projects. State or federal regulatory agencies (depending upon who passed the carbon regulation laws) would provide oversight and assess stiff penalties for not meeting carbon reduction goals or keeping emissions within the allowances purchased. A potential problem that arises in this scenario is that the government could conceivably spend the money on tax cuts, military spending, health care, education, or some other preferred government priority, and then we would be not very much closer to a solution on the energy front. But ideally (from a global warming perspective) government would turn around and invest the money gained from carbon allowances in energy efficiency, conservation, and renewables, which will directly address the problem.

Auctioning allowances is expected to work well in certain sectors, where government is either responsible for the infrastructure that shapes emissions levels (such as transportation), or where government is able to shift the clean energy investment from one sector to another, when emissions reductions may not be directly possible (such as in the case of an industrial plant that cannot be retrofitted to reduce emissions). The scenario goes something like this: A manufacturing company is required to meet declining carbon emissions standards, but there’s nothing they can do—there is no retrofit for their plant to reduce carbon. So they go to the carbon credit market and purchase the credits they need to meet the standards. That money is then invested by the government elsewhere to clean the system. Company management raises the cost of their product enough to cover the cost of the credits, passing that cost along to their customers, and other parts of the economy become more efficient. The system becomes greener and the entire ecosystem becomes one step more stable.

Giving allowances for free to industrial companies opens up a potential problem, what we will call (tongue in cheek) the windfall pitfall. This would be a scenario where government gives allowances for free to the company, they are able to retrofit their operations relatively inexpensively to reduce emissions; however, they still pass along a higher cost to customers, letting shareholders reap the benefits of the free allowances when they are sold to other emitters. This is specifically a pitfall associated with giving allowances to unregulated, for-profit companies, and would not apply to regulated utilities, since regulators examine costs and profits closely and would not allow such a corporate windfall to occur (because we won’t let them!).

Regulated utilities are a unique entity, combining a system of existing regulatory oversight with ever-changing resource portfolios offering many opportunities for direct emissions reduction. Regulated utilities have numerous ways to reduce emissions, such as energy efficiency, distributed generation, or replacing dirty generation with clean energy. For example, an electric utility company would mostly likely meet its goal by shutting down coal plants, a carbon-intensive power source. If a company were to shut down a coal plant and be 10% under 2005 levels, when only 5% under was required, they could sell those unneeded credits and invest the money in a replacement. Each year, the idea goes, the cap would reduce emissions even more and the system would become greener.

That is why CUB prefers a cap-and-trade design that auctions allowances generally, but gives free allowances to regulated utilities. Regulators will prevent corporate windfalls and can see that the value of the allowances is invested for the benefit of customers and the climate. Also, CUB recommends giving credits to regulated utilities rather than auctioning them off, because it seems to better meet CUB’s two major criteria for a carbon regulation scheme, which are: 1) effectiveness; and 2) affordability. One benefit of giving emissions credits to utility companies is that that is where the investment in clean energy has traditionally happened and needs to continue to happen, at an increasingly fast rate. It seems to be the most effective route. Equally important, giving emissions credits to regulated utilities would make the greening of the system more affordable for customers. If the utility has to buy credits to begin with, it will make it harder for customers, on whose shoulders the cost of regulation will be falling, to pay for the new investment in cleaner energy sources. Electricity is a necessary service in today’s world and people of all income levels must pay for its use; we want to make sure that lower-income people are not “priced out” of being able to use the heat and appliances they rely on in daily life.

Ownership of the credits will be a sticky problem to solve under some scenarios. CUB feels strongly that customers have invested in the system that exists now, and customers should receive the benefits when the dirty power sources in use currently are retired and credits sold. As a general principle, we feel that carbon credits should go to whoever is going to be building a new clean system, and customers will be footing the bill for their utilities’ investments.

We chose to focus in this article on cap-and-trade, because of the political traction it has gained in recent months. While cap-and-trade has advanced significantly further politically than a carbon tax, there are many who would prefer to enact a carbon tax. We agree that it is appropriate and necessary to compare these two carbon reduction options, but we hope that these discussions can happen in a way that is not damaging to either option. We need to enact one or the other within a relatively short time frame, to start turning the temperature down.

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