Greenhouse Gas Reduction Talks Focus on Cap-and-Trade, Carbon Tax

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“Climate change poses a serious threat to the economic well-being, public health, natural resources, and the environment of Hawai`i.”

That statement, included in the preamble to Act 234, passed by the Legislature last year and signed by the governor on June 30, serves as a stark backdrop to the coping strategies that the law anticipates. Weaning Hawai`i off fossil fuels and moving it in the direction of more sustainable energy sources will doubtless play an important role in reducing the state’s emissions of carbon dioxide, the gas that is largely responsible for climate change and global warming. But just as important, under Act 234, will be the development of regulations and incentives that curb such emissions. Without regulatory measures, the state has little chance of meeting the goal of reducing by 2020 statewide greenhouse gas emissions to a level at or below that set in 1990.

In less than two years, by December 1, 2009, the Greenhouse Gas Emissions Reduction Task Force is to deliver to the Legislature a “work plan and regulatory scheme” to achieve these reductions. Among other things, the work plan is supposed to identify ways to reduce emissions directly as well as techniques of achieving the goal through market mechanisms and “potential monetary and non-monetary incentives.”

By December 31, 2011, the Department of Health is to have rules in place, to take effect January 1, 2012, that will put the state on course to achieve the targeted reductions. The rules are to ensure that the emissions reductions achieved “are real, permanent, quantifiable, verifiable, and enforceable.”

So what could a regulatory scheme to reduce emissions look like?

Capping versus Taxing
Elsewhere, governments grappling with this question have come up with two competing approaches: one involves development of a market in permitted emissions of greenhouse gases, the other involves development of financial disincentives (such as taxes) to curb such emissions.

Other approaches do exist, though. There are standards-driven approaches, such as the fleet efficiency standards for automobile manufacturers, or energy-efficiency standards for appliances. Carbon sequestration schemes effectively offset carbon dioxide emissions through reforestation efforts or the actual removal of offending gases from smokestacks through sophisticated scrubber technology. Drawbacks exist to these approaches, however. Requiring new appliances or vehicles to be energy efficient depends on market turnover to achieve the desired goals – and that can be a long time coming. Corporate-average fuel economy (CAFÉ) standards are generally regarded as having been ineffective in putting fuel-efficient vehicles on the roads. Other standards require widespread adoption (at the federal level, generally) if they are to have any impact at all. In the case of reforestation, the actual amounts of carbon held by the new plantings can vary tremendously from one area to another, or from one year to another in the same area, making the actual value of the offset difficult to calculate. With respect to greenhouse gas scrubbers, no practical, economical technology yet exists that would give legs to this approach.

Without foreclosing the prospect of standards-based regulations, carbon offsets, or carbon sequestration, the most important policy decision facing the task force will be whether to go with a cap-and-trade system or a carbon tax.

The Carbon Market
A cap-and-trade system is generally the preference of economists. It is modeled on the stock market, and plugs easily into the system of trading that has developed in that sector. It works something like this:

Businesses or other major emitters are assigned a quota, or allowance, for carbon dioxide emissions. This is based usually on past history of emissions, although if the goal is to reduce emissions by a targeted amount, the quota may be set at a certain percentage of historic emission levels. This is the cap.

If the companies anticipate exceeding their emission allowances, they must purchase an allowance equal to the excess from another company that has not emitted their full allowance. This is the trade. Emitters thus have a real incentive to lower their emissions: not only do they save on fuel and achieve other economies resulting from more efficient operation, they can also use their excess emission allowances as a source of revenue. Affected businesses recover costs of the emissions they need to purchase by passing them onto the consumers of their products or services.

Critics of this system note that it has inherent inequities. It places new enterprises at a disadvantage, since they must purchase an allowance before they can start up operation. Should demand for allowances be high, companies with allowances can cut production, sell emission credits, and still reap windfall profits – which, in the end, consumers will be forced to pay.

In Europe, where the cap-and-trade system has been in effect since 2005, the emissions market has been blamed for a 7 percent rise in electricity bills. Overall carbon dioxide emissions across the European Union rose between 1 and 1.5 percent over the same period, and, in England alone, the windfall profits to electric utility companies was estimated at 1.7 billion pounds. According to the group Energywatch, based in England, “consumers increasingly accept the need for reductions in carbon. However, they are paying the price and not seeing the benefits. The big generators are banking huge amounts of money and consumers aren’t benefiting.”

Point Carbon, a company that closely follows the trading in carbon emission allocations, conducted a study of the European market last year, in which it determined that when the system was established, the allotments granted to industries actually exceeded emissions by some 170 million tons. As reported in The Guardian, “In the early days, nobody realized quite how badly the European commission had miscalculated, and so the price of the EUAs [European Union allocations] was quite high… But individual companies, particularly energy companies, rapidly saw they had millions of tonnes of EUAs that they didn’t need, and so they sold their surplus, making huge profits.”

The Guardian cited another report, this one by Open Europe, which found that oil companies in the United Kingdom “were also poised to make a lot of free money: ₤10.2 million for Esso; ₤17.9 million for BP; and ₤20.7 million for Shell. And behind this profiteering, the environmental reality was that these major producers of carbon emissions were under no pressure from the scheme to cut emissions.”

“At the other end of this EU market,” The Guardian report said, “smaller organizations like UK hospitals and 18 universities, who had been given far fewer EUAs, were forced to go out and buy them – while the price was still high. So, for example, the University of Manchester spent ₤92,500 on UEAs. Now that the truth about the glut has been revealed, the university would be doing well if it managed to get ₤1,000 for the lot of them.”

Defenders of the cap-and-trade approach say the problems are just growing pains associated with the start-up of any new system. In an interview with Environment Hawai`i, Paul Brewbaker, chief economist with the Bank of Hawai`i, says, “the way my mind works as an economist, I don’t see a realistic way of getting there” – to the goal of lowered greenhouse gas emissions – “by just getting people informed and relying on their good will.”

“We need to have a market for this stuff,” he continued. “When we make that market, and have a limit on how much we’re going to load, it’ll work…. If you have the right price for carbon loading, it’s an even greater incentive for people who are coming up with alternatives – modes of transport, vehicle designs, even shopping mall locations. A whole range of choices will be made more efficiently.”

Several members of the state task force appear to share his views. Last October, at the panel’s first meeting, Mark Fox of the Nature Conservancy of Hawai`i, one of two appointed members representing the environmental community, noted that his organization supported market-based approaches, such as carbon credits, cap-and-trade systems, and auctions of emission allowances. Frank Clouse of Tesoro, appointed as one of four members from affected business sectors, suggested looking into what other states are doing, especially with regard to carbon trading.

Tax and Spend
Citizens of Boulder, Colorado, have a different view. In November 2006, they approved a tax on electricity consumption that will be used to finance a Climate Action Plan, approved by the City Council five months earlier. The tax went into effect last April.

According to a press release issued by the city, “This energy tax is also referred to as a carbon tax since most of Boulder’s electricity comes from the burning of coal, which is directly related to carbon or greenhouse gas emissions.”

The average household’s electricity bill rose about $1.33 a month, while the average bill for businesses rose on average $3.80 a month (although the rate of tax is higher for households.) The city estimates that the tax will generate about $1 million a year through 2012, when it is set to expire. The long-term savings in energy that are expected to occur as a result of the Climate Action Plan will come to about $63 million,
the city estimates.

Economist Charles Komanoff, who has monitored energy trends for decades, comes down squarely on the side of a carbon tax. To promote this, he has a website, [url=http://www.carbontax.org,]www.carbontax.org,[/url] that presents the pros and cons of a tax versus a trading system. He cites five “five fundamental reasons” to prefer a tax:

  • A tax will “lend predictability to energy prices,” while cap-and-trade systems do little to mitigate the price volatility that has historically discouraged investments” in more efficient technologies;
  • It is less cumbersome than cap-and-trade systems, which are subject to lengthy negotiations before they take effect – and “we do not have the luxury of waiting”;
  • A tax is transparent and easily understood, whereas the cap-and-trade approach is opaque and difficult to understand;
  • A tax is far less vulnerable to manipulation by special interests than is a cap-and-trade system, whose “complexity opens it up to exploitation by special interests … that can undermine public confidence and undercut its effectiveness;”
  • A tax can be revenue neutral, where rebates can be distributed to the public through dividends or tax shifts, “while the costs of cap-and-trade systems are likely to become a hidden tax as dollars flow to market participants, lawyers, and consultants.”
  • Komanoff notes that the carbon content of every different type of fuel is precisely known, as is the amount of carbon dioxide released when the fuel is burned. “A carbon tax thus presents few if any problems of documentation or measurement,” he writes. Administration of such a tax should be simple, he says: “utilizing existing tax collection mechanisms, the tax would be paid far ‘upstream’ (e.g., at the point where fuels are extracted from the earth and put into the stream of commerce, or imported into the U.S.). Fuel suppliers and processors would pass along the cost of the tax to the extent that market conditions allow.”

    While some politicians despair over the prospect of a new tax, even one that might be revenue neutral, New York City Mayor Michael Bloomberg has come out swinging for the idea. At a two-day conference on climate change attended by mayors from across the country, Bloomberg advanced the proposal. “As long as greenhouse gas pollution is free,” he said, “it will be abundant. If we want to reduce it, there has to be a cost for producing it.”

    Bloomberg acknowledged that “cap-and-trade is an easier political sell because the costs are hidden – but they’re still there. And the payoff is more uncertain.”

    Although the system is intended to give manufacturers and others incentives to invest in pollution-reducing technologies, “the price volatility for carbon credits can discourage investment, since an investment that might make sense if carbon credits are trading at $50 a ton may not make sense at $30 a ton. This price volatility can also lead to real economic pain. For instance, if 100 companies release higher emissions than they had planned for, they all have to buy more credits, which can create a very expensive bidding war.”

    In addition, he said, “a cap-and-trade system will only work if all the credits are distributed from the start – and all industries are covered. But this begs the question: if all industries are going to be affected, and the worst polluters are going to pay more, why not simplify matters for companies by charging a direct pollution fee? It’s like making one right turn instead of three left turns. You end up going in the same direction, but without going around in a circle first.”

    In Hawai`i, Henry Curtis of the group Life of the Land, which closely monitors energy issues, favors a carbon tax: “By having a high carbon tax, and by encouraging conversion of gas stations to electric stations, where you can recharge vehicles, we can shift away from liquid fuel to renewable-based electricity,” he told Environment Hawai`i.

    Rep. Mina Morita, chair of the House Committee on Energy and Environmental Protection, also favors underwriting energy initiatives through a tax on oil. “We need to look at our taxation policies carefully… Our tax policies aren’t right. We went along with the governor’s plan to eliminate the excise tax on alcohol fuels, but nobody saw prices go down. That’s $35 million out of the general fund — $35 million you could be investing in clean technologies or schools, while people just burn up more gas in their gas-guzzling SUVs.”

    Putting the state on a new, clean energy course “is kind of like education,” she continued. “Reforms aren’t going to happen overnight. You have to sustain the political will to get to your vision.

    “We should be looking at a barrel tax on oil. Now, the barrel tax is primarily for environmental cleanup, but I think we should have the tax increased to specifically target energy initiatives. Even 5 cents a barrel – some ridiculous amount – would go far.”

    — Patricia Tummons

    Volume 18, Number 7 — January 2008

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