Cap and Trade Delusions
This week listening to the radio I heard the cap and trade system described as something that would raise the price of carbon-based energy while lowering the cost of alternative energy. That cap and trade will raise carbon-based energy prices is correct. However, that cap and trade will lower alternative energy prices is correct only if one makes several other assumptions.
First, the statement is true if one adds the qualifier "relative;" alternative energy prices will fall relative to carbon-based energy. But this doesn't mean alternative energy becomes cheaper, only that it becomes slightly more attractive in relation to oil and gas. Unfortunately because the price of alternative energy is currently much more expensive than carbon based fuels, this may not induce much substitution unless the price of carbon based rises substantially. Ron Bailey's article "Cap and Trade Delusions" in Reason points out that electricity from solar energy costs 33 cents per KwH, from wind costs 9 cents per KwH and from coal costs just 6.5 cents per KwH. Cap and trade may only induce substitution to these alternatives if the carbon fuel prices rise substantially.
The statement is also potentially true if cap and trade induces sufficient innovation in alternative fuels that lowers the cost of these energy options. This is indeed likely to occur but there is no way to know how long it will take. Research has been conducted for many years on alternatives but they still don't come close to providing energy at the same cost.
Thus, as Bailey points out, there is no way that cap and trade will not raise energy prices and reduce the overall number of jobs throughout the economy as a result of the drag on the economy. Remember that energy is an input into every good and service in the economy and with higher energy prices the cost of all goods will rise, without a comparable increase in individual incomes to compensate ... That is unless you take latch onto the new rents that will accrue to the lucky few. (See today's article by Bjorn Lomborg in the WSJ)
3 comments:
I generally agree with your comments, Steve. Confusion often arises in this issue because the current "cap-and-trade" bill, refereed to as Waxman-Markey actually contains provisions for 4 energy-related issues:
1) Energy efficiency
2) Clean energy (renewables)
3) Cap-and-trade
4) Competitiveness
On clean energy, the bill proposes a Federal Renewable Portfolio Standard (RPS) which would penalize load-serving entities who do not account for some fixed percentage of their load as derived from renewable sources (solar, wind, tidal, biomass, geothermal). The punitive costs of non-compliance will drive firms towards investing in such projects that do need to be built and maintained (insert jobs here). This provision will stimulate renewable energy projects much more than any carbon constraints would.
On the rent-seeking behavior of firms in the carbon finance sector, one need only look at the EU cap-and-trade system to see the flaws of freely allocating emission permits. Whereas the original draft form of the Waxman-Markey bill left the question unanswered of whether or not to auction (or how much), the reading of the tea leaves (as of today) suggests that merely 15% of permits will be sold at auction. The Commander in Chief has argued in favor of 100% auctioning, but the members of the House and Senate must appease their supporters by making some transfer of wealth to the private sector.
Industry lobbyists argue that free allocation will mean that firms can maintain their current costs (and jobs) only by receiving the permits for free. The same argument was made in Europe. One may guess (correctly) that in fact firms passed the higher costs onto their customers, leaving firms awash with windfall profits.
The alternative, distributing emission permits through auction, has also been tried and has been greeted with much success. The regional cap-and-trade system in 10 northeastern US States (ME to MD, excluding PA) has successfully organized and executed 3 auctions for those permits. The revenue generated from these auctions is utilized in different ways by different states. In general though, states have directed the funds towards energy rebates for low-income families, energy efficiency projects, and yes even towards incentives for renewable energy projects. 100% auction allocation of emission permits could be revenue-neutral through similar programs at the Federal level.
For further reading on allocation auction and its design, I suggest the following paper:
Discussion Paper No. 08-081, Center for European Economic Research
“Auctioning of CO2 Allowances in Phase 3 of the EU Emissions Trading Scheme”
http://www.zew.de/en/publikationen/publikation.php3?action=detail&nr=4848
Finally, I am a bit surprised that you passed on the opportunity to discuss externalities. Writing that “solar energy costs 33 cents per KwH, from wind costs 9 cents per KwH and from coal costs just 6.5 cents per KwH” is misleading because those costs do not capture the externalities associated with the production and consumption of that energy. As society at-large chooses to internalize the negative externalities of a carbon-based economy we could just as easily rejoice at how “fortunate” we are to have gone so long without paying those costs as we could bemoan that the discount is now exhausted.
I neglected to link to a more comprehensive analysis of the Waxman-Markey bill that EPA published in April.
See here: www.epa.gov/climatechange/economics/pdfs/WM-Analysis.pdf
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