Sins of emission - America and climate change

Barack Obama is keen to curb greenhouse-gas emissions with a cap-and-trade scheme. Can Congress come round to his way of thinking?

The Economist print edition, Mar 12th 2009

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AS HE clinched the Democratic nomination for president last year, Barack Obama declared: “This was the moment when the rise of the oceans began to slow and our planet began to heal.” Not yet two months into his term, despite lots of other pressing concerns, Mr Obama has taken on the task of tackling global warming with zeal (although the oceans nonetheless continue to rise: see article). He has increased government spending on environmental causes, instructed civil servants to increase the fuel-efficiency of America’s cars, promised to double America’s output of renewable energy and urged Congress to pass the greenest measure of them all: a cap on the country’s emissions of greenhouse gases. Could Mr Obama live up to his grand green rhetoric?

There is no questioning his enthusiasm. He has appointed ardent advocates of emissions-cuts to senior jobs, including secretary of energy and head of the Environmental Protection Agency (EPA). Many of his appointees, such as Carol Browner, who is charged with co-ordinating policy on climate and energy, are veterans of the Clinton administration, which agreed to cut emissions under the Kyoto protocol but could not muster enough support in the Senate to get it ratified.

The administration has dedicated roughly a tenth of the $787 billion to be spent under the stimulus bill to energy and the environment, making it “the biggest energy bill the country’s ever seen”, according to Miss Browner. That includes $33 billion to green the country’s electricity supply, $27 billion for energy efficiency and $19 billion for cleaner forms of transport. Voguish technologies such as renewables (meaning windmills, solar panels and the like), high-speed rail, carbon capture and storage, advanced batteries, “smart” electrical grids and plug-in hybrid cars all received big dollops of cash.

In his first budget, too, Mr Obama has proposed spending more on greenery. The EPA would receive a third more than it did last year. Some of that is slated for closer monitoring of greenhouse gases. The Department of the Interior would get more money to assess the potential for renewable energy and to protect endangered species from global warming; $150 billion would go towards improving green technology over the next decade.

Meanwhile, Mr Obama has directed the EPA to produce tighter fuel-efficiency standards for cars and to reconsider its refusal under Mr Bush to allow California to regulate greenhouse-gas emissions from cars. The EPA is also wondering whether to overturn another decision from Mr Bush’s day and regulate greenhouse-gas emissions itself. That, in effect, would allow it to set emissions standards for new power plants, and also to raise fuel-economy standards for cars beyond the levels required by existing laws.

All this, says Miss Browner, would complement Mr Obama’s broader ambition to tackle global warming through a cap-and-trade scheme, whereby the government would set steadily declining annual limits on emissions, and would then auction permits to pollute up to that level. The president has consistently called for such a scheme, most recently in his first address to Congress, and even included revenues from permit auctions in his budget projections. Ideally, officials say, they would like to see cap-and-trade enacted this year, in time for a United Nations summit in Copenhagen in December, where negotiators hope to agree on a new treaty to stem global warming.

Congress seems receptive to the idea. The leaders of both the House of Representatives and the Senate have promised to allow a vote on cap-and-trade this year. The relevant committees in both chambers have said they will produce draft bills soon. The increased Democratic majority in both houses bodes well, since Democrats are keener on environmental measures, on the whole, than Republicans. But Environment & Energy Daily, a website that follows congressional wrangling on the subject, reckons there is not yet a majority in favour of cap-and-trade in either chamber. In the Senate, where 60 out of 100 votes are needed, it counts only 47 probable supporters and 21 fence-sitters.

The odds of winning over the waverers depend on the details of a cap-and-trade bill. But provisions designed to appeal to one lot might put off others. One of the most hotly disputed questions is what to do with the money earned by selling emissions permits. Some congressmen want it spent on the industries and households hardest hit by the rises in fuel and power prices that cap-and-trade will inevitably bring. Others want it spent on research into and subsidies for cleaner forms of energy. Yet others fear that the government will squander its takings, and so propose returning the money to citizens in the form of tax rebates or cuts, an idea known as cap-and-dividend. The president proposes a mixture of all three approaches.

The role of administrative measures is also up in the air. Mr Obama has repeatedly argued that it would be better for Congress to take charge of emissions than for the EPA to regulate them under the Clean Air Act, as the Supreme Court has said it can. But while Congress ruminates, the EPA is going ahead with measures that will have a bearing on emissions from vehicles in particular. Some congressmen might prefer to leave the reduction of emissions from transport up to the bureaucrats at the EPA rather than be seen to increase the price of driving—a red rag to many voters.

The volatility of carbon markets is another worry. In recent months the price of an emissions permit in the European Union, where a cap-and-trade system has been up and running since 2005, has reached a peak of over €30 and a trough of less than €10, thanks to the sour economic outlook. Analysts fear that such wild swings will make businesses reluctant to invest in low-carbon technology.

One solution is to adopt a tax on carbon instead of a cap-and-trade scheme. But that idea has little support in Congress, despite endorsements from Al Gore, America’s climate-crusader-in-chief, Exxon Mobil, its biggest oil firm, and this newspaper. Alternatives doing the rounds include setting reserve prices for emissions permits at auction and creating a “Federal Reserve of carbon”, which would manage the supply of permits—or try to—much as its namesake manages America’s money supply.

Up in smoke

By far the most common concern, however, is that the price of carbon emissions will rise too high, and so cripple the economy. Many Republicans denounce cap-and-trade as a “stealth tax”. PointCarbon, a consultancy, calculates that Mr Obama’s plan would raise fuel prices by 6% and power prices by 7% on average in 2012, and by gradually increasing amounts thereafter. At a time when the economy is shrinking and hundreds of thousands of jobs are being lost, any law that would add to the woes of firms and families is bound to be a tough sell.

Moreover, higher energy costs would be unevenly spread. States with lots of heavy industry, and especially those where coal fuels most power plants or provides lots of mining jobs, will suffer most. Many of the waverers in the Senate come from such states, primarily in the Midwest; much of the congressional leadership comes from coastal states with less to lose.

The “Gang of 15”, a group composed mostly of wary Midwestern senators, say they will not vote for cap-and-trade unless their concerns about the economic impacts on their constituents can be assuaged. They might be mollified by a generous slug of auction revenues for their states, or a mechanism to cap the price of permits, or a rule that allowed extensive use of cheap international offsets in lieu of emissions cuts at home. But those fixes would upset both fiscal conservatives and environmental hawks.

In theory, the cap-and-trade system automatically minimises the cost of reaching any given emissions target, by allowing whichever firms can reduce their emissions most cheaply to do so on behalf of others, using whatever technology they like. But neither Mr Obama nor the Democratic leadership in Congress wants to leave things entirely to market forces. They all support the idea of obliging utilities to generate a certain proportion of their output—perhaps 15% by 2020—from renewable sources, for example, and want such a rule included in a cap-and-trade bill.

As several sceptical congressmen have noted, this “renewable portfolio standard” is redundant at best, in so far as utilities constrained by an emissions cap would choose to invest in renewables anyway. At worst, it will oblige utilities to invest in renewables when there are cheaper low-carbon alternatives available, and so add to the cost of cutting emissions. Ed Markey, the chairman of a House committee that focuses on climate change and energy security, disagrees. He wants to force utilities to invest not only in renewables, but in energy efficiency too.

The president and Congress are also keen to complement cap-and-trade with subsidies of various kinds. The main beneficiary, again, is renewable electricity. The stimulus bill extends the life of an existing tax credit for investments in it. It also allows developers to swap that credit for a grant from the government, since the credit is of use only to firms that are making taxable profits—a rare thing these days. In addition the bill sets aside $6 billion for loan guarantees for renewable projects, to add to the money originally allocated for the same purpose in 2005, but never used, and further funds proposed in the latest budget. On top of all that, the stimulus allocates billions to upgrade the grid, a step that will help bring power from remote wind farms and solar plants to big cities.

Most of these measures would be unnecessary if a cap-and-trade scheme were in place. Extending the tax credit, for example, would stimulate only slightly more investment in renewables than a cap-and-trade bill, at greater expense to the government, according to a recent study by the Peterson Institute for International Economics and the World Resources Institute, two think-tanks. Unless most subsidies for renewables are phased out once a cap-and-trade system is in place, says Paul Bledsoe, a former adviser on energy to the Clinton administration, they risk creating a boondoggle akin to the proliferation of incentives for corn ethanol. If taken too far, such handouts tend to become a crutch rather than a leg-up, and can end up sapping public support for the policy.

The Department of Energy’s loan-guarantee scheme certainly has the potential to create a bonanza. The $6 billion budgeted should allow it to back loans worth $60 billion, assuming a default rate of around 10%, says an official. That, in turn, should prompt $120 billion in investments. This comes on top of $10 billion in loan guarantees for renewables initially authorised by the Energy Act of 2005, but not yet disbursed. Guarantees are also on offer for new nuclear plants and coal plants with low emissions.

The department says it aims to pick projects in as transparent and objective a manner as possible, and to concentrate on projects that were well advanced, but collapsed when finance dried up as a result of the credit crunch. But those, arguably, are the least in need of government support. And with such a lot of money to spend, the bureaucrats will need to cast their net quite widely.

In general, the emissions cuts picked by politicians are far more expensive than those chosen by the private sector. The study by the two institutes puts the cost of every tonne of emissions avoided thanks to the provisions of the stimulus bill at somewhere between $69 and $137. PointCarbon, by contrast, estimates that the carbon price under the sort of cap-and-trade bill the president envisages will be roughly $13 a tonne.

Congress is unlikely to swallow the castor oil of cap-and-trade without such sweeteners, Washingtonians say. But the more lavish the subsidies, the more expensive cutting emissions becomes—and the harder for voters to stomach.

Copyright © The Economist Newspaper Limited 2009. All rights reserved.

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