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Countercyclical Capping
A few days ago I suggested that although Barack Obama's revenue projections for his greenhouse gas cap-and-trade plan might be a little optimistic, they were "in the right ballpark." Partly this is because the plan won't take effect until 2012, and I suspect that demand for energy will rise by then, increasing the auction revenue for permits enough to generate $80-100 billion per year. Megan McArdle disagrees:
I doubt economy-driven demand will have recovered by 2012. The major economies are crashing so hard that it will take years of growth to get demand back where it was, and the big developing countries that drove demand past capacity are in worse shape than we are....
[In addition] I think it is decidedly iffy whether congress actually passes any cap and trade system with teeth. For a cap and trade system to work, it will have to make energy more expensive at a time when incomes are declining. This will be very, very, very unpopular.
These are reasonable points, but my guess is that (a) demand will have largely recovered by 2012 and (b) the initial permit price will be low enough not to have a huge effect on the price of energy at first. So it won't be all that unpopular. Beyond that, though, there's another point buried here that's worth unpacking a bit.
In my magazine piece (which you should read!) I go into a little more detail about the difference between cap-and-trade and a carbon tax, but the nickel version is simple: Financial folks generally prefer a tax because it's predictable. You know exactly how big the tax is now and how big it will be in the future, and that allows you to plan your investments. Conversely, you don't really know what effect any particular tax rate will have on carbon emissions. You have to take your best guess.
A cap-and-trade system is similar to a tax in the sense that you have to buy a permit for every ton of carbon you emit, but the predictability is exactly the opposite. There's a firm cap, so you know exactly what effect the plan will have on carbon emissions, but you don't know for sure what the permit price will be at any given time. If demand for energy rises, the price of permits gets bid up. If demand goes down, the world is awash in permits and the price goes down.
There are pros and cons to both a carbon tax and cap-and-trade, but here's one of the pros of cap-and-trade: The price of permits is likely to go up in good times, when energy demand is high, and down in bad times, when energy demand drops. In other words, it's countercyclical. During recessions the effective tax rate goes down, and it does so automatically. Macroeconomically speaking, that's good. So that's a point in favor of cap-and-trade.
As for whether Congress will pass a plan with teeth? Good question. As with a tax, there are lots and lots of opportunities for special interest tinkering in a cap-and-trade plan. Auctioning 100% of the permits, rather than giving some of them away to existing polluters, is the key issue to insist on, but there are others too (it's point #9 in my article). Later this year we'll see if Obama can keep the sausage factory on the straight and narrow.
I hate to say this, Kevin,
I hate to say this, Kevin, but you are acting in the standard American political fashion, which is to assume that the only universe that exists is America, and that the outside world has no relevance to anything in America.
It's not like cap-and-trade is some completely novel concept that's never been heard of before. There is plenty of experience with at least some aspects of it, based on schemes all over the world. Rather than theorizing about what *should* happen (according to the same economists' view of the world that gave us the recent financial unpleasantness) we can actually go out and measure things. Long story short
(a) there is fsckall convergence in the price of carbon across the world
(b) there has been precious little real reduction in carbon emission; what there has been an awful lot of is very smart people applying very legalistic readings of the relevant laws and contracts so as to shuffle lots of money around.
Would a carbon tax do any better? It certainly couldn't be less effective, and it would probably allow for substantially less of the sort of shenanigans that we have see as a result of carbon trading.
But you don't have to take my word for it. You can listen to David Victor, Director of Stanford's Program on Energy, discuss the whole sorry saga here. This file is pretty recent, only about ten days old.
(Note, the inital http : // part of the URL has been stripped so I am not banned as spam. Readers will have to cut and paste the URL manually --- sorry about that.
And yeah, yeah, it's an iTunes URL and Apple sucks. Whatever, get over it. It's a damn interesting talk, regardless of where the URL lives.)
deimos3.apple.com/WebObjects/Core.woa/Browse/itunes.stanford.edu.1299566665.01913194582.1937281042?i=1525419968
Disagree with megan.
My Indian friend says they are still growing, only at about half the rate pre crisis. China,I'm not so sure about, and they are a much larger consumer. In any case, the conjunction of depletion, and the collapse of investment in new oil capacity, mean world oil production capacity will soon be dropping. Of course exploding oil costs, might well make adding any extra energy costs politically inexpedient. Remember how whenever the price spikes, politicians pander to their constients and propose gas tax holidays.
Megan's second point is very likely correct, I am sad to agree.
I would much prefer a tax (and I'm not a financial type). Because it allows some flexibility economy wise. Because we don't risk a putting a ceiling on an important part of the economy, it should be possible to be more aggressive with the tax. And of course there will always be the incentive to keep making reductions, even if the country overall is way below the cap.
Imagine you're preparing to
Imagine you're preparing to invest in a new oil refinery, to meet burgeoning demand in the Northeast for local mixtures of gas and heating oil. You're talking with your accountants to get an estimate of operating costs; you're incorporating the latest technologies so that you're producing a few percent less than the current refineries you'd be competing with.
With a tax, your accountant says "this is how much the tax will add to the cost of our operations."
With a cap, when you ask your accountant how much the necessary carbon credits will cost, he's going to answer, "We don't have any goddamned idea." There's best-case and worst-case scenarios, and the worst-case scenarios and a lot of the "bad but not worst-case" ones put you so far out of business you can't even see the break-even line. Are you going to invest in that sort of situation? Heck no.
Even worse, consider it from the point of a manufacturer looking to open a new plant in Peoria, maybe to employ some recently laid-off workers or something. You've got a pretty good idea what it's going to take to buy the equipment, the raw materials, and what you can sell them for, but... Your manufacturing process is energy-intensive. What's your energy going to cost, under a cap-and-trade system? Who the hell knows? Some Wall Street wizard corners the market in carbon credit futures and your factory's headed for closed-door city. Or you could put it in China, where nobody's going to give a crap about what got emitted to make the juice you need. Congrats! You've added yet another disincentive to invest in American manufacturing! I'll bet you'll be asking "where did all those good-paying jobs go?" when all is said and done, too...
The cap-and-trade system's unpredictability makes it a terrible thing to look to implement during an economic downturn. People are already making conservative capital investment decisions (i.e. not spending any money) because they're uncertain about future returns. Do you really think adding an additional layer of uncertainty on top of that is going to help?
A point in favor of cap-and-trade? I don't see it!
tagged as:- solution
Kevin, you say that the price of carbon-emission permits will go up when the economy booms, while it will go down when energy demand drops. But that's not unique to cap-and-trade - when fossil fuel is taxed, tax proceeds will similarly fluctuate with the state of the economy.
For another look at the various policy options, see my Open Letter warning President Obama about a Global Cap-and-Trade Scheme.
tax is useless, that's why cap.
tagged as:- solution
Uhh, no.
We need businesses to realize there is no free lunch. They've been getting a free lunch. There's a limit to how much water they can get, how much air they can pollute, and we need to charge them for this.
A tax won't reduce anything. They'll just pass it on to consumers, who'll pay higher everything, which will lower demand... And not raise demand for non-taxed items.
You want to emit carbon into the air? You need to know how much you can and will. Just like the price of steel or employees for your building, you'll have a best case and a worst case estimate. Yes, the answer right now is 'dunno'. But guess what... Project out steel or employees a few years and you won't know, either. Especially if you look at highly variable things like metals, oil, rubber which have a fairly inelastic short-term supply and a high demand.
What terrible arguments, if I can knock them down without a degree.
Yeah, except it's quite easy
Yeah, except it's quite easy to set up long-term contracts for commodities if you think that's going to be advantageous. And labor costs aren't particularly variable. You can't necessarily predict the carbon pricing regime into the future - especially as the entire point of carbon credits in the first place is that you want to ratchet down the supply of them as time goes on.
Of course, that's also true of a carbon tax. But at least for a tax, it will require an affirmative action of government to increase the cost. For carbon credits, a few large financial firms deciding to speculate in the market could cause a huge disruption. (Not to mention a cartel of your competitors, who might snaffle up the available credits specifically to drive you out of business!)
All this is still ignoring that putting carbon taxes on industries that can relocate to other jurisdictions which will not charge a carbon tax, or issue carbon credits, under any circumstances is mistaken on its face. At least with traditional industries displaced by pollution controls, at least the locals don't have to deal with the mess the plant would have been emitting. But with CO2, it doesn't matter if it's being emitted in Massachusetts or Mongolia, you've still got to deal with it. Policies which cause energy-intensive manufacturing to relocate to areas where their power is produced by unregulated coal-fired power plants is, quite literally, worse than doing nothing at all, even if you're ignoring the costs to American employment.
You also seem to misunderstand the nature of the volatility of the carbon credit market. The problem isn't that businesses are unsure of how much carbon they'll emit if they engage in X activity; that's just a math and engineering problem. The problem is that the cost of securing the credits involved is volatile, and you can't afford to budget for the low-end projection. How much manufacturing didn't happen in Europe because businesses anticipated carbon credits would cost significantly more than they do now? (And don't get me started on the intellectual bankruptcy of trading carbon credits sourced from reductions of economic activity associated with the Soviet collapse...)
volatilility is not an advantage
A cap-and-trade (to the extent that it works) is like a tax. Even though nominally it is driven by the cap, actual behavior is still price driven. Limited permits results in a price created by supply and demand. Behavior is driven by a combination of current price and anticipated future price.
Price volatility might be tolerable if we were going to set a one time cap. But the point with using cap-and-trade as part of the solution to the climate crisis is a tightening cap.
So suppose we institute the first stage of the cap during a depression. Carbon emissions are lower just because GDP is shrinking. OK, so at the point permits are low in price. Under those circumstance investments in reducing carbon will be low, because lower production takes care of that.
OK, but the cap will be lower later. Smart investors will buy some of these cheap permits now to bank for later, and make investments on that basis besides.
If you look at actual behavorior that doesn't happen. For example, the famous RECLAIM incident. Buyers will indeed banks permits of they are cheap enough, but that won't drive prices very high. And when companies do their projections they will NOT project high emissions prices. They will project based on today's emission prices. For one thing CEOs bonsus are based on controlling costs today. They don't want to hear about reasons to invest money in environmental protection to reduce costs down the road. They want to hear why they can put any money they have to invest into cutting current costs or increasing market share. So, as happened with RECLAIM, if todays costs are low everyone will anticipate that tomorrows permit cost will also be low - higher than today maybe, but not very high. Everyone will assume that everyone else will make investments in reductions. Cause there is always a great business case to make for the other firm making investments to reduce its emissions. Volatility is NOT a good thing for emissions reductions. You need to consider the way budgeting politics works within firms.
Anonymous above is Gar Lipow
tagged as:- result
Retries due to Captcha changed an identified post to Anonymous
All those points 'against' are actually forces we <i>want</i>.
tagged as:- result
There's no reason someone can't create a hedge against future increases in the carbon credits... It'd likely be much more expensive than with most commodities, because there's less chance it'll go down, but...
These are all positive points in favor of carbon credits - that someone could buy them up and not use them, driving up price? Positive! That they're tougher to predict and reflect the actual market and atmosphere? Positive!
Find a real negative, please. Because the point is to get people to avoid expelling carbon, not to make money.
"All this is still ignoring
"All this is still ignoring that putting carbon taxes on industries that can relocate to other jurisdictions which will not charge a carbon tax, or issue carbon credits, under any circumstances is mistaken on its face"
This is bullshit. A carbon tax makes it EASIER to force world wide compliance,not more difficult.
The way it works is that the US imposes a tariff on all imports equal to the imputed carbon generated in the manufacture, minus whatever carbon tax was imposed at the source. (Sure, imputed carbon is not an exact science, but one can do well enough.) Now China has a choice - they can impose no carbon tax and have the US capture all this revenue on chinese imports, or they can impose their own tax. Both ways, there will be severe constraints on future Chinese pollution.
By structuring this as a tax, and by applying it in this way to all nations, WTO restrictions on tariffs would, I imagine, not be relevant --- as far as I know, all WTO cares about is that you treat foreigners and local producers equally, they couldn't care less about the rest of what you do.
Conversely, trying to impose this sort of regime on other countries via a cap-and-trade system is a lot trickier, Now their is a vast amount of room for bickering about what counts as preferential treatment, especially if, as we all expect, huge numbers of CO2 permits are simply given away or grandfathered in, the way polluters were grandfathered in with the air and water control acts of the early seventies.
Demand recovered by 2012
I hope you're right. Noted economist and financial expert Suze Orman thinks that we won't recover completely until 2014-15.
Sausages
KD: "..we'll see if Obama can keep the sausage factory on the straight and narrow..."
Nah. The sausages are headed down the primrose path, unless the domsday scenario is nipped in the bud today.
Volatility
Under RECLAIM, hedgins was allowed and encouraged. The problem is that if prices are low enough, hedging won't drive those prices high enough to encourage investments needed to meet the next phase of the cap. In the RECLAIM NOx trading scandal, when the cap tightened, not enough capital investment had been made to meet the next phase. The industries involved had to be given an extension, combined with standards based regulations.
This is not saying "No Cap-and-trade ever". It is saying that volatility is a bug,not a feature and if you want cap-and-trade to work you need to find a way to reduce that. Market solutions like allowing banking and enouraging hedge funds is NOT enough to reduce volatility enough to drive change. One suggestion is when you auction permits, put a MINIMUM PRICE on those permits. That minimum price should rise as the cap tightens. That may seem like a very wonky point, but if you absolutely want cap-and-trade to work, it is essential. And Kevin's painting volatility as a positive thing does not help the situation.