"Cap and Trade" Market System for CO2 Reduction Likely to Raise New York Electricity Prices

Congress is nearing action on a proposed “cap and trade” market system intended to lower carbon dioxide emissions from power plants. Basically, a “cap” on emissions is set, and certificates equaling the amount of the “cap” to emit CO2 are given away or sold at auction by the government, and are also traded in unregulated secondary markets after their initial purchase.

Consumer issues include

  • whether certificates to emit CO2 should initially be given away or sold,
  • how to use the sale proceeds if they are sold,
  • the price impacts when the cost of CO2 allowances is factored into wholesale electric prices,
  • the price impacts of unregulated secondary trading markets, and
  • whether a carbon tax would be preferable.

Sale or Gift of Allowances
In Europe, CO2 allowances were given away to existing power plants. These allowances had value, and were soon trading in secondary markets, and that price is included in the price of wholesale electricity. The lesson is that if a “cap and trade” system is begun, the certificates which allow injection of CO2 into the air, a public or common good, should be sold with the proceeds going to the public. Current federal legislative proposals would allow the gift of a portion of the allowances to power companies with coal-burning plants.
State utility regulators and consumer advocates are urging Congress to eliminate a provision in the pending climate-change bill that gives free emission allowances to certain companies that burn coal to make electricity.

The Waxman-Markey bill, which cleared a key House committee Thursday, would give as much as 5% of initial credits to merchant coal generators and 30% to electric utilities when a cap-and-trade program is scheduled to begin in 2012. Unlike utilities, whose prices are controlled, merchant coal generators sell electricity to other companies at market prices.

Utilities are expected to use their credits to cover their own emissions, or sell the credits and use the money to hold down consumer energy costs, which are expected to rise as a result of the legislation. But there’s no guarantee unregulated coal generators would use their credits to reduce electricity prices, which would ultimately benefit consumers. They could take the credits and not reduce their prices.

Under a cap-and-trade program, companies that produce greenhouse gases would be given credits covering a portion of their emissions. If some companies produce less than their “cap,” they could “trade” their credits with others.

In the past few days, state regulators have urged bill authors Reps. Henry Waxman (D., Calif.) and Edward Markey (D., Mass.) to redirect to utilities all of the credits earmarked for merchant coal generators. The National Association of Regulatory Utility Commissioners, in a letter, wrote the congressmen that giving credits to the coal generators “will only lead to windfall profits for a particular sector of the electricity industry at the expense of end-use customers.”

Other groups, including those that represent consumer advocates and public-power utilities, also oppose the allocation method laid out in the House bill, HB 2454. “Our concern is that market prices will rise anyway, and consumers won’t get the benefit of the allowances given coal generators,” said David Springe, consumer counsel of the Citizens’ Utility Ratepayer Board in Topeka, Kan., and president of the National Association of State Utility Consumer Advocates.

Wall Street Journal, May 23, 2009, Coal Generators Face Opposition on Credits.

New York participates in the RGGI program, a regional “cap and trade” system spawned in the Northeast during the Bush administration when it refused to regulate CO2 emissions. RGGI allowances are sold by NYSERDA, a state authority, and the proceeds spent as determined by NYSERDA. New York, in a concession to power plant owners, has decided to give some allowances away, outside the auction system. See Did Court Challenge to Legislatively Unauthorized Greenhouse Gas Allowance Scheme Prompt Governor’s Concession to Power Plant Owners?

How to Use Proceeds from the Sale of Allowances
A cap and trade system will raise the price of electricity adding to the energy burdens of the poor, who often have the least energy efficient homes and appliances. PULP has argued in its comments to NYSERDA that the CO2 emission allowance sale proceeds from the RGGI program should be used for energy efficiency purposes with a substantial amount targeted to reduce energy burdens of low income customers. See PULP Urges NYSERDA to Use RGGI Auction Revenue to Support Low Income Energy Efficiency Programs.

NYSERDA did not adopt PULPs recommendation.

Price Impacts of Cap and Trade
The price impact of a federal cap and trade program has been estimated to be one cent per kWh or more in New York, so a customer using 500 kwh/month might see a $5 monthly increase. This adds to the burdens of New York’s low income customers, 330,000 of whom were shut off in 2008 for nonpayment of bills, which are close to the highest in the nation. Also, raising the price of electricity does not address the other major sources of CO2 emissions such as cars and trucks and fuels for home heating.

Secondary Trading Markets
The cap and trade system is heavily backed by energy traders, who would trade allowances after their initial sale – or gift- by the government in unregulated markets. Reliance on the “invisible hand” to accomplish CO2 reduction has many skeptics. As stated by one environmentalist:

Cap-and-trade could too easily be manipulated or gamed. In an age of global financial turmoil, much of it brought on by dubious financial creations such as credit default swaps and subprime mortgage derivatives, these folks didn’t trust the market makers (or regulators) to properly manage the process. They weren’t buying the argument that financial trading markets are always elegant and efficient. Instead, they see cap-and-trade as being rife with potential mismanagement and corruption. Equally important, they didn’t believe that a cap-and-trade system could be transparent or open enough to guarantee critical safeguards and to provide a fair and accurate pricing mechanism.

Changing Climate: Carbon Tax Gaining Momentum over Cap-and-Trade? Renewable Energy World, May 19, 2009. It is conceivable that the price of allowances could be driven much higher through a combination of secondary market price spices in the organized electricity spot markets such as those of the NYISO, and that the market system simply will not work.

Carbon Tax – A Better Alternative to Unregulated CO2 Allowance Markets?
A carbon tax would be aimed only at producers who emit CO2. One of the anomalies of a cap and trade system is that it will raise the price of electricity produced without major CO2 emissions, such as nuclear, hydro, and wind. This is especially true in states like New York where power plants were sold to merchant power owners who can obtain spot market clearing prices set by fossil fueled plants that have incorporated into their price demands the cost of CO2 allowances. The system will create a huge windfall for nuclear power plant owners. And it will do nothing regarding major CO2 sources other than electricity production.

The cap and trade system appears not to be successful in Europe, other than to raise the price of electricity. Yet the infatuation with market solutions lingers, and coupled with the benefits to traders and sellers who will enormously benefit from the system. With endorsement by some environmental groups — who have never seen an electricity price increase they didn’t like — the policy discussion has moved from a carbon tax, which had been advocated by Al Gore, toward the trendier market system that does not involve a “tax” — even though its impact is likely to raise electricity prices far more than a carbon tax would to accomplish the same result of raising the price of power from CO2 emitting power plants. Its popularity is political, not practical:

Cap and trade, by contrast [to a carbon tax], is almost perfectly designed for the buying and selling of political support through the granting of valuable emissions permits to favor specific industries and even specific Congressional districts.

See From a Theory to a Consensus on Emissions, NY Times, May 16, 2009. New York City Mayor Bloomberg , in a speech to the National Conference of Mayors in 2007, why he prefers a carbon tax over the can and trade market based system, and using the tax proceeds to reduce federal payroll taxes:

Both cap-and-trade and pollution pricing present their own challenges – but there is an important difference between the two. The primary flaw of cap-and-trade is economic – price uncertainty. While the primary flaw of a pollution fee is political, the difficulty of getting it through Congress. But I’ve never been one to let short-term politics get in the way of long-term success. The job of an elected official is to lead – not to stick a finger in the wind. It’s to stand up and say what we believe – no matter what the polls say is popular or what the pundits say is political suicide.

From where I sit, having spent 15 years on Wall Street and 20 years running my own company, the certainty of a pollution fee – coupled with a tax cut for all Americans – is a much better deal. It would be better for the economy, better for taxpayers and – given the experiences so far in Europe – it would be better for the environment. I think it’s time we stopped listening to the skeptics who say, “But for the politics,” and start being honest about costs and benefits. Politicians tend to prefer cap-and-trade because it obscures the costs. Some even pretend that it will lower costs in the short run. That’s nonsense. The costs will be the same under either plan – and if anything, they will be higher under cap-and-trade, because middlemen will be making money off the trades…

For the money, a direct fee will generate more long-term savings for consumers, and greater carbon reductions for the environment.

See Bloomberg Calls for Carbon Tax on Emissions, N.Y. Times City Room Blog, November 2, 2007

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