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An Inconvenient Solution By: Nicole Gelinas
City Journal | Wednesday, September 05, 2007

In a short time, global warming has graduated from niche cause to accepted fact. Though skeptics may still grumble (or shout) that the science isn’t settled, they’ve lost the battle when President Bush agrees to “seriously consider” an international climate-change treaty; when media mogul Rupert Murdoch writes that “climate change poses clear, catastrophic threats”; when conservative standard-bearer National Review runs a cover article saying that “it’s no longer possible, scientifically or politically, to deny that human activities have very likely increased global temperatures”; when Ford CEO Alan Mulally tells the Detroit News that “temperature has increased . . . mainly because of the greenhouse gases keeping the heat in”; and when New York Times everyman columnist Tom Friedman exhorts us to “go green.” Al Gore—who, less than a decade ago, dropped his nearly career-spanning obsession with climate change, recognizing that no serious politician could make it the cornerstone of a presidential campaign—now has an Oscar for the global-warming documentary An Inconvenient Truth. Some 84 percent of Americans think that human beings are contributing to global warming, with 78 percent (and 60 percent of Republicans) saying that we should do something about it “right away,” according to an April New York Times/CBS News poll.

The political answer to all this anxiety has arrived. Prominent politicians—including first-tier Democratic and Republican presidential candidates—are embracing a national “cap and trade” program to cut greenhouse-gas emissions. Powerful corporate leaders are right behind them, and the few execs still on the sidelines privately say, as one put it, that national regulation of greenhouse gases—above all, carbon dioxide—“is now as certain as death and taxes.” The mechanics of greenhouse-gas regulation are complex. But one likely result is all too clear: it will exact a significant toll on the American economy.

Cap and trade enjoys support from many free marketeers and moderate politicians because it seems, at first glance, market-friendly. If the perceived problem is power plants’ and factories’ heating up the planet by spewing too much carbon dioxide and other such gases into the air, why not impose a cost on them—currently, there isn’t one—for those damaging emissions? Just as firms pay for the carbon (coal and natural gas) that they put into their operations, the argument goes, so they should pay for the carbon that comes out (carbon dioxide).

Here’s how the cap-and-trade system likely would work. Assume that the government starts by capping greenhouse gases in two energy-hungry sectors of the economy: electricity generation and heavy industry. (Europe, seeking to comply with Kyoto Protocol environmental targets, has taken this route in its two-and-a-half-year-old cap-and-trade program.) To avoid too much shock, the government sets a generous cap in the program’s first year. It asks every factory and power plant how many tons of greenhouse gases it released into the atmosphere during the previous year, and then makes the cumulative total—let’s put it at 4 billion tons—the initial cap. Each plant or factory can emit exactly the same tonnage that it did in the previous year.

But the government doesn’t just want to hold greenhouse gases steady; it wants to cut them by as much as half over the next half-century or so. So in five years, say the feds, the cap will go down by 5 percent overall, to 3.8 billion tons, and each company’s cap will decline by the same proportion. After another five years, the government will cut the cap again, and so on. Because the companies know that the cap will keep tightening, they’ll aim to make their operations more energy-efficient, or so the feds would hope.

But what if a factory can’t reduce its emissions? Maybe it was pretty efficient already, and its customer orders are up, to boot. That’s where the “trade” part of cap and trade comes in. Suppose that a power plant elsewhere does have room to cut energy waste—say, by replacing its 30-year-old generator with a cleaner model. Now that the power plant can produce the same total power with fewer emissions, it has extra greenhouse-gas permits and can—under the new regime—sell them to the humming factory, which needs to push past its own limit. What happens if all the firms in the country can’t cut pollution enough to stay below the cap? Cap and trade has an answer for that scenario, too. Halfway around the world, in Guangdong, China, Mei Xiang Air Conditioners coughs up 10 million tons of greenhouse gases each year, but a simple upgrade would get emissions down to 8 million tons. Now, the Chinese plant can sell those 2 million tons’ worth of emissions “savings” to its American counterparts for cold, hard cash—and use the money to pay for the upgrade.

Lawmakers have introduced nearly a half-dozen cap-and-trade bills in Congress this year, including one jointly sponsored by Senators John McCain, Barack Obama, and Joe Lieberman. Presidential candidates Hillary Clinton, John Edwards, and Rudy Giuliani have all expressed interest in the idea. “So much has happened so rapidly over the past 12 months,” says Véronique Bugnion, head of North American research for Point Carbon, a group that analyzes Europe’s carbon markets. And there’s a chance that legislation won’t even be necessary. This April, the Supreme Court ruled in Massachusetts v. EPA that the federal Environmental Protection Agency could regulate greenhouse-gas emissions as a pollutant, likely allowing the White House, should it someday wish, to implement a cap-and-trade program on its own.

Individual states aren’t waiting. California governor Arnold Schwarzenegger wants the state to slash emissions to 1990 levels by 2020, and the California legislature has passed a law to use “market mechanisms,” like cap and trade, to start cutting emissions by 2012. Five western states, and one Canadian province, say that they’ll join California’s effort. On the opposite coast, New York governor Eliot Spitzer is proceeding with a ten-state cap-and-trade plan, announced by his predecessor George Pataki, that would decrease emissions by 10 percent over ten years, starting in 2009.

Corporations signing on in support of a national carbon cap-and-trade program read like the Fortune 500 list, from General Electric, which sells clean-energy technology, to PepsiCo. Some of the nation’s largest electricity generators, including American Electric Power, North Carolina’s Duke Energy, and Pacific Gas and Electric, have formally offered support. On the energy-voracious industrial side, there are General Motors, DuPont, Alcoa, Caterpillar, and Deere. Oil firms BP, ConocoPhillips, and Shell have also given thumbs-up.

Pragmatism partly explains the corporate support. Some power-industry firms see that public and political opinion is changing, and they know that the faster they sign on to proposed regulation, the more opportunities they’ll have to shape it so that it’s less harmful to them. For example, as in Europe, American power-company execs would like to see a generous initial cap and want to make sure that they can pass on to customers the cost of buying emissions allowances on the trading market.

Many corporate leaders also think that the alternative to cap and trade is a snarl of even costlier litigation, as trial lawyers and state attorneys general try to convince juries that greenhouse-gas-spewing companies unleashed natural disasters like Hurricane Katrina. A suit filed last year by California’s then–attorney general, Bill Lockyer, against Detroit automakers, alleging that they’re worsening global warming on the West Coast, is a preview. “The sooner we have a price on carbon, the better,” says Duke Energy spokesman Thomas Williams.

Executives and politicians certainly prefer a cap-and-trade program to a carbon tax, which is another policy option. With a tax, power companies and industrial energy consumers would suddenly face a huge, nonnegotiable cost to doing business. Under cap and trade, by contrast, a plant operator unable to spend tens of millions of dollars to upgrade his plant might find it cheaper to buy carbon credits from a company that can slash emissions more readily. As for the pols, proposing a cap-and-trade program, which most people won’t even understand, doesn’t carry the same electoral risk as suggesting a new tax.

Many investment banks also favor a national cap-and-trade program, at least informally, anticipating the opportunity to trade a whole new asset class on the financial markets—assets worth from $50 billion to $300 billion annually, depending on economists’ estimates of the eventual price per ton of emitting carbon. Lehman Brothers has joined American Electric Power and other companies in a voluntary pilot effort, the Chicago Climate Exchange, to cap and trade carbon in the United States. A competitor, the New York Mercantile Exchange, soon will offer standardized carbon-emissions contracts, too. And many other companies, ranging from niche start-ups to GE, support the idea, recognizing the potential for investing in emissions-credits projects in the Third World. Attend a meeting with the i-banking and power-industry players looking at this emerging market, and you’ll see that all of them think mandatory cap and trade all but a done deal. They’re already planning financial and investment products based on it for five to ten years down the road.

Soothing economic reports make support for cap and trade all the easier. The United Nations’ Intergovernmental Panel on Climate Change, for example, says that the world could reduce future greenhouse-gas emissions without suffering much economically. Costs, it believes, would equal at most a tenth of a percentage point of global annual growth. The Energy Information Administration at the U.S. Department of Energy estimates that cutting greenhouse-gas growth less aggressively would eat up under half a percent of America’s annual GDP by 2030. These figures beguile policymakers. If global warming is so cheap to fix, why not?

While cap and trade is an elegant system on paper, politicians and most of the public don’t seem to grasp that it will be much messier and costlier in practice. Any program strict enough to cut emissions growth—never mind slashing emissions!—will raise power prices in America, plain and simple. In fact, hiking power prices is really the point of any carbon cap-and-trade program. We’d be taking a huge competitive advantage—much of our power is cheap and plentiful and not dependent on international fuels—and transforming it through regulation into a disadvantage.

Keep in mind that half of America’s power comes from coal. Coal is dirty, but it has been good for us economically. Building and running an old-fashioned coal-fired electricity plant is more than 35 percent cheaper, per kilowatt of power produced, than building and running a natural-gas-fired plant, which emits far less carbon dioxide, and nearly 20 percent cheaper than a nuclear plant, which emits no carbon dioxide, according to Tufts University economics professor Gilbert Metcalf. Coal also costs less than wind or solar—by 40 percent and 70 percent, respectively—even though they’re subsidized by tax credits. Nor do we need to worry about running out of coal or reeling from an international supply shock. We’ve got at least several hundred years’ worth of the stuff right here in the U.S.

From an environmental perspective, though, coal is too plentiful and cheap, making it hard for cleaner energy to compete with it. The only way to make it cost more—and thus begin the process of weaning us off it—is through regulation. And over time, that’s exactly what a carbon cap-and-trade program does. Because burning coal creates so much carbon, coal-fired power plants would have to pay far more than cleaner competitors to continue business as usual as the government tightened the cap.

How much would power prices go up if carbon emissions were no longer free? The Energy Information Administration estimates that under a plan cutting expected emissions growth by half by 2030, the price of electricity after inflation would be higher than it would otherwise be by 4 to 6 percent by 2020 and by 11 to 13 percent by 2030, as power companies spent money both upgrading power plants and buying the emissions credits that they’d need should they choose not to upgrade. Carbon cap and trade has pushed wholesale power prices in Europe up 5 to 10 percent just since 2005, says Phil Hare, director of U.K.-based Pöyry Energy Consulting. And if Europe lowers its initially generous cap enough to encourage companies to switch permanently from coal to gas power plants, prices could rise 20 to 40 percent over a decade or so.

But prices also would depend on political decisions. The first, naturally, is how generous the government would be with its total carbon cap. Another involves determining which emissions-reductions projects in the developing world investors can fund to get carbon credits. Europe has allowed the United Nations to make some of those decisions, but given the UN’s rampant cronyism, its participation almost guarantees opaque political favoritism. Under what circumstances could the friends, fathers-in-law, and various hangers-on of UN delegates not think it’s a great idea to launch dubious businesses investing in clean energy?

The UN carbon-credits program has already proven wildly inefficient. In an article in February’s Nature, Michael Wara, a Stanford sustainable-development program veteran, noted that the UN initiative is spending billions of dollars in Western carbon-credits money to do work that should cost much less, and may be contributing to the problem instead of solving it. In fact, upgrading refrigerant plants, a popular way of winning carbon credits to sell in the European market, is so cheap and easy that many Third World firms were doing it voluntarily until the cap-and-trade West started paying them to do it. And now there’s evidence that some firms may be purposely increasing emissions just so that they can win Western money to decrease them.

Then there’s Russia, which hasn’t joined Europe’s cap-and-trade program but would enjoy a huge competitive advantage if it did. Each country’s cap is based on the Kyoto Protocol’s recommendations. Kyoto calls for Russia to cut emissions to 1990 levels—but the country’s economic decline means that it already emits far less carbon now than it did then. The likely result: tens of billions of dollars’ worth of extra emissions credits to trade in Europe’s market. “Russia is the Saudi Arabia of carbon,” a spokesman for Gazprom, the nation’s natural-gas company, told the New York Times in April. And Russia’s abundance of credits would let it influence prices by affecting supply, just as the Saudis try to do with oil prices. In a global carbon market like that envisioned by many multinational companies and trading firms, Russia’s decisions on how many carbon credits to release into the market would help determine how much a New York power company paid for its greenhouse-gas allowances. A global carbon market, in other words, could make the price of American coal-fired electricity dependent on global forces, just as oil prices are.

American companies and consumers would also feel the squeeze of the phenomenon called NIMBY: “Not in my backyard!” The feds’ Energy Information Administration assumes that American power companies would respond to the new cost of carbon by readily switching from dirty coal to cleaner technologies such as nuclear, natural gas, and biomass. It predicts that the nation’s power producers would boost nuclear generation by 50 percent over the next 23 years—five times the growth expected without a cap—and increase natural-gas output 20 percent above the level expected without a cap. But this happy scenario requires politicians to let power companies build new plants. Often, the very same pols backing cap and trade don’t want any company to build property-value-destroying, voter-repellent power plants in their constituents’ backyards.

Nuclear energy, for instance, is already an established way to produce mass-scale power for a reasonable cost. But no company has started up a nuclear plant in America in three decades, partly because fierce local and state government opposition makes it nearly impossible. In New York, Governor Eliot Spitzer wants to cap carbon emissions, even though the state’s power prices are already 57 percent above the national average. But at the same time, he hopes to close the downstate region’s only operating nuclear plant, Westchester County’s Indian Point, “as soon as replacement power is available.” If New York caps emissions and encourages power companies to build more nuclear plants, power prices will go up to pay for the new construction. But if New York caps emissions and effectively caps new generation by discouraging power companies from building nuclear plants, prices will go way up. Financiers also hesitate to back new nuclear plants, because Washington opponents—these days led by Nevada Democrat and Senate majority leader Harry Reid—have stalled on building a permanent fuel-waste storage site in a remote area of Nevada.

Natural gas is a second cleaner alternative to coal. But natural-gas power plants, even if companies get to build them, need, well, natural gas, and our domestic production falls short of growing demand. To import gas, we’d have to build more natural-gas terminals on our coastlines—where, citizens fear, terrorists might blow them up. Earlier this year, Chevron canceled plans to build a terminal off the California coast, after years of resistance; on the East Coast, politicians on Long Island and in Rhode Island have stubbornly opposed terminals.

Wind meets with NIMBY resistance, too. Last year, Massachusetts senator Ted Kennedy maneuvered to block the proposed Cape Wind power farm off Hyannis, saying that it would hurt navigation and tourism. Consultants studying an upstate New York project found that windmills had killed hundreds of bats and migrating birds over a period of five months.

Many cap-and-trade supporters, joined by coal-mining interests, point to newfangled “clean” coal technology as a catchall solution, claiming that it would allow us to exploit our coal supplies while lowering emissions. Clean coal could replace regular old dirty coal to make electricity, it’s true, but it would involve either gasifying the coal instead of pulverizing it, so that it burned more cleanly; or capturing and storing carbon emissions from the plant, most likely underground, so that they didn’t escape into the atmosphere; or both.

The technology and expense of such new approaches are uncertain. Michael Rencheck, senior vice president of engineering at American Electric Power, supports a cap-and-trade program but estimates that the cost of producing electricity at the first type of cleaner-coal plant would be at least 20 percent higher than at a conventional one. Capturing and storing the carbon, Rencheck believes, would cost 60 to 70 percent more than old-fashioned coal generation. If and when the technology works, the price will fall, but that could be decades away.

The political and legal hurdles to making coal plants cleaner might dwarf the technical issues, says James Liles, a regulatory advisor with the Milbank, Tweed law firm who also supports cap and trade. While it’s quite possible, he explains, for power-plant operators to lay underground pipelines to depleted natural-gas fields, where they could store carbon emissions, such an undertaking would cost tens of billions of dollars and involve heavy construction work near hundreds of power plants, “many located in densely populated areas far away from any fields.” Because of inevitable state and local opposition, property-rights rows at now-dormant gas fields, and investor worries about technical glitches and legal liability, it’s likely that the feds would need to coordinate, and perhaps financially guarantee, the first few carbon-storage projects.

The biggest problem with cap and trade, however, is that it collides with the reality of global competition. We live not in a world of united nations, where the environment comes first, but in a cutthroat competitive economy, where small changes in certain prices can determine, say, whether a businessman keeps his manufacturing plant in upstate New York or places his orders instead with a factory in China. Developing nations won’t voluntarily give up a major competitive advantage—cheaper power—should we hand it to them. Can what’s left of New York’s industry, for example, stomach a 10 percent or greater increase in the price of power, without sending more jobs offshore?

Even if we decide to hurt ourselves economically to save the world, helping China and India and other less developed countries become more energy-efficient won’t reduce the planet’s global-warming emissions anyway. Over the past 25 years, for instance, because China has been growing and modernizing its economy, it has actually decreased its carbon inefficiency by nearly two-thirds. But as China’s corporations and citizens grow richer, they use more carbon even as they get more efficient, using the profits from their newfound productivity to buy energy-gobbling automobiles and dishwashers. (As the Manhattan Institute’s Peter Huber explains, Americans similarly take advantage of higher energy efficiency by using more electricity to do once-unheard-of new things, such as charging cell phones.)

If America’s politicians and corporate leaders truly believe that much of the world will suffer irrevocable damage from climate change within the next century, then obviously we should try to stop it. But the first step shouldn’t be a feel-good cap-and-trade regime. Federal, state, and local government should instead work together to remove all obstacles that prevent private companies from building new nuclear power plants, since it’s foolish not to take immediate advantage of a proven, cost-competitive alternative to dirty coal.

After taking that obvious step, pols and business leaders should do a gut check. Are they so certain of the catastrophic effects of climate change that they would support a straightforward emissions tax, rather than a carbon cap-and-trade program that (deceptively) seems so easy? After all, strip away the rhetoric about cap and trade, and it would have the same effect as a tonnage tax on carbon emissions: making such emissions more expensive; discouraging carbon-intensive power generation; and allowing the market to decide which environmentally friendlier technologies—solar, wind, what have you—would be competitive enough to take its place.

The pols and business leaders could suggest that America gradually impose such a tax, one that’s high enough within a decade to encourage industries and consumers to switch permanently to cleaner technology. A tax would mean higher power prices, too, but at least it wouldn’t mean directly subsidizing competitors abroad. And the feds could use the tax’s revenue to reduce taxes elsewhere in the economy—perhaps cutting dividend and capital-gains taxes further, to encourage the massive private investment needed to build the next generation of power generators. Nor would a tax create a new multibillion-dollar global commodity whose value could depend on political manipulation in dark corners of the world.

If it’s true that a consensus about global warming really exists, not just in press releases and on op-ed pages but in the back rooms of power, too, the politicians and the business leaders wouldn’t be afraid to suggest such a tax. They would insist on it.

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