UPDATED exclusive report: Preventing windfalls for polluters but preserving prices — Waxman-Markey gets it right with its allocations to regulated utilities

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"UPDATED exclusive report: Preventing windfalls for polluters but preserving prices — Waxman-Markey gets it right with its allocations to regulated utilities"

UPDATE:  The authors have clarified a key example with a figure and answered some of the questions, so I’m reposting this:

As the U.S. makes significant progress towards enacting a cap-and-trade system to control greenhouse gas emissions, some are worried that the new Waxman-Markey bill (W-M or H.R. 2454) may enable polluting utilities to reap windfall profits.  We disagree.  The allowance allocation provisions of this bill have been thoughtfully crafted to avoid a repeat of Europe’s experience.  There certainly are issues and challenges remaining with the legislation, but windfall profits arising from allowance allocations isn’t one of them.

So begins an exclusive analysis of Waxman-Markey for Climate Progress by two of the country’s leading experts on the electric utility industry and energy economics, Peter S. Fox-Penner and Marc Chupka.  The debate over the large amount of allowances given to utilities is certainly heated (see “Greenpeace’s indefensible attack on the House clean energy bill perpetuates myths about the European carbon trading system“).  But very few are expert on the economics of regulated electric utilities — including me.  That’s why I asked for this analysis from two former colleagues from the Clinton Energy Department.  Fox-Penner is an internationally recognized authority on electric power industry issues, whose forthcoming book is The Future of Power (Island Press).  He held the position of Principal Deputy Assistant Secretary for Energy Efficiency and Renewable Energy right before I did.  Chupka is an economist with two decades of public and private sector experience analyzing the market impacts of both domestic and international energy and environmental policy.  He was Acting Assistant Secretary for Policy when I was at DOE.  This analysis examines the likely impact of the allowance allocation to utilities and includes an extended Q&A at the end.

The key to W-M’s success in this area is that it is careful to give the overwhelming majority of free utility allowances to the electric or gas retail distribution company, not the generator or the entity that sells wholesale gas or power itself.  Whether or not you have electric or gas deregulation in your state, you still receive your power or gas deliveries from a regulated distribution company.  If you are served by a rural electric co-op they are your distributor, and similarly for a government-owned utility like LADWP.  All distributors are either state-regulated, customer-owned, or government-owned.

While you may not know it, every monthly power or gas bill that customers pay separates the cost of delivering gas or power from making or buying the energy itself.  State regulators, city managers, or coop management boards — who have full access to the accounts of distributors –  set distribution charges so as to manage the profits earned by the distributor.  This is a key point.  Unlike some other parts of the utility industry, distributor profits are strictly controlled.

W-M specifies that the bulk of free allowances given to utilities can be given only to a gas or electric distributor — not to a standalone retailer or generator.  Furthermore, the law says that “the allowances distributed to an electric or gas local distribution company “¦ shall be used exclusively for the benefit of retail ratepayers of such”¦company.”  Each state regulator or manager of a coop or municipal utility must conduct a proceeding to determine how the value of allowances will be treated – for example some of the proceeds might help fund energy efficiency if the regulators decide that represented benefits to retail customers.  But, W-M does not allow the size of individual customer rebates to reflect that customer’s metered energy consumption.

With these provisions, it will be awfully hard for any utility to harvest a windfall from the free allocations — especially a shareholder-owned utility.  Yes, the free allowances given to the distribution utility will be worth a lot.  But the law is pretty clear that the benefits of receiving the free allowance go to the utility’s customers, not their shareholders.

As folks who’ve been involved in utility regulation for a long, long time, we see this as pretty straightforward and transparent.  State regulators will all know the number of allowances each utility gets and their value. [See the Q and A below for more on this] They will see the accounts books of utilities (as they do today).  To give ratepayers the value of the allowances, they will probably do one of two things:

  1. Have the distributor sell the allowances in the secondary market and use the revenues to lower distribution bills to their customer dollar for dollar;  or
  2. If the distributor also supplies power, which most do these days, use the allowances as currency to pay for power.

Either way, profits are unchanged.  For those who want to delve more deeply into the details of ratemaking for the free allocation, at the bottom of this post we include some Q and A on some of the fine print.  But the important takeaway is that material windfalls are about as likely as the Washington Nationals winning the pennant this year.

If you’re wondering about natural gas utilities, pretty much the same process and rules apply.  Natural gas allocations are easier to figure out than electric utilities because it is easy to calculate the precise amount of CO2 created by the customers of any gas distributor.  This amount is used to set an allocation of free allowances to the regulated gas distributor.  As with electric distributors, the value of the free allowances must be given entirely to gas customers via the same kind of uniform rebates or credits given to electric customers

Preserving the Price Signal with Free Allowances

It is important not to confuse this absence of windfall profits with the “price signal” issue, as in: “Doesn’t giving away allowances blunt the very carbon price signal we are trying to send with a cap and trade system?”

Free allocations can blunt the price signal along the value chain, but here again W-M includes protections against this happening.

When cap and trade kicks in, one thing will certainly happen — wholesale power and gas prices will begin to increase in proportion to the carbon content of the power source and the (actual or estimated) price of allowances.  Coal-fired generation produces roughly one ton of CO2 per Megawatt-hour (MWh); allowances priced at $20/ton will raise coal-fired power prices in the wholesale marketplace by about $20/MWh.  This wholesale marketplace is where utilities and deregulated generators respond to economic signals to dispatch their plants, sell power to each other on either a short or long term basis, and it is also the market utility managers and regulators look to when they set utility rates or decide what type of plant to build.

Everyone trading in this market already has a lot of experience with including the cost of emissions permits in their power prices.  In most of the country all coal-based power includes the cost of sulfur dioxide permits in just the same way it will include carbon prices.  Regardless of how any power generator gets their allowances — including for free — they will offer their power in the wholesale market at a price that will cover all of their costs, which include the market price of allowances consumed in generating the power.  It’s economically correct (an opportunity cost is just as valid as an out-of-pocket cost), it’s good business for them, and best of all, it makes sure that the price signal is sent downstream to the market regardless of how allowances are allocated.

So far so good.  What about the prices seen by individual power customers?  Doesn’t giving out the allowances to power distributors for free undo the very price signal that will help consumers get away from high-carbon fuels, invest in energy efficiency, and so on?

Here’s where W-M got it right.  It forbids distributors from giving customers the value of the free allowances as a “per unit price rebate.”   So retail customers will still have to pay a price for power and natural gas that includes a carbon price signal.  The free allowance value must be given to them as a lump sum rebate.

Continuing the example above, suppose that a utility was 100% dependent on coal, so its own power price went up $20 per MWh, which is the same as 2 cents/kWh.  This utility will pass on its cost increase dollar for dollar (if it doesn’t then its own profits will go down.)  The average customer of this utility uses 1000 kWh a month, so they’ll pay 2 cents/kWh x 1000 kWh = $20 more a month.  They see the price signal because every additional kWh they use costs them 2 cents more and every kWh they save will lower their bill an added 2 cents.

This customer will get a monthly credit on the distribution portion of their bill of $10 $18, offsetting about half 90% of their overall bill increase [see figure, click to enlarge].

utility-allowance-allocation-example-for-waxman-markey-bill-big

But it receives this credit (or rebate) no matter how many or how few kWh they use — that’s the rule in W-M.  The credit or rebate doesn’t change the customer’s incentive to switch to lower-carbon power or (better yet) reduce their power use.  In fact, if customers saved enough power they could be better off under the W-M bill, since the rebate will be based on the average customer’s power carbon footprint.  If they are well below the average for that utility, they might actually come out ahead.  Moreover, since energy consumption and expenditure is related to household income, the uniform rebates represent a progressive approach to consumer cost mitigation.

[JR:  I would add that Waxman-Markey has an energy efficiency requirement for utilities -- and the Public Utility Commissions can also use some of the allowance value for efficiency programs.  In the example, even a modest 20% efficiency gain for the average customer -- easily achievable by a typical customer of a coal-based utility, since most of those are ones with relatively weak efficiency efforts to date -- would lead to a net reduction in total energy costs.]

All in all, W-M got it right on windfall profits and price signals.  Other parts of the bill might pose efficiency or equity concerns, but these parts shouldn’t.

Q and A

1.    Your examples assume that all companies are independent.  What if a deregulated generation company also owns a regulated wires company?  Don’t the shareholders of the overall holding company get windfall profits?

No.  When regulated wires companies are owned by larger holding companies, they are always required to keep separate accounts for the regulated wires company only.  The allowances go to this company and can be used only for its customers.  Transferring the value of the allowances to another part of the holding company would violate the W-M law.

2.  State regulators, municipal power managers, and co-op managers already have a lot to do.  How do we know they’ll get it right?  Didn’t they often fail to regulate holding companies properly in the past?

Mistakes are always possible, but this is about as straightforward and transparent as anything in utility regulation.  The profits of utilities are easily observed, allowance allocations and prices will be public, and the law is very clear on this point.  Regulators and coop & public power managers will have little incentive to allow manipulation of the ratepayer benefit standard.

2.    In your example, the per-customer rebate is $10 $18 per month.  If the fixed distribution charge is $20 per month, a rebate is possible.  What if the real numbers are reversed, and there isn’t enough money in the fixed part of the distribution bill to give a credit?

The credit or rebate can be larger than the fixed distribution charges, and offset some of the generation or commodity gas charges.  After all, the total customer rebates only reflect the total value of allowances given to the distribution company — so they are not affected even if the allowance value is higher than the overall fixed distribution charges that they are entitled to charge for providing distribution services. But, it will not affect the marginal cost of consuming additional energy or the marginal savings from conservation.  In addition, a credit can be spread across many months or years.  If necessary, the distribution company can literally give the money back to customers via a refund check.

3.    How will free allowances actually be allocated to distribution companies?

Out of the available total amount of free allowances, they will be allocated pro-rata based on the estimated baseline emissions of CO2.   For electric utilities, baseline emissions will be estimated as the average of 2006-2008 CO2, or any other consecutive three year period between 1999-2008 chosen by the utility.   This allocation formula also targets the consumer benefits to those regions that experience the highest cost increases, such as the South East and Midwest, which is not only politically necessary but also equitable in our view.

Of course, we expect utilities to choose the three year period with the highest CO2 emissions to boost their percentage of the allowed auctions.  While this may set off rivalry for the free permits, it doesn’t change the emissions limits, which is what’s important.

4.    Isn’t it impossible to trace actual power flows from generators to individuals, and therefore its impossible to allocate free allowances accurately?

We can model power flows with more than enough accuracy today to ensure that allowance allocations among distribution companies are reasonably accurate and fair – that is, they will approximately reflect the underlying amount of CO2 allowance costs incurred in the wholesale power markets.   They won’t be perfect, but they’ll be more than “close enough for government work.”

5.    Even if your analysis is right, won’t free allowances prevent a fall in the stock market value of coal-based utilities and coal-based generators – and isn’t this a different kind of windfall?

The impact of allowance prices and allocations on individual companies’ value is very complicated, but in general we would expect the market values of the most coal-intensive utilities or generators to be lower under W-M than they would be absent CO2 legislation.  However, the decline in stock market value under W-M will be smaller than what would be expected to occur under an otherwise identical bill with 100% auctioning.   In both cases they are likely to go down.  In our view, going down by less isn’t exactly what we call a windfall.  Similarly, low-carbon power sources will be worth more after this legislation passes than before – but this is inevitable.  It would be true regardless of how allowances are allocated.

[JR:  In a letter to the editor of the WSJ today, Jim Rogers, Chairman and CEO of Duke Energy, Charlotte, NC writes, "... the climate change bill being debated in the U.S. House ensures that the value of emission allowances must go directly to utility customers. The House bill also requires that this must be validated by the Environmental Protection Agency.Our state regulators also testified before the committee that each and every dime of any emission allowances granted to regulated utilities must flow directly back to customers, not shareholders."  This will ensure that the 25 states that depend on coal for more than 50% of their electricity are not punished with immediate rate shock by climate change legislation. These states will have to shut down and replace the majority of their fossil fuel power plants as a result of the climate change legislation. Having to pay for emission allowances up front to keep power flowing is an unfair "double hit."]

Author Biographies

Peter Fox-Penner is a consulting executive and internationally recognized authority on energy and electric power industry issues;  his forthcoming book is The Future of Power (Island Press)  He is a Principal and chairman emeritus of The Brattle Group, a leading international economic consulting firm and serves on the advisory boards of Enviance, Inc. and Daylight Technologies.  He was a senior official in the U.S. Department of Energy and the White House Office of Science and Technology Policy and helped found and lead the Environmental Alliance and Environment 2004. For more information about Peter, click here.

Marc Chupka is a principal at The Brattle Group with over two decades of public and private sector experience analyzing the market impacts of both domestic and international energy and environmental policy.  He formerly served as the Acting Assistant Secretary for Policy and International Affairs at the U.S. Department of Energy, and was the Associate Director for Air, Energy and Transportation at the White House Office for Environmental Policy.  For more information about Marc, click here.

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26 Responses to UPDATED exclusive report: Preventing windfalls for polluters but preserving prices — Waxman-Markey gets it right with its allocations to regulated utilities

  1. David B. Benson says:

    But would have Adam Smith approved?

    My mind reels…

  2. Brett Jason says:

    I’m sorry, maybe I’m just stupid, but the more I read about this the more complicated and less likely to really reduce CO2 emissions this whole process seems to me. They may be avoiding “Europe’s Mistakes” but they seem to be inventing a Rube Goldberg machine that could easily make Europe’s errors look like strokes of emission-reduction genius before it is all sorted out. If it ever is. This is like reading descriptions of sub-prime mortgage derivatives or credit default swaps.

    The process is so complex that only the lawyers will truly understand it, and they will all be working for the polluters. By the time the rest of us figure out it’s not really working the way it’s supposed to, like with the sub-prime derivatives market, it will be too late. The Q&A section of this article is a great idea and a nice try. And I understand the questions well enough. But the answers generally don’t seem, to me, to really fully answer the questions (or the concerns behind the questions).

    [Fox-Penner Responds:

    Sorry to be a bit of a contrarian about this, but I think that W-M is NOT "overly complicated." I think any bill that makes changes this profound across the entire energy infrastructure, and affects every American in multiple ways, should be crafted carefully, with many exceptions and details that are politically, environmentally, and/or economically important. Why should anyone assume something so important and complicated would take any less than 900 pages to get legislation that a majority of Congress will vote for?

    Two related points: First, this isn't the same thing as saying that mistakes won't be made. However, in thirty years of economic and engineering modeling I have not seen any relationship between complexity or lack thereof and big mistakes. The California energy markets, also designed by policy wonks, was disastrous. Other electricity markets, equally complex, have worked well. The Original British electric market design was the simplest of all and worked poorly. Uncomplicated solutions to policy problems often sound good but I see no indication that they work better.

    You didn't raise it, but as my second point I want to rebut a related point I often hear, namely "wouldn't it just be a lot simpler if we did a carbon tax." Every time I hear this I wonder what on earth is being talked about? The U.S. tax system is by far the most complex on earth. Our tax code is over 60,000 pages long, not counting innumerable rulings. If our elected officials wanted a much simpler tax code we would have one -- no one is stopping them from enacting one. There is absolutely no evidence that a carbon tax bill would be any shorter or less complex than W-M; the much more likely outcome is that every special provision of W-M would have a parallel special provision in a carbon tax bill that had similar odds of passage.]

  3. MarkB says:

    What impact does this legislation have on the EPA public health ruling on greenhouse gas emissions?

    [JR: This legislation would supersede that ruling.]

  4. So the allowance is priced at $20 a ton and given to the LDC for free.

    It raises the cost of power $20/MWh.

    Customers get a rebate of $10, covering half their increased cost and providing an incentive to be more efficient.

    What happens to the other ten bucks the LDC got for free?

    [Peter Fox-Penner Responds:

    Apologies if the example was confusing, let us try it a different way. In either example the distributor does not get or keep the free allowances for themselves. In the original post the example was that the distribution company was 100% coal so its costs went up by $20/MWh.

    If the distribution company gets 90% of its increased cost via free allowance, $18 for each megawatt hour (MWh). Since power rates went up $20/MWh, customers paid a NET $2 more to the distributor. The distributor passed on its increased revenues to the coal generator, whose costs went up by $20/MWh because it had to purchase allowances.

    The post now contains a picture of the money and allowance flows. Remember, in this hypothetical, simplified example the customers use a total of one MWh of power, and the allowance price is $20/ton. (See Waxman-Markey Graphic Document)]

  5. Ken says:

    They are trying to counteract the natural market response to enforced scarcity in combination with a protectionist allocation scheme (grandfathering). Rather than trying to make water go uphill, why don’t we make gravity work in our favor? Inclusion of new sources in the allocation could foster competition, maintain downward pressure on energy prices, and induce rapid clean-energy capacity expansion. Here’s how:

    Divide the electricity sector into two sub-sectors: new sources (including renewables) and old sources (coal, NG, legacy hydro and nuclear). The industry’s allocation between new and old sources is based on generation output (MWh). Both sub-sectors get the same number of allowances per MWh — or equivalently, the same $/MWh subsidy. At least some allowances could be auctioned so that new renewable sources can be given their allocation in cash. (Auctioning could also help maintain market liquidity and could accommodate a price floor.) The allocation distribution within the “old-sources” sub-sector could be based on historical emissions (grandfathering), or whatever industry is agreeable to.

    Since both sub-sectors get the exact same average $/MWh subsidy, the free allocation has no effect on their relative competitiveness. But since there would initially be no “new sources”, the industry’s regulatory cost would initially be very low. With 100% free allocation, the industry’s regulatory cost on day 1 could be zero even if the carbon price is $100/ton. But the latent potential of a $100/ton economic incentive would put extreme competitive pressure on the industry to clean up its act — either switch to clean energy, sequester the CO2, or get into another business.

    “Price” does not equate to “cost”. Allocation can be employed to impose a very high carbon price at (initially) very low net cost.

  6. PaulK says:

    I don’t think I’m alone in being confused by the free allocations. As recently as March of this year, you posted: “Obama tells Business Roundtable: “If you’re giving away carbon permits for free … it doesn’t work’ and ‘the science is overwhelming’…” quoting the President that the one hundred percent auction the President was right and necessary. Now free allowances are hunky – dory. How did this happen.

    Was 100% auction really the better system? Did someone convince the President that he was wrong? Does anyone know if the President does now think free allowances are better?

    One criterion for judging is fairness. Neither Waxman – Markey nor the Lipnski – Flake version of a carbon tax adequately represent the consumer, the ultimate payer of both the tax and the cost of cap trade.

    Lipinski – Flake proposes offsets in the payroll tax but its real problem is that it taxes carbon at the wrong point. They would tax at the point of production. For a carbon tax to work to end fossil fuel use, it must be levied at the point of combustion.

    Apparently the consumer offsets in Waxman – Markey have changed too. This is very different from President Obama’s statements in March.

    [JR: The subject is confusing, which is why I posted this long piece by people who know a lot more about it than I do.

    I think auctioning as high a fraction of the permits as is possible is best. Absolutely. What we are witnessing is real politics. Waxman and Markey are two of the most progressive and environmentally conscious House members. If they think this deal is what is needed to get the bill passed, then I can't see a lot of point in spending time attacking them -- especially if, as is clearly the case here, the approach they have taken it is perfectly reasonable.

    Indeed one of the points that Peter and Marc make, and that I have made, is that this approach deals with the very important regional equity issue, of not taking money from, say, Midwest consumers, and giving it to other people, which is not only critical from a fairness issue, but also from political necessity.]

  7. I agree with Peter and Marc. However, there is an issue that they and others have not yet addressed. Pricing carbon would create wealth transfers, from consumers to electricity generatiors who do not emit CO2, such as nuclear generators.

    According to a recent study – “Adverse Consequences of Pricing Carbon” released by the Wingaersheek Research Institute (www.wingrg.com), a small percentage of the increase in consumer costs would reflect real cost increases (such as the cost of substituting higher-priced natural gas for coal). All the rest would be wealth transfers from consumers to the government (about half) and to margins earned by some electricity generators (the other half).

    Economic efficiency is touted correctly as a primary justification for putting a price on carbon. However, in competitive electricity markets, pricing carbon would also affect the prices paid by consumers for the output of non-CO2 emitting technologies (such as existing hydro and nuclear). This infra-marginal effect would result in transfers of wealth from consumers to the owners of non-CO2 emitting technologies, particularly nuclear generation.

    Economists often dismiss wealth transfers since they have no effect on economic efficiency. But in fact real people care about wealth transfers, particularly when the transfers are from them to someone else. As such the political process must care about wealth transfers too.

    The government could use its share of the wealth transfers to mitigate consumer cost increases. Peter and Marc explain that the W-M bill does this well. However, the rest of the large consumer cost increase would flow to generation companies (particularly to nuclear generation companies) in increased generation margins. The political process has not yet dealt with the equity of this transfer of wealth.

    Wealth transfers were not an issue when the acid rain legislation was enacted in 1990, because the electric utilities were regulated (and they still are in some parts of our country). Hence, cost increases resulted in regulated rate increases, but not in market price increases, because there was no market price. There were no wealth transfers from consumers to generators with no SOx emissions.

    In order to reduce CO2 emissions in electricity markets, at least three major steps must be taken. First, economic projects such as the long-distance transmission of wind must be built, when the benefits (including the value of reduced emissions) exceed the costs. Second, uncontrolled new coal-fired power plants must not be built. Third, existing coal-fired power plants must be replaced with cleaner generation (and/or reduced consumption).

    Putting a price on CO2 emissions can create market incentives for all three of these steps. But there would be adverse consequences, including the wealth transfers.

    Traditional regulation can ensure that these steps are taken. Wind/transmission projects could be approved by current regulatory processes. EPA could promulgate a performance standard that requires significant control of CO2 emissions for new coal-fired power plants. Also, EPA could set a mandatory retirement age for existing coal-fired power plants. If EPA set a retirement age at age 60 on existing coal-fired plants, CO2 emissions (in the electricity market assessed) would be reduced by about 45 percent in 2030 and by about 75% in 2040.

    These new regulations would have costs, just as a pricing carbon would have costs, but the adverse consequences would be less. The shift from coal to gas would be much less, because the cost of existing coal-fired generation would not increase. The market price would eventually increase to cover the full costs of the best new generation option, but this increase would not occur until new generation capacity was required. Also, this increase would be less because no price would have to be paid on the residual carbon emissions from the new generation option. Hence, wealth transfers from consumers to generators with no CO2 emissions would be reduced.

    Traditional regulation combined with less reliance on carbon prices could accomplish the same or more emission reductions with reduced adverse consequences. Also, traditional regulation could supplement low carbon prices to accomplish the emission reductions that are needed, without material adverse consequences. Exclusive reliance on pricing carbon is probably not the best option.

    [Peter Fox-Penner Responds:

    Hoff, glad to see you are a Climate Progress reader. Rather than reply point by point, I'll just note that I agree with you that some amount of regulation is appropriately paired with the W-M carbon marketplace. Every market is a creature of government, which sets the market rules. I also agree wealth transfers are an exceedingly important fairness issue -- and this is one reason why legislation gets complicated. Finally, I think that W-M requires that all coal plants capture and sequester half their carbon by 2020 -- a (legislated) performance standard.]

  8. Modesty says:

    Re “free allowances”

    Isn’t part of the communication problem re the allocation of allowances to electricity local distribution companies (ELDCs) the fact that these companies are NOT getting allowances “for free” in the sense suggested by “free allocation” or “free allowances”?

    Even with 100% auction, ELDCs would not have had to purchase any allowances.

    ELDCs are not—in their capacity as ELDCs!—covered entities. That is, they are simply not entities with capped emissions (nor are they entities with any interesting uncapped emissions, for that matter). The local electricity “pipes” are not the sources of GHGs.

    So the “100% auction or not” discussion is irrelevant with respect to the decision to, in effect, distribute proceeds from such an auction to ELDCs, (“in effect” because what is distributed or, “allocated” (which is a tricky word in this context since it lends itself to suggesting distribution to a covered entities), are (of course) allowances rather than proceeds from the sale of such.

    I think there are legitimate and interesting questions re where in the hierarchy of optimality, in terms of reducing emissions and in terms of crafting legislation that will pass, this use of allowance value fits, but, again, I think it’s unfortunate that it’s become so entangled in the particular “100% auction” issue as well as the auction vs. free allowance issue in general, when it arguably is an entirely separate matter.

    The method for allocating a given amount of allowances *within* the pool of ELDCs (“who gets what share”) is also an interesting question; this too should be kept separate, for clarity.

    Finally, this issue needs not to distract attention from the cases of actual “free allowances” allocation. And within these actual cases, there are additional critical distinctions to be made, such as between allowances provided to merchant coal generators and allowances provided to energy-intensive industries that compete internationally (steel, aluminum, etc.).

    Just my 2 cents.

  9. Ken says:

    Hoff Stauffer – “Pricing carbon would create wealth transfers … a small percentage of the increase in consumer costs would reflect real cost increases …”
    The allocation method could be constructed to minimize wealth transfers within the regulated sector (e.g. from emitting generators to nuclear) and out of the regulated sector (e.g. to the government). At the same time, the method can avoid impeding wealth transfer to new renewable sources. This would foster competition and renewable capacity expansion. (See my previous post.)

  10. Brendan says:

    Hoff makes a good point about the wealth transfer. If I’m understanding the concept correctly, using the example above, the distributor get’s $20 worth of credits, trades them for some electricity that comes from a carbon source, rebates $10 of that to the consumer, and keeps the other $10 to pay for the increased cost of buying electricity from providers who are selling new less-carbon or carbon neutral power. So basically the consumer will pay $10 extra dollars to pay for renewable sources, and the user who uses $40 worth of carbon sourced electric will pay $30 extra (both get a $10 rebate). This seems all fine and dandy. Assuming that I’m reading that correctly, that puts the decision in the hands of the distributor to decide who they want to buy from. While the free market creates some great incentives, it seems like we should be shifting away from free market electricity toward a more public source (since today it’s use and need are virtually ubiquitous, it just strikes me as one of those things better handled in the public sector, like water… I have nightmares of working with private water providers – most think they’re god and can get away with anything, even under the thumb of the same regulators that regulate the grid in my state).

    With this system the problem is that the distributors will go out and buy renewables from a company that develops them, buying land from a land speculator and equipment from the manufacturer. I have no problem giving the manufacturers their cut. But with this system, first we transfer some more money to land speculators. And then we’re setting ourselves up for Enron V2.0 because we’ll be beholden to a group of owners (who will inevitably conglomerate) and can set their own prices. If you don’t want to pay their prices, they can stop the blades or turn off the inverters for a few hours. This is much easier than say, spooling down a 500MW coal plant. Smells like a recipe for future price manipulation. Wouldn’t we be better off taking that $10 (or $30) and putting it in a separate public fund to build new power sources on, say, BLM land owned by the citizens of the United States? I know this might not be completely politically expedient, but it seems like now would be a good time to start planting those seeds. Or, at least some money could be used to buy already constructed private projects. Maybe $3 of that $10 goes directly to a fund to build/buy public projects. With all of it’s problems, I’d be much happier seeing a new TVA over a new Enron.

  11. Dan says:

    http://www.economist.com/world/unitedstates/displayStory.cfm?story_id=13705417&source=features_box_main

    “the bill’s supporters say that consumers will be protected from higher energy prices because the largest chunk of the free permits will go to tightly regulated electricity distributors. Regulators can simply order these firms to keep prices low. Problem solved.

    Not so, says Alan Viard, an analyst at the American Enterprise Institute, a conservative think-tank. If electricity is cheap, Americans will buy more of it, generating more emissions than would otherwise have been the case. Other industries will accordingly have to cut their emissions more, since there are a fixed number of permits. The cost of this will be passed on to consumers. Overall, ordinary Americans will endure price hikes just as severe as they would have under Mr Obama’s plan, while receiving far less compensation. Mr Viard likens giving permits to polluters to handing the proceeds of a tobacco tax to the shareholders of Philip Morris.”

  12. Floyd Smith says:

    Joe,

    Excellent commentary. You’re not only doing a great job yourself but bringing a lot of firepower to bear in support. Well done!

    I admit, I can’t carefully read every word of your analysis, let alone of the draft bill in question – but I’m sure the people who need to are doing so, and that you and your colleagues are making a big difference in this tremendously important legislation.

    Even if this blog stopped the day Waxman-Markey is signed into law (I hope), it would have done tremendous service just by helping make that happen, and in a better way than otherwise. Keep it up.

    Floyd

    PS Looking at the names of the sponsors and the fact that this bill is being “mark(ey?)ed up” – does it also have to be “wax(man)ed up” before it can get out of committee?

  13. PaulK says:

    Brendan, Ken and Huff,

    In any system, the cost of carbon pricing is borne by the consumer. Maybe that is why Ralph Nader opposes Waxman – Markey. One of Dr. Hansen’s objections is also the unrelieved burden on consumers.

    David B. Benson,

    Energy utilities didn’t exist in Smith’s day. He probably would see them as outside the normal marketplace. About W – M, he would say nice try, but the trade part is not good. The wrong thing is being traded. He would also disapprove of the source of what is traded.

    The allowances are a form of penalty avoidance coupons. These coupons become the currency of the new cap/trade market. Smith would say allowances are the wrong currency to assure the new market achieves its goal, which is to eliminate carbon burning. Allowances, in a way, favor it. In addition, the source of the currency should also focus on eliminating carbon burning.

    Smith’s currency would derive from actual alternative energy production. Each watt or therm of energy produced or saved, whether by the largest corporation or the poorest individual, would be worth a designated amount of cap compliance. Everyone, including consumers, can now benefit from the market. It greatly reduces the cost of alternatives and greatly promotes deployment.

  14. James Newberry says:

    In regards to atomic fission (nuclear power is solar power to me), the effect of this bill on better marginal pricing for fission and new funding for fission in the “Clean Energy Bank” part of W – M, along with existing loan guarantees for new reactors is troubling. We just went through several decades of preventing hundreds of planned nukes from being built, thereby saving our nation from the scourge of much greater quantities of “nuclear waste” or meltdowns. People are sick and dying from daily radioactive contamination and now we have to fight again because we pay nothing in the market for the price of plutonium, cesium, and hundreds of other contaminants. All citizens have ownership of this permanent debt, not the stockholders. Atomic fission is not freakin’ clean, just tragic.

  15. Regarding Adam Smith, I would add that Smith believed in market economy, not in capitalism. One cannot find a single place in any of Smith’s works where he has anything but the strongest criticisms of “merchants and manufacturers” (the word “capitalism” did not come into use until 14 years after the publication of The Wealth of Nations). Governtment intervention, according to Smith, is necessary in order to prevent those folks we now call “capitalists” from manipulating the natural forces of the market to suit their greedy and short-sighted purposes.

    So it is scarcely evident that these sorts of regulations are in any meaningful sense a violation of Smith’s principles. Indeed, it is no more possible to have a free market without regulation than it is possible to have a free society without law.

  16. Modesty says:

    “Finally, I think that W-M requires that all coal plants capture and sequester half their carbon by 2020 — a (legislated) performance standard.”

    “All coal plants”?

    This seems inaccurate in more than one way.

    Unless I am mistaken, the only plants the 2020 performance standard would apply to would be plants permitted in or after 2020. That is, the performance standard would NOT apply to plants permitted in 2009-2019 (these could,depending on status of CCS, be allowed to wait until 2027). And it would NOT apply to any plants permitted prior to 2009.

    I’d be very happy to be wrong about this, though.

  17. Ken says:

    This still misses the main point. How do prices translate into renewable energy incentives? If “the allowances distributed to an electric or gas local distribution company … shall be used exclusively for the benefit of retail ratepayers of such…company” then they shall not be used for the benefit of new renewable generation.

    If new renewable generation is 10% of fossil-fuel generation, then a $20/MWh charge on the latter could support a $180/MWh subsidy for the former. If it is not politically feasible to impose a $20/MWh charge on ratepayers, then just decide how much is feasible, and use the revenue exclusively to support new renewables that serve the same ratepayers.

    Re “These states will have to shut down and replace the majority of their fossil fuel power plants as a result of the climate change legislation.”: Yes, that is the point of climate change legislation. If the carbon fees on fossil-fuel plants are used exclusively to expand renewable generation serving the same customer base, then ratepayers would not necessarily be disadvantaged. The subsidies for new renewables can be provided in exchange for equity shares, which will give ratepayers dividends that increase — not decrease — as carbon is phased out.

  18. Modesty says:

    To follow up on my comment from May 21 above, I’m still not clear why “we” are referring to the LDC “allocation” as “allocation,” “free allowances,” etc.

    The ELDCs are NOT covered entities. “We” are NOT choosing between giving them permits for free and having them purchase them at an auction. They do not have to hold any permits whatsoever. Right?

    Distributing a certain amount of allowances to ELDCs in the specific manner specified in W-M is simply one use of allowance value, not really “free allocation.”

    That said, I would be interested in understanding the pros and cons of distributing this value to ELDCs as allowances rather than as auction proceeds.

  19. Rick Covert says:

    I use a ‘Green’ energy provider called Green Mountain energy and I pay for the 100% renewable energy plan. Now I know that my electricity is sourced from natural gas mostly, nuclear and some coal. So how does the W-M bill effect my utility bill? (No pun intended)

  20. Dean says:

    This seems to me to be the critical assertion:

    “they will offer their power in the wholesale market at a price that will cover all of their costs, which include the market price of allowances consumed in generating the power. It’s economically correct (an opportunity cost is just as valid as an out-of-pocket cost),”

    Does an opportunity cost have the same price signal as an out-of-pocket cost? In the short term, I don’t think so, though over time, the two will merge. In a pure market environment, the two would be closer, but given inertia in a large company with an expensive infrastructure, the free permits will make it easier for some utilities so inclined to sit on the status quo since the regulations protect their profit margins. The lack of out-of-pocket costs will let them take their time in making changes compared to having to actually pay.

    So I think that the main impact of this is to slow down the process. When dealing with partial solutions, the question is whether the partial solution blunts pressure for a full solution, or opens the door to it. I don’t think there really is any way for us to know which path W-M leads in that sense. A lot will be determined by whether the US is hit by a string of extreme weather events in the next year or two.

    I also read that the committee that passed W-M is the friendliest part of the legislative process. Ag Committee wants a shot at it, only to water it down – is it Pelosi’s decision whether they get a shot? Then it has the full House, and the Senate sees it as close to DOA as is. So this is only the first step in the sausage-making process. A snapshot of W-M now probably looks great compared to whatever might make it to Obama’s desk, if anything.

  21. When cap and trade kicks in, we will already be EXTINCT. As you said on the subject of the EPA ruling, Joe Romm: “JR: This legislation would supersede that ruling.”

    [JR: I disagree. But if you are right, then nothing will help us and you should move on to a different website.]

    We have crossed at least 3 tipping points already and we are about to cross a fourth. There is enormous hysteresis, which means that a tipping point, once crossed, cannot be uncrossed for thousands of years. Tipping points mean death and extinction.
    Tipping Point 1. Reference: “With Speed And Violence” by Fred Pearce, 2007. Mr. Pearce has seen formerly frozen peat bogs in the tundra in Siberia that are now lakes outgassing so much methane that they don’t freeze over in Siberian winter. There is enough methane in tundra peat bogs to raise the global temperature by 18 to 21 degrees Fahrenheit. Reference: “Six Degrees” by Mark Lynas. Another 10 degrees Fahrenheit will surely cause our extinction.
    Tipping Point 2. Methane is bubbling out of the Arctic Ocean. This methane is coming from the methane clathrates that are frozen at the bottom of the ocean. [A CLATHRATE is an ice thing that traps methane.]
    Tipping Point 3. Loss of ice on the Arctic Ocean. The dark ocean water absorbs sunlight. Ice on the ocean reflects sunlight. A change in the amount of ice tends to run away.
    We are about to cross Tipping Point 4. 450 parts per million [ppm] CO2 equivalent. We are at 387 ppm CO2 but when you add in the CH4 [methane] and the other greenhouse gasses, we Are at 430 ppm equivalent and rising fast. “The vanishing Face of Gaia” by James Lovelock, 2009, page 153 says that paleohistory shows a sudden 9 degree rise at 450 ppm equivalent. The physics is not stated. We are almost there. Note that climate does not change in a continuous, linear fashion. The climate lurches. The climate has in the past made many sudden and unexpected changes. There seem to be stable states. In between stable states, the climate jumps back and forth between the stable states.
    Arctic ocean ice makes as much difference as 70% of the 386 ppm of CO2. Source: “The vanishing Face of Gaia” by James Lovelock, 2009. With Zero CO2, the earth average temperature would be at, if memory serves, [don't depend on my memory] 18 degrees below zero Centigrade. Actual earth average temperature is 15 degrees centigrade above zero. That is a 33 degree centigrade difference. Melting all of the Arctic ocean ice adds 70% of 33C which is 23 degrees centigrade or 41.4 degrees Fahrenheit. Add 20 degrees for the methane coming out of the tundra peat bogs and 20 degrees for the methane coming out of the Arctic Ocean clathrates. That makes 81 degrees of temperature rise. If the land temperature is above 75 degrees F, it turns into a desert because of fast evaporation. Source: “The vanishing Face of Gaia” by James Lovelock, 2009. The sum of the 3 tipping points that we have already tipped is 8 TIMES what is required to make Homo Sapiens extinct.

  22. Sam says:

    I mean could Peter & Marc equivocate argument any more is this “key” section:

    “With these provisions, it will be awfully hard for any utility to harvest a windfall from the free allocations — especially a shareholder-owned utility. Yes, the free allowances given to the distribution utility will be worth a lot. But the law is pretty clear that the benefits of receiving the free allowance go to the utility’s customers, not their shareholders”

    The law is “pretty clear”? It will be “awfully hard”?

    This is not the definitive language of your headline Joe…

    I have a crazy idea-if we want to protect consumers why not return the auction revenue to them directly?

  23. Midwest says:

    Joe,

    You stated:

    “This will ensure that the 25 states that depend on coal for more than 50% of their electricity are not punished with immediate rate shock by climate change legislation. These states will have to shut down and replace the majority of their fossil fuel power plants as a result of the climate change legislation. Having to pay for emission allowances up front to keep power flowing is an unfair “double hit.””

    I’m sorry, but your last sentence confuses me. Are you really saying that in 2012 when the cap starts, they will have to shut down all the coal plants to avoid buying allowances to avoid passing on this double hit to consumers? This is exactly the point my electric company is arguing right now but they don’t seem to read it the way you do–they say that the coal plants will keep running and consumers will just pay more. They say free allowances will only cover 50% of their emissions, so we will have to pay for the other 50% plus the cost of the new infrastructure which won’t be ready very soon. While they generate slightly over 50% from coal, they do get 20% from wind and are a big wind leader. To me it looks like they either have to replace 50% of their generation nearly overnight, which seems impossible, or pass on the double hit to the consumers which you say is to be avoided. Please explain how the double hit is avoidable in this situation.

    Also, since this post started as avoiding windfalls, can you explain how a generator who has say a 10:90, coal:hydro mix who directly supplies their electricity to a massive urban population does not end up with a windfall? They surely will be given more allowances than they have emissions based on the 50:50 allocation formula.

  24. mike says:

    I am still confused. But what is there to stop the coal or energy company from keeping most if not all of the profits and passing very little oor nothing to the consumer?

    [JR: The same thing that stops them now from overcharging you for electricity -- the PUCs.]

  25. F-P & C wrote, “Here’s where W-M got it right. It forbids distributors from giving customers the value of the free allowances as a “per unit price rebate.” So retail customers will still have to pay a price for power and natural gas that includes a carbon price signal. The free allowance value must be given to them as a lump sum rebate.”

    First, how will this apply to industrial and commercial customers? For example, the North Carolina legislature applied a per account cost cap when it implemented a state RES. This has never really been satisfactorily resolved due to questions about facilities with multiple accounts, etc. In practice, this kind of a lump sum rebate becomes problematic precisely for the utility customers who are most likely to be sensitive to these sorts of price signals.

    Second, how will this be interpreted in light of very specific state laws that require NET environmental costs to be passed along as part of the metered fuel-related (energy) charge to customers? Sales of acid rain permits are, I believe, netted out of these accounts.

    I am not aware of any precedent for the treatment you describe in W-M and I expect that proceedings to establish these lump sum rebates would be quite confusing and contentious. Consumers will have to hope that their interests are protected by commissions and the state’s consumer representatives (if any, see South Carolina for an example of a state without a dedicated consumer representative). Certainly no clean energy/environmental group can afford the lawyers and experts needed to effectively engage in the many proceedings that will result.

    Ultimately, there are two ways that utility commissions can affect the global warming pollution from power plants. First is to drive dispatch decisions by ensuring that the utility is held accountable for minimizing the fuel-related charges passed through to the customer. Seems like this essay is saying that W-M has that covered.

    Second, is to drive utility investment in clean energy choices rather than continuing to build and operate coal plants. This will take a while – utilities have already locked in their power plant approvals through 2015 or even 2020. A utility commission will not hold a utility accountable for continuing to develop and build an already-approved power plant, even if that power plant results in higher costs for customers as soon as it is brought on line.

    This is the fundamental reason that Duke Energy is fighting hard for this treatment. They made a business decision to move forward with the Cliffside power plant, and now they are very carefully maneuvering to ensure that higher than “anticipated” cost to operate the power plant is not something that a utility commission asks them to absorb. It is these plants “in the pipeline” that fundamental questions about regulation, fairness, etc. are played out, and there is no easy answer. Even the answers that look “right” will be complicated and subject to manipulation.

  26. edward says:

    Your discussion overlooks a HUGE loophole in the Bill that eliminates any assurance that the carbon price signal will make it thru to LDC customers. Here is the key text from the bill including the key loophole (the word “solely”):
    “An electricity LDC shall not use the value of the emission allowances distributed under this subsection to provide to any ratepayer a rebate that is based SOLELY (emphasis added) on the quantity of electricity delivered to such ratepayer.”

    And your text:
    Here’s where W-M got it right. It forbids distributors from giving customers the value of the free allowances as a “per unit price rebate.” So retail customers will still have to pay a price for power and natural gas that includes a carbon price signal. The free allowance value must be given to them as a lump sum rebate.