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Why Warren Buffett Is Wrong About Cap and Trade

I am reprinting a commentary for Bloomberg by Eric Pooley. Pooley is a former senior editor of both Fortune and Time, who is writing a book about the politics of global warming. Earlier this year, he documented the media’s mistakes and biases during the Lieberman-Warner debate in a must-read Harvard study [see How the press bungles its coverage of climate economics “” “The media’s decision to play the stenographer role helped opponents of climate action stifle progress.”]

Warren Buffett carries plenty of weight in any debate — even when he gets it wrong.

So as the Senate digs into the climate-change bill that passed the House of Representatives last month, it’s worth taking a hard look at how Buffett’s views on the bill went off course.

Buffett knows global warming is real and carbon emissions must be cut. But he’s worried that the bill might hurt his electric utility, Des Moines, Iowa-based MidAmerican Energy Holdings Co.

He may be right. But that doesn’t mean this is a bad bill; it may mean MidAmerican made some bad decisions.

On another count, Buffett is simply wrong when he calls the bill a “huge, regressive tax” that would ensure “very poor people are going to pay a lot more for their electricity.” Likewise David Sokol, the chairman of MidAmerican, was wrong when he testified that the cost of buying carbon allowances under the bill would drive up Iowa electricity prices by $110 per month per customer in the first year.

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Opponents of the bill have latched onto Buffett and Sokol’s words, trumpeting them on the House floor and in a July 7 Senate hearing. So let’s examine their three basic claims:

Claim 1: It’s regressive. No, the bill doesn’t punish the poor. The nonpartisan Congressional Budget Office found that it would cost the average household $175 a year by 2020, while the 20 percent of Americans with the lowest incomes would come out ahead by $40 a year.

Claim 2: It’s a tax. In spite of the Republican Party’s relentless “cap-and-tax” talk, cap and trade isn’t a tax. It is a dumping fee for greenhouse gases. The dumping permits, or allowances, are distributed to utilities and other large emitters, who can then buy and sell them.

How is this different from a tax? First, the number of allowances declines over time, guaranteeing that emissions go down. A tax can’t do that. Second, since allowances can be bought and sold, capital flows to the most cost-effective technologies. A new tax means more work for accountants. Cap and trade unleashes the engineers.

Buffett and Sokol don’t want cap and trade or a tax, which means there would be no price signal driving innovation. They prefer what Sokol calls “cap and no trade,” which is another way of saying they want old-school government regulation. That approach would be more expensive than cap and trade.

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Claim 3. It costs $110 a month. In early June Sokol told a House committee, “In Iowa, our cost increase just for”¨784,000 customers is $283 million in the first year” for buying the emission allowances that aren’t given away. “That’d be $110 per month, per customer.”

Texas Congressman Joe Barton repeated the scary number during the floor debate in late June. “It’s just basic math!” Barton cried.

Sokol now says he got his math wrong. The $110 figure, he told me, assumes that MidAmerican’s 217,000 Iowa residential customers would bear the entire burden of buying allowances and that commercial and industrial users wouldn’t pay a dime. “But it’s not conceivable that the regulator would put all of this on the residential customers,” he said. “So that is not a terribly useful number.”

Why didn’t Sokol correct the figure before Barton said it again? Sokol now says $110 equals the combined monthly cost of buying allowances plus paying for all the new technology MidAmerican will need to slash emissions over the next 40 years.

In reality, the technology cost is unknowable. It’s also the sort of estimate utilities routinely exaggerated in previous environmental battles. And MidAmerican’s new calculation happens to work out to the precise figure Sokol had already used — a remarkable coincidence.

Cutting carbon emissions won’t be free, but Sokol hasn’t helped his case by hyping the costs for Iowa consumers, who have gone 14 years without a rate increase. His revised estimate for the allowance costs comes to an average of $30 per month per customer — residential, commercial, and industrial.

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That’s a far cry from $110, but even it is too high, according to economist Nat Keohane of the Environmental Defense Fund, because it assumes that rate payers will foot the bill for all of MidAmerican’s allowance costs — including the 30 percent of its power it sells into the deregulated wholesale market.

MidAmerican wouldn’t get free allowances for that wholesale power under the bill, and I think that’s the real reason Buffett and Sokol are against it. The system is designed so that free permits flow downstream to the people who pay for the power. That’s good for consumers, but could hurt MidAmerican shareholders, meaning Buffett’s Berkshire Hathaway Inc.

Bottom line: MidAmerican made some bad calls. It turned on a huge new coal-fired plant in 2007. It chose not to spin off its wholesale power business. And when other utilities were hammering out their allocation deals with Congress, Sokol and Buffett sat out the negotiation.The Oracle of Omaha apparently didn’t see this one coming. But it’s not too late: the next round of negotiation is just getting under way.

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