More on Waxman-Markey

Anonymous, in his/her/its/their comment to the last post makes a good point that I hadn’t considered carefully enough in my argument, which boils down to this: opportunity cost is not everything. I partially agree.

Yes, electricity providers generally pass variable costs through into rates, and Waxman-Markey’s free allowance allocations to utilities are accompanied by structural measures that are intended to make sure those “negative variable costs” get passed through too. So rates should not go up to the extent that permits are freely allocated, whereas if permits were auctioned, we would expect rates to go up.

Anonymous goes from there to make two points. First, the higher the rates, the more frugal the average consumer with his or her electricity usage; higher rates means less electricity consumption. Second, higher electricity bills for coal and natural gas makes renewables (and nuclear, btw) more cost competitive.

Before directly engaging those points, let’s be clear about something: whether you freely allocate or you auction, you have the same fundamental question: What do you do with the allowance value? Either way, there’s a store of value created by the policy – it’s the market price of an allowance times the number of allowances. It’s a transfer from the people who have to pay for the permits to the treasury, and policymakers are immediately faced with the question of what to do with that value. If the permits are auctioned, that value comes in the form of cold hard cash. If you don’t auction the permits, the value stays in the form of the allowances themselves. On a balance sheet, the difference between cash and a liquid commodity is not very different at all.

Here’s a political reality: If you are going to inject a multi-billion-dollar cost into every nook and cranny of the economy, and if taxpayers are going to see their share of it every single month on their electricity bill qua direct mail campaign advertisement against every incumbent congressman, you’d better find a way to ease the pain as best you can. It’s hard to imagine getting a bill through congress wherein most of the allowance value does not flow back to consumers.

With that under our collective belt, we can get to Anonymous’ point. The environmental objective of cap and trade comes from two things: A) the relative price of energy from carbon and carbon-free sources, and B) the overall price of energy. It’s not hard to get A right without raising electricity prices in the aggregate. You simply slap a price on carbon emissions, and then send all of the allowance value back to consumers, either by auctioning allowances and rebating electricity customers based on volume, or by handing out allowances, again based on volume. Waxman-Markey is a partial success in this respect – about half of the allowances that are allocated for this purpose are distributed as a function of volume, and half on the basis of greenhouse gas intensity. To the extent that they are distributed on volume, A is very cleanly achieved, though B is not, and Anonymous’ second point – about renewable – is not correct. But if you allocated purely based on volume, then people whose electricity usage now is especially greenhouse gas intensive get shocked. Hence the 50-50 compromise. For the permits that are distributed based on greenhouse gas intensity, A is still achieved, because the coal generator still has something to gain from reducing emissions and selling permits, but Anonymous’ point about renewables is correct – the policy does not help them. It’s a true giveaway to coal and its consumers. However, per my last post, I think that 50-50 split in the early-going is fair.

As for B, Anonymous, you are right, I was painting with too-broad strokes. Free allocations under cap and trade should keep prices overall lower than if we had 100% auction, so the potential efficiency gains are foregone. Point well taken. I guess I would just say a few things in response to that, in defense of the bill. One, Title 2 is all about energy efficiency. Two, I think objective A is more important than objective B. And three, as evidenced by what a gut-wrenching cave-in to the all powerful agricultural lobby was made to get this thing passed, you can only do what you can do.

This post is too long to respond to Chris’ point (which he artfully hid under the wrong post.) That’s next.