Cap-and-Auction

Knowing that the current government likes nothing better than to spend my taxes on pirate raids on oil producing states I can't say this is a good idea. The cap and auction revenues will be used to provide tax cuts for the wealthiest while the poorest continue to die in the streets.

Why do I think this might be a bad idea?

Unless the first premise is that the people own the air and should be reimbursed for the pollution of said air directly we will get nowhere. Once it's clear that individuals will get a direct cash benefit from carbon taxes it will be supported. Otherwise it's just another raid on their wallets to subsidize the schemes of fat cats.

Put the Carbon Back

How about we really get serious. Give each legal resident a personal grid energy quota as well as a gasoline/diesel quota and a natural gas quota. Everyone is put in the same boat and we can begin to work on stemming the tide of global warming together, instead of just continuing to hammer the poor. This would provide an added benefit by encouraging people to make do with fewer cubic feet of house/office (no one would be able to heat/cool 8000 square foot cathedral ceiling McMansions), thus allowing for less sprawl and more local food production.

If our grandparents could manage to survive,and even thrive, under quotas for gasoline, sugar and flour, surely we are clever enough to rebuild livable communities while limiting our individual harm to the planet.

Climate facts to warm to

Marohasy: "That's right, very much so. The policy implications are enormous. The meteorological community at the moment is really just coming to terms with the output from this NASA Aqua satellite and (climate scientist) Roy Spencer's interpretation of them. His work is published, his work is accepted, but I think people are still in shock at this point."

If Marohasy is anywhere near right about the impending collapse of the global warming paradigm, life will suddenly become a whole lot more interesting.

A great many founts of authority, from the Royal Society to the UN, most heads of government along with countless captains of industry, learned professors, commentators and journalists will be profoundly embarrassed. Let us hope it is a prolonged and chastening experience.

I've called for Cap, Allocate & Trade here on Grist and elsewhere
not merely because the mode of Allocation defines the outcome
- which makes "Cap & Trade" pretty meaningless as a policy goal -
nor merely because both auctioning and grandfathering heavily favour the incumbent corporations
(especially if, as might seem likely, "pollution futures" are permitted).

The core reason for including the term Allocation is to reflect the need for permits' allocation on a per capita basis,
whereby the public will own the resource and trade it as we see fit,
thus quite predictably tending to favour Innovation over BAU.

Without that per capita Allocation, I've yet to see any clear justification for expecting significant beneficial trade to occur.

Regards,

Billhook

An auctioning system immediately forces people to pay for things they previously got for free.  The trade mechanism (which only kicks in once the thing that used to be free now has value) then drives the price down.  

Auctioning is entirely separate from the trade concept.  It simply ensures that all parties who impose costs participate from the start.  (As compared to the SOx cap & trade system, that was done by allocation and grandfathered old dirty folks).  The economic distinction is one of timing.  Allocation + cap & trade = a longer time constant between when the rules are imposed and when reductions begin (both in the regulated pollutant, and in the price thereof) - for the simple reason that with lots of pollutants getting a free pass, the don't participate until their plants get shut down.  By contrast, Auction + cap & trade starts the process sooner.

But there is zippo reason to argue that an auction system eliminate the benefits - or incentive - to trade.

New entrants don't need to trade. They can buy permits at the same auctions as everyone else. Exit - ok, but I mentioned that as a case where permits be sold a second time. However normally I'd expect firms to buy permits as needed - thus an exits should be responsible for marginal cases. Environmental groups who wish to retire permits. Well they can either compete at auction with everybody else and buy at market price, or buy from existing holders - and pay above market price. Again there are marginal cases: an innovation occurs suddenly and leaves firms with permits they don't need, or permits they can sell at a profit. But unless the system is deliberately set up to encourage large holdings, that is marginal. Mostly deployment  of innovation is rewarded by not having to buy permits in the first place.  

The way I visualize and auction system working is permits for , say a three year period, are divided into two parts. For simplicities sake we will say in half, though that probably is not the actual division. OK so half are auctioned in large auctions every quarter, so that big permit users don't have to constantly buy  a trickle of permits. The other half (again not the actual ratio) are sold electronically on a weekly basis for small users.  Of course permits are sold as far upstream as possible, so mostly permits are bought by fossil fuel extractors or importers and added to the price of fossil fuels.

I challenge either Jason or Sean to name one case where the presence of a large secondary market encourages innovations that would not be encouraged by an upstream permit auction that mostly acts as a carbon tax.

For a percent of them as far upstream as possible is not that far upstream: for example dumps that don't burn methane;cement plants (because cement plants produce emissions from heating limestone over and above fossil fuel use); or F5 gases.  But in all cases it is levied at the furthest point upstream you can find. But still rebated to the public.

That means only a tiny percent of the population needs to directly purchase permits. Most pay for permits indirectly in the higher costs of fossil fuels, or electricity produced by burning fossil fuels, or cement or  cement products. And again that revenue is rebated to the public.

And even without rebating, it's doing a world of good.

Just so long as it doesn't get funneled back into subsiding significantly increased carbon emissions, one can consider it mission accomplished.

No need to make perfect the enemy of the good.

-David Ahlport

How is this going to drive investment into renewables and conservation?

How is that going to "hedge" GHG climate disaster?

A subsidy diversion will only pay those who actually put solar panels on their home or save energy with geo heat exchange heating/cooling or plugin hybrid cars charged up on those solar panels.

The auction plan also leaves the huge corporate welfare for fossil, nuclear, and agribizz fuel farming in place.

Bidness as usual.  The contractors on america take over environmentalism.  Cooption at its worst.

http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin

A reminder, lest we forget.  People who read/listen to this stuff uncritically, as the mass audience does, participate in the mass delusion that the Murdochs of this world create with their media empires.

http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin

You seem to assume that the auction is set up and remains the continuing operating mechanism by which markets are set.  This may be right - but it is not my understanding of how these markets will work.  

My understanding is that the cap & trade mechanism remains the operating rules within which carbon is priced, bought and sold.  (And while the precise mechanism is not yet fixed, there is no reason why it couldn't be like any other market, handling spot trades, bilateral deals, swaps, strips, etc.  But none of these trading details need to be set by a regulator at the outset; they naturally emerge in any market that has buyers and sellers.  As an aside, one of the great limitations of the voluntary carbon markets that presently exist in the US is that they are so constrained that none of this has emerged, and it's keeping a lot of capital on the sidelines - probably a good subject for a future post.)

The auction, by contrast is needed only to set the  starting number, and to reflect the fact that at t=0, there are lots of carbon buyers that got to buy at zero cost.  (e.g., existing emitters).  Societally, we have two choices: we can either let them continue to emit without charge, but only charge new market entrants for marginal emissions (an allocation methodology), or we can compel those existing buyers to bid into the first auction  with everyone else.  But so long as the first auction is economy-wide, there is no reason to hold subsequent auctions - after that, there are simply buyers and sellers.  (Clearly, gov't has a role to play in market oversight at t>0, just as they do in any other market, but there is no reason for them to set price, supply or demand after that point - supply has already been set by the Cap, and the market will figure out demand and price on it's own accord.)

I think the closest analogy is land.  In our legal system, the state is the initial owner of the land, which the public may use subject to certain restrictions, but does not own.  Then at some point, the state decides to sell off land in chunks to people - either because the city limits are expanding and new subdivisions are coming up, or because lots of people listened to Horace Greeley and Went West, Young Man or any of a number of other reasons.  When that happens, the state charges a one time fee to sell the land - often in an auction-ish process.  And after that point, the owner can upgrade, combine lots, apply to get rezoned, etc... but buyers and sellers of that land in the future can do all that (and sell it at prices determined solely by themselves) independently of what the initial price was.  

And I think that's exactly the example you're looking for.  When a property owner builds a house, clears the brush, plants crops, adds septic, builds a manufacturing facility or does any of a zillion other things to upgrade their property, they are innovating because they own the property - and they have the potential to re-sell it at a price they will negotiate with future buyers.  (And I think it is safe to say that none of us would make property improvements if the only financial upside we had was a gamble on what future gov't run-auctions came up with.)

So where are we misunderstanding each other?

Look emissions permits are not issued with indefinite lifespans. (Well in the EU, after the collapse, permits that would have expired had their life extended indefinitely. That is another, and very dirty story>) Even in conventional cap and trade that does not happen. Permits are issued for a given period, with an expiration date. At the end of that expirations date, fewer permits are issued.

Now if you don't have a giveaway, then there is no point in issuing all the permits for a period at once. Rand's proposal is that auctioned permits have three year lifespans. (It is actually a bit more complicated than that, but essentially that is the idea.) You can argue for shorter expiration dates. But if you want continues reductions in emissions year by year, then the way to do it is to issue permits with short or moderate expiration dates, replaced by fewer permits until the day almost no permits existing.  You don't issue ten years of permits all at once, and most people agree it was a mistake even for the EU to issue permits with as long a lifespan as they originally did, not to mention the freaking extension.  I would say three year lifespan at most, maybe shorter.

However, lets take the system you propose. You isssue the permits all at once, meaning that carbon brokers buy them up, and big corporations buy more than they need for trading purposes. You have an active carbon market where permits are constantly traded. Explain the advantage of it over system like I describe that is very close to a carbon tax where you buy most permits at auction as needed. While a real life example would be great, we are discussing something that has not been tried - so a hypothetical is quite acceptable. Make up  a story; give me a really clear fr'instance where a system with a lot of trading produces a positive result that a continuous auction system with very little (but not zero) trading does not. If you can, go down to the firm level; imagine an example where a firm makes a reduction under a trading regime they would not in a  direct auction system. (Think of direct auction as basically a carbon tax where the cap guarantees the price of carbon won't be set too low.)

Does Lieberman-Warner do allocation, or auction?

-David Ahlport

Lieberman Warner started out as 100% giveaway. I think they may have added a tiny percent of auctioning, but basically is all (or almost all) grandfathering.

To give you a f'rinstance, take one close to home: my company trying to figure out whether or not to make an investment based on carbon pricing.  Any non-zero price for carbon makes it more likely we'll invest capital in a project, since it gets the project closer to our hurdle rate.  And if I can enter into a long-term contract with someone and lock that in against my project, I'll factor it into my investment analysis.  But if I don't know beyond the next auction whether the carbon reduction I produce will be sell-able (or at what price), then it rapidly approaches zero value.  Not because I wouldn't participate in those later markets, but because the ability to trade doesn't affect my investment consideration.

Let me show with numbers.  Consider the following three efficiency investments, all of which we will stipulate reduce an equivalent amount of GHG:

1. $1000 capital investment generates $125/year in energy savings.

2. $1000 capital investment generates $125/year in energy savings, but carbon markets exist which add another $125/year in project revenue through a tax / continuous auction process, such that I have no way of knowing whether that revenue stream will still be around 3 years hence.

3. $1000 capital investment generates $125/year in energy savings and through a trading regime I can sell my long-term offsets at $100/year to another party who anticipates being short on carbon for the next 10 years and will lock in a long-term contract.

I'd also disagree with you that no cap & trade works that way.  Kyoto actually does work that way.  Admittedly, they f'ed up the allocation bit, but there are financial players who will now buy long-term strips in Kyoto and CDM countries - not because of the allocation vs. auction decision, but because the secondary market is allowed to function external to the regulator.  But the US meanwhile has no such financial engineering taking place, in large part because of the uncertainty about what future policy is going to be - and that's in spite of the fact that there are active voluntary carbon markets like CCX out there.  So as a practical matter, you really don't make investments in the US based on their ability to reduce carbon even though that reduction has a financial value today.  This is in part because of price, but more significantly because of the lack of long-term certainty.  A system that relies on on-going auctions and/or politically maintained tax policy also lacks that long-term certainty.  Ergo, even if the price is the same, that approach provides a much weaker signal to reduce GHGs.

A mass emission cap and trade program then says "OK, by this date give me a 15% reduction," or something like that.  

This allows the regulated industry (hopefully not consumers) to reduce emissions or buy some from another company that has banked extra reductions.  Just as with any new source permit, one would have to buy credits in order to construct and operate a facility, since no doing so would create excess emissions.

There is no auction and no money exchanged unless one cannot meet the percentage reduction targets.

How hard is that? Occam's Razor says to keep it simple. I fail to see why we need to debate elaborate schemes that are too hard to explain and too hard to understand.  

Then there's what is called a "pull ahead" for wayward industries that are known to have best available retrofit equipment and best available technology. Again, no cap or auction required. The rate of reduction over time is simply steeper. Think coal here.

Of course, nothing is that simple. If hundreds of people on a US island require a diesel generator and can't reduce CO2, what are you going to do, kill the people in the minus 40 degree weather? Of course not. You're not going to auction or allocate them; you're going to hand out exemptions.

And I think that's what environmentalists fear the most, that any system even as simple as mine would require special cases, temporary delays, and potential loop-holes. Well that's just a fact of being a regulator.  Caps, auctions, and international trades (especially to palm oil plantations) is not the way to business though, none of it.
-sam

Onward through the fog

Hand waving. You don't that the savings in emission tax (because that is the revenue stream) will be around in three years? We have taxes all the time that people count on being there. The way you deal with this point in any system is to pass it once in such a form that changes have to go through the legislative process. One problem with the Kyoto system is that only one phase was negotiated at a time. Or the tax credits for renewable electricity. If you pass any system, including a cap and giveaway system, where each phase has to go through the entire legislative process, then of course you end up with a high degree of uncertainty. Any system you need has to have automatic escalator clauses where permits have a life span, expire and are replace by fewer permits, or a carbon tax that goes by a predetermined amount every few years.  If the only way the permits won't be needed is the law requiring them is repealed for amended, that is a strong enough degree of certainty to act on. Or don't companies take long term action to minimize other tax burdens.

Sam I'm not going to waste much time with you. An arbitrary percent reduction with trading as flexibility mechanism puts enforcement too far upstream. You are asking for fraud and game playing.

David. yeah I think you are right. My bad. But still, L-W starts with the majority of permits given away, and puts in an full auctioning long after the system will have collapsed like Kyoto in the kind fraud, manipulation and game playing that has accompanied both the various Kyoto created markets and the voluntary markets.

Random responses:

1. I'm not suggesting that carbon taxes won't drive behavior - simply that they won't drive it to the same degree as the same price in a market mechanism.  If I sign a contract with you for $15/ton for the next 5 years worth of reductions, my only risk that you won't fulfill your obligations is that you welch on your contract - in which case I have legal protections.  But if I sign a contract with the state for $15 this year and hope it will still be there every year for 5 years hence, I have the risk that taxes will get shuffled in the name of other political priorities (see: renewable credits punted in favor of oil & gas tax breaks in 2007) or that the rules of participation will change.  That may not drive it to zero value, but it certainly drives it to less than the first scenario.  

2. A big problem with carbon generally is that it is bound up in many other things.  There are no carbon markets right now that reward you solely based on your tons reduced.  Between nuclear exemptions, additionality tests, premiums (in voluntary markets) for so-called "charismatic carbon" (wherein a wind farm is worth more per ton than an efficiency investment) and any number of other features, one finds that different carbon reductions have wildly different values - all of which are set through a political process.  This makes those markets much more unpredictable, and greatly raises the transaction cost of participation.  We are looking at a project in Canada right now that is eligible for both carbon offsets and RECs.  The carbon is in theory worth more - but the REC rules are so much simpler that we will pursue those instead.  Where the carbon is renewable, it's nice to have that arbitrage.  But for GHG reductions that don't have a renewable signature, you end up looking at them and heavily discounting that carbon price for the same reason.

3. My general frustration with the way carbon markets are going (and this includes even the best of the proposals out there right now) is that they all suffer from varying degrees of market-phobia (and why I keep chiming in on this post).  If I grossly oversimplify, the Ds are marketphobic and the Rs are business-philic.  There is no pro-market constituency, but if we had bipartisan leadership on carbon policy, we might get there through negotiation.  As it is, with the Rs largely absent we've ended up with some really goofy proposals that suffer from all the failures I've pointed out in this thread.  And my concern with all that is because I'm sitting here, running a business with capital raised specifically to profitably reduce CO2 emissions.  You'd think we'd be sitting pretty in a new carbon regime, but the more we end up with something that looks like a tax, the more we tend towards a model where I will make $ on projects I would have done anyway, but that $ won't affect my willingness to invest in a project.  I'm not opposed to making money, but it's a sign of a failed system if it's not encouraging marginal investment in carbon reductions.  The $125 tax case above is therefore a lot more than hand-waving - it's very real, but invisible to regulators who have no visibility beyond economic theory (as opposed to the practice of capital allocation).

Secondly, if you do offsets, there HAS to be an additonality test. That is not anti-market,that is asking that markets function properly. (It is also one reason why offsets don't make sense. To keep the discussion as simple as possible, lets just assume a straight carbon tax. IF there is a 150/t tax on carbon, why would your customers NOT take it into consideration. OK so they discount it for the possiblity that the tax wll be repealed. Why on earth would they discount it more than a comparatively small company would honor a contract. For that matter in a trade system, there is always a possiblity that will be repealed too, yes? Even if the person selling the permits doesn't have to take that into consideration, the person buying it does.

The risk of government failure, of repealing the permit requirement or tax does not vanish with a secondary market. So really you are saying either that people who could save energy over-estimate that risk, or that a secondary market helps find suckers who under-estimate that risk. If a secondary market is needed because of the risk of repeal, one of those two has to be true. Which do you think it is?

As illustration, consider two scenarios:

1.  The gov't imposes a carbon tax of $15/ton.  I reduce carbon by 1 ton/year, so I get the benefit of $15 worth of tax I don't have to pay.
   
2.  You buy a ton of reduction from me for $15 for the next 5 years, contingent on my ability to provide.

But the second essentially cuts the gov't out of the process.  The buyer may not like the fact that she is forced to buy, but the point at which she signs a long-term contract with me is the point that the law creates a political constituency to maintain the regulation.  (And the payment is almost certainly treated as ordinary income, thereby creating tax payments to the fed, and aligning their interest in preserving same.)

So could both laws possibly be repealed?  Sure.  But I put a much higher probability on the first, and will discount accordingly.

Re: additionality - it's a great intent wrapped in a crummy package, but that is the subject of a longer discussion.  I've been through the additionality process enough to go crazy from it, because it forces you to favor projects that don't pencil on their own and/or stretch the truth about why the project won't go fwd.  The result is transactional costs and a bias away from the lowest cost carbon-reduction approaches which - since all wallets are finite - is equivalent to a bias away from maximum carbon reduction.

Re: whether or not single year taxes get taken into consideration, you may simply have to trust me on this.  Witness electricity market deregulation that was framed as if once you could sell into spot markets, private actors would suddenly rush in and build power plants.  They haven't - because while the old, regulated utilities can still get long-term contracts with the state (through the magic of a rate case), the private guy has to build a plant on the gamble that next year's price will be the same as this year's.  Equity doesn't like that, and debt really doesn't like it, and so lots of plants haven't been built in response to the price signal that (theoretically) exists.  The same thing happens with any carbon price that can't be locked into a long-term contract.

Some participants will grow or shrink and will trade. Some new participants will join.

The expected marginal cost of abatement (in both overall terms and in terms of the differences between industries) will change, leading to trading.

>New entrants don't need to trade. They can buy permits at the same auctions as everyone else.<

Possibly, but having quarterly auctions would mean that those new entrants would only compete for permits with those other players on that particular permit cycle, which could potentially distort costs from quarter to quarter.  The administrative costs of quarterly auctions would need to be evaluated. You would have a similar issue with environmental groups wishing to retire permits - how will they choose when to compete at auction? will they have the resources to compete every 3 years as permits expire?  For someone that spends a great deal of time talking about the dynamic efficiency effects of carbon policies, it seems like you glossed over that issue here.

>Now if you don't have a giveaway, then there is no point in issuing all the permits for a period at once.<

I'm not sure I get this one.  If you don't have an initial auction of all the permits, then aren't you going to be bringing a number of businesses to a halt as they wait for the next quarterly auction?  Or are you saying that the cap would be phased in over a 3 year period until the last emitter has bought its permits at auction?  I think of the example in water quality caps (TMDLs) where once the cap is set, all permits are issued at once and renewed as a group every five years.  If you stagger the initial allocation of permits, you're going to be creating a lot of uncertainty.

> carbon tax, or a carbon tax like permit system IS a market solution.<

Since the meaning of phrases seems particularly important here, I'd tread carefully on this one.  A carbon tax would provide economic incentives and would rely on market mechanisms (prices), but is not necessarily a "market solution," since there would be no market!  Having a price set by the government means that the necessary conditions for a market do not exist.

>Secondly, if you do offsets, there HAS to be an additonality test. That is not anti-market,that is asking that markets function properly.<

>Re: additionality - it's a great intent wrapped in a crummy package, but that is the subject of a longer discussion.  I've been through the additionality process enough to go crazy from it, because it forces you to favor projects that don't pencil on their own and/or stretch the truth about why the project won't go fwd.  The result is transactional costs and a bias away from the lowest cost carbon-reduction approaches which - since all wallets are finite - is equivalent to a bias away from maximum carbon reduction.<

Sean's point is one that I have tried to explain here before, but was unable to get my point across.  Yes, additionality is what want, but there is no objective test for it.  Sean's example makes it clear that you're deal with a moral hazard when it comes to determining whether or not a project meets the additionality criteria.

This thread was great for creating a new discussion on this issue, but the premise is shaky.  I think Gar's idea of this behemoth permit  trading market is somewhat of a straw man.  He says don't focus on trading since it will only take place on the margins.  Duh, ALL trading only takes place on the margin.  That doesn't mean you don't need an institutional structure for it.  Setting up an exchange with trading rules seems less costly than holding auctions every quarter.  The government would still have regulatory oversight, but there's no need for it to have such an active role.  This, along with my other concern about the periodic auction system make me disagree with Gar here, even though I agree with the importance of auctioning permits as the method of allocation.