If the U.S. cut emissions to zero tomorrow the savings would be overwhelmed by world growth in a short time. Reducing U.S. emissions is the wrong goal.

Our goal should be to use our high technology research and development capacity to develop low emission energy sources that are less expensive than fossil fuel. The world will rush to make the transition away from fossil fuel if they have a more attractive option.

This goal would also give us something of great value to sell to the rest of the world, providing high paying jobs and lifting the value of the dollar.

Things Everybody Should Know About Energy

There is consistent support for carbon taxes across the political spectrum, as I've summarized here.

If a price ceiling is imposed, then it's no longer cap-and-trade because it doesn't cap emissions. (How about "target-and-trade"?)

If you want to cap emissions and ensure cost acceptability, you have to set the cap so high that costs will be acceptable under worst-case predictive assumptions. Then the problem is price erosion or collapse, which can be avoided by imposing a price floor to ensure prices won't be excessively low. That way, you can guarantee a stable, minimal incentive for emission reductions while also achieving "environmental certainty".

WTF?

grist.org

No, I don't like safety valves.  No I don't support delays until CCS is available.  On the other hand, I think the federal pre-emption issue is not so clear.  This is, after all, a global pollutant and anything short of global regulation creates leakage issues.  Does that mean that strong state bills should be pre-empted by weak federal ones?  Of course not.  But ultimately, this is not a problem that the states alone can solve.

But at core, here's what I really like about what Bingaman has to say:

The bill should be focused on cutting greenhouse gases and not be weighed down with proposals aimed at solving other goals. Climate change legislation shouldn't be overly complex without carve-outs for different states or interests.

Read: this should be a GHG bill.  Not a bill that has a little bit of GHG, a little bit of social welfare and a little bit of pork.

The bill shouldn't be full of plans for the distant future, unlike the Lieberman-Warner bill that included appropriations 42 years into the future.

Read: Be flexible, not proscriptive.

It makes more sense for the bill to use existing agencies and institutions to run its new laws, saving the time and expense of setting up new ones.

Read: see previous.  We know how the EPA/SEC/DOE/FERC/etc. work, where their jurisdictions lie and under what precedents they operate.  Let's not open ourselves up to lawsuits and litigation over jurisdictional fights for new entities that delay our GHG goals.

Some of what we both disagree with may be legitimate flaws with Bingaman's philosophy and some may just be politics.  But what I like about what he has to say is that it belies a fundamental understanding of why L-W didn't work.  Not because the science wasn't there, not because there wasn't enough pork in it, and not because there isn't political consense to act, but rather because it became a massive clusterf**k of a bill that got wildly off track of it's initial intent.

(Point of candor: I have met Bingaman several times, including most recently testifying before his subcommittee.  I have consistently found him to be one of the most bright, well motivated and genuinely inquisitive folks on the Hill.  A part of what I like about this may be reading in from those prior interactions.)

Read: Be flexible, not proscriptive.

You may not mean that, but Bingaman sure does.

Any reasonable person ought to concede that there is a price for GHG reduction that is unacceptable, even while we may have massive disagreements about what that price is.  Some, a la CT Governor Jodi Rell think that maximum allowable price is just $5/ton.  Others think much higher.  But clearly, there is some price at which the societal impacts are too great.  My sense is that a smart politician seeking consensus makes the general observation long before suggesting their specific idea of what the limit is - and while I certainly don't claim to know what's in Bingaman's head, I'll give a pass to most politicians on that front in the early stages when it is simply the qualitiative observation that there must be some economic considerations in the bill.

My larger agnosticism on this issue though is structural.  From the studies we've done to the work McKinsey has done to the past experience of damn near every pollution abatement measure, I am quite certain that the cost of reducing GHG emissions will be way lower than anyone predicts.  It was true for all the criteria pollutants, and at core we know it to be true for CO2 (otherwise, why have additionality testing to block cost-effective projects?)  

There's a tenet of negotiation that says you ought to find the thing that costs you little but is worth a lot to the counter party that you can "give up" at an appropriate time.  So just between you, me and the tiny fraction of people who read this far down the comment thread, I'd put the safety valve in that camp.  Make GHG policy economy wide.  Set all tons at the same price (e.g., no grandfathering, nor differential pricing to different sectors).  No winner picking.  Then let markets work and get out of the way.  That will unleash a flood of very low cost CO2 reduction (and in fact, much that is profitable), driving the cost down.  Put that in, and I think the enviro community is then well advised to give on the safety valve, because we'll never get there.

Note that I'm not suggesting that I like the idea of a safety valve in a vacuum - simply that strategically, it's a good idea to keep the option available.  And at this early stage, I have no problem with that approach.

A carbon tax, by contrast simply fixes the price and doesn't even know if it's wrong.  Worse, a carbon tax - while it does provide price certainty - actually provides a lesser investment thesis for those of us who would like to deploy capital to lower GHG emissions.  In a cap & trade model, I can theoretically lock in a long-term buyer for my reduction, which I can factor into my decision to invest.  But in a carbon tax model, I only realize revenue gain to the extent that the price set by the feds is (a) permanent, and not subject to change as electoral winds blow and (b) ripples through to affect the price of high carbon options in a way that actually generates revenue for me.

Neither of those represent very good investment theses, and as a result, the carbon tax ends up being factored into GHG-reduction investments as a "great if we get it, but I'm not going to invest on the assumption that I will."

See more on the latter point here.

RGGI has a 3 year compliance period that can be extended to 4 if prices are sustained high.  This is a good hedge against short term price spikes without compromising reductions or just putting them off decades (like B-W-L "offramp").  A price floor set reasonably high could generate a stream of unsold allowances that could be carried over to be released in the event of subsequently high prices.  Obviously more money for investment in R&D and advanced research would help smooth the transition from the low hanging fruit to harder reductions.  But these don't really enter the serious discourse when that oh so tempting Soviet style just-decide-what-the-cost-can-be option is available.  

The same dynamic occurred with the allowances to companies (both generators and LSE's) to mitigate price increases in electricity.  If you try and cut prices without cutting the carbon content of a product (in a CO2 capped economy), you are ultimately doing more harm than good economically.  Many politicians don't really understand the economics and market dynamics that get in the way when your cost containment strategy is just "deciding" that you won't allow costs to get to a certain point.  It happens with bid caps in organized wholesale electricity markets as well, although to some extent they're necessary because other poor design aspects make them at risk of gaming because of lack of other systematic protections.  But again, the answer should be to try and perfect the underlying structure of the system, not just insist you won't let prices get to a certain point.    

The problem with suggesting a price ceiling then is not that its intellectually bankrupt, but it is intellectually lazy and ultimately counterproductive.

(A) Cap-and-trade, with the cap set according to limits of cost acceptability (taking into account predictive uncertainty), and with allowances or auction revenue distributed according to some allocation formula (grandfathering, output-based, recycled, whatever).

(B) A carbon tax with the tax rate also set according to the limits of cost acceptability, and with revenue distributed according to the same allocation formula (e.g., instead of giving an entity an emission allowance having a market value of $100, they instead get $100 in cash).

Ultimately, this is frankly true of many aspects of carbon policy, from sectoral coverage to the depth of cuts to allocation vs. auction calculus.  Set the first 15 variables and I can tell you my opinion on the 16th, but it's hard to say in a vacuum.  (Indeed, this problem continues to bedevil the AB32 process in CA.)

I'm not so sure there will be a ton of profitable or cheap reductions unless some of the regulatory barriers are removed, supplementary policies are passed, etc. Remember, the coal biz wants reductions to be expensive.

I'm not so sure that this is a value-less chit. It's part of a highly deceptive push from the fossil industry. We need to think about other ways of keeping the cost down, and a safety valve is an excuse not to think or talk about or implement those.

grist.org

I think you'll find that alot of industry (ex- the power industry that is) feels similarly.  Dow and BP have both publically set targets to reduce their own GHG emissions and have found that the effort created massive shareholder value, and gone so far as to say that the media still doesn't get CO2, because they still think it costs money.

In that context, there's a real danger of putting a floor price in, because it imposes societal costs that may not be necessary.  

But ultimately, we're on the same side of this issue - and all I'm saying is that a politician speculating about structures in the immediate fall-out of L-W shouldn't be criticized too harshly on that one single issue.

Your first sentence is true.  But I strongly disagree with the conclusion you draw from it.

1. In order to substantially reduce our emissions, we will have to deploy and tremendously scale up both renewable energy (supply side) and energy efficiency (demand side).  In so doing, we would develop techniques and solutions that could be exported to the rest of the world.

2. US policy has tremendous influence over the rest of the world, but we cannot directly control what happens outside our borders.  We can act much more directly and (at least in theory) effectively within our own borders.  So that's where we should focus.

3. The biggest thing missing from the global climate discussion is leadership by the
   

Ultimately, addressing climate change will demand a global effort.  But the best thing we can do to promote that is get our own house in order.

I have yet to go inside an industrial facility that doesn't have massive, profitable opportunities to lower CO2, many of which are not blocked by regulation.  A large chemical company which shall remain nameless recently asked us if we could help them with their operations, wherein they have identified $750 million worth of investment opportunities that would save them $350/year in energy costs at $7 gas.  Gas is higher now, but they can't get corporate approval to fund.  Not because of any regulatory barrier, but simply because industrials tend not to allocate capital to non-core activities, which include energy.

Now imagine a world where we have GHG reduction mandates, either through declining caps or through a voluntary market adding a bit more value to those options.  In either case, the aforementioned unnamed chemical company (which is far from unique) finds themselves being "forced" to invest capital that's earning a >30% return.  That's a massively negative cost of GHG reduction, and there's a ton of it out there.

I'd also question that the coal biz wants the price to be high.  The CCS industry absolutely does, because their technology doesn't work otherwise, but coal doesn't pencil out if it comes in... So I'm not sure I see your argument as to why they'd want this (or how they'd have the ability to encourage.)

How do you guard against the danger of not imposing societal costs that may be absolutely necessary?

Ergo, if facility X emits a fixed number of tons each year and makes no effort to reduce, they are increasingly exposed to be buying at the margin.  It is not quite a forcing in the sense of a government dictating thou shalt, but it's forcing nonetheless.

Whether or not society has to pay $5/ton to achieve the mandated cap, it will have to pay that much - or probably much more - to avert catastrophic climate change. Nobody knows how much climate stabilization will cost, but a carbon tax - unlike cap-and-trade - can at least incentivize society to pay as much as it is willing to pay for GHG reduction.

If you think cap-and-trade is in any sense economically efficient, then look at the U.S. Acid Rain program, which is expected to cost $3 billion  and produce $122 billion in annual benefits in 2010. If SO2 emission prices had been maintained at their expected level when the program was introduced in 1990, then industry costs ($3 billion) might have been doubled, but the corresponding societal benefits ($122 billion) would have also increased commensurately.

My bona fides on this, should they be relevant is that our company has a mission to profitably reduce GHG emissions, and raised  $1.5 billion specifically to do so.  I have a strong interest, and a strong resource specifically to invest in projects that will lower GHG emissions.  My beef with a carbon tax is that - CBO theory notwithstanding - it does not affect my ability to deploy capital, for all the reasons I've outlined above.  

I don't for a second mean to suggest that our GHG policy ought to be measured by the happiness of my investors.  But I am quite positive that meaningfully reducing our GHG emissions will require massive changes to the way we produce, distribute and consume energy, which in turn will require massive capital investments.  If a GHG policy does not provide a differential thesis to make that investment, it is a lousy policy.  The CBO and economic theorists never get this point, primarily because they get caught up in neo-classical economic ideals that make for wonderful theory, but are grossly at odds with the facts on the ground.  

Anyway, enough rant on that point - but check out the link I posted earlier to carbon taxing, which includes a socractic dialogue with our investors that hopefully explains why I get so fired up over this particular issue.

The great thing about truly competitive markets is that they sniff out the cheapest opportunities, creating maximum value at the lowest cost.  This is exactly what taxes don't do, since the cost is fixed.  I would certainly agree with you that if the price were higher, other SOx reduction projects would be built, but that doesn't mean that high prices are necessarily the solution to lowering SOx.  After all, we could just lower the cap.  In theory, that would raise the price per supply and demand, but it would do so in a way that still maintains a downward pressure on price.  (Getting rid of grandfather pollution rights would have the same effect.)

Note also that there is no reason why spending 2x as much on SOx reduction would lead to 2x as much social benefit.  Indeed, most pollution abatement costs are highly non-linear.  Getting the first 90% of the NOx out of your exhaust is pretty cheap.  Getting the next 5% is massively expensive.  A properly designed cap & trade model doesn't have to worry about this, because the price levels off at whatever is necessary to achieve the targetted reduction (the cap).  But a tax system never gets it right.

As an interesting aside, Toyota did a study for CA back in the early 90s showing that the ~$50/car cost in catalytic converters to get to the next Tier of CA emissions standards reduced less NOx at a higher price than if CA had simply offered $10,000 to every owner of an uncontrolled car - e.g., all those old Dodge Darts, since the former got a couple ppm out of a large number of cars while the latter got 10,000s of ppm out of a small set of cars at a lower overall price per ton of NOx.  CA did nothing with the report, and Toyota obviously had a self-serving motivation, but it's a great illustration of why markets are preferable.  They get the low-hanging fruit in ways that top-down regs & taxes never do.

Getting back to our theme, the environmental community too often ignores the economic angle.  This is not to say that it trumps, but rather that the two are linked.  In a world of finite resources, maximum environmental gain can only be realized by minimizing the cost per unit of gain.  If I've only got $1000, I get 10 units of goodness from something that costs $10/unit than one that costs $100/unit.  Which means that a regulation that causes $100/unit options to be deployed in advance of $10/unit options is implicitly a regulation that is failing to maximize its environmental benefit.

Much of our environmental policy ignores this, under the naive concept that one cannot put a price on the environment.  The concept is true (I sure as hell can't), but that doesn't therefore mean we shouldn't preferentially  pursue the lowest cost environmental solutions.  More on that here, if you're interested.

Re "Given the choice to reduce pollutant X cheaply or expensively, why shouldn't we prefer the [cheaper option]?": We should choose the cheaper option, but that does not imply that we should not make further emission reductions, particularly if such further reductions can be achieved cheaply. If the first dollar investment in SO2 reduction yields $40 in quantifiable benefits, then another dollar investment will very likely result in much more than one dollar in benefits, so why shouldn't we make that additional expenditure?

Markets don't create "maximum value at the lowest cost" - they generally create either predetermined value at lowest cost, or maximum value at predetermined cost. Cap-and-trade incintivizes industry to "sniff out the cheapest opportunities", i.e., to minimize dollars per ton GHG reduction; while a carbon tax induces industry to "sniff out the lowest-emission opportunities", i.e., maximize reduction tons per dollar.

What should our policy priority be: (a) minimize costs (while capping emissions at an unsustainable level), or (b) minimize emissions (while capping costs at an acceptable level)?

And the certainty issue shouldn't be dismissed either I think.  You talk about needing a degree of certainty to deploy capital.  This allows firms to know that certain projects won't end up having been bad investments if all of a sudden the price of permits crashes.  This has effectively happened now with CAIR being thrown out, which the utility industry was investing in preparation of needing compliance with.

If in every year of compliance the price floor is triggered, then its just a carbon tax and misses the point.  But no one ever suggests a price floor like that.  The idea is that you encourage more actual reductions to happen when they're cheaper to soften what would otherwise be volatile price spikes when reductions might become suddenly more expensive.

The reason this debate will never end is that people have different goals. Is your goal to;

1     Maximize quality of human life.
or
2     Reduce emissions to some specified level without regard for its impact on people.

For those who choose number 1 a dumping fee equal to the best estimate of the cost of damage done by the emission is the way to go. Free market forces will automatically evolve a balance that provides the optimum quality of life possible using available technology.

For those who choose number 2 cap n trade sounds good but it probably won't work. People's lives will be hammered and we will have a new set of multimillionaires who made it big gaming the system selling carbon credits, but we probably won't hit the caps because many of the credits will turn out to have been overestimated.

Meanwhile in China there are 300 million middle class citizens and another billion who want to join them along with 3 billion other people around the world.

Shooting ourselves in the foot is not setting a good example for the world.

The sun delivers 23,000,000 watts per person, in the U.S. we use about 13,000 watts per person. Energy consumption does not cause climate change, greenhouse gasses do.

We should start a $100 billion dollar per year R&D program to develop low emission energy sources cheaper than fossil fuel so that more people can enjoy a comfortable life without wrecking the planet.

Things Everybody Should Know About Energy

A price floor is effectively a carbon tax as long as some allowances remain unsold, and it only increases emission reductions as long as the price remains below some predetermined "burdensome" level.

Using emission caps to manage costs is kind of like trying to drive a car with the accelerator floored and using the brake to control your speed. Price limits (floors and ceilings), which provide direct regulatory control over costs, can be employed to maintain some degree of sanity in the carbon market.

Re CAIR, there would have probably been no need for CAIR if a price floor had been employed.

But even if we did achieve such perfection in the regulatory process, one is still left at the mercy of whether the gov't identifies all the relevant parties who ought to receive those distributions.  Because if Lieberman-Warner taught us nothing else, it's that the feds have a really hard time simply funnelling proceeds to CO2 reduction, pro-rata with the amount you reduce.  Much more likely is that they pick winners, leaving lots of good ideas untouched.

And of course, there is then the risk that they might decide to reduce the tax in the future (witness the on-again, off-again nature of production tax credits depending upon the party in power and the fiscal needs of any given budget cycle), which makes it very problematic to plan for the carbon-tax remaining in place over the life of the project.

A final observation on taxes.  Let's say that the taxes raise the price of all carbon containing fuels, pro-rata with their carbon-content.  If that happened, it would actually make it harder to do CHP projects because of the lag time between increases in fuel costs and power costs (this happened during the gas price run up in the early 2000s, when new CHP installations virtually came to a standstill).  Eventually, this catches up - and of course, the issue doesn't affect non-fueled sources like renewables (but it doesn't really help them either, since until the electric rate increases, they don't benefit).  But in the meantime, the low-hanging fruit that is precisely the stuff that could quickly and cheaply lower the  use of fossil fuels and serve as a bridge technology ends up being blocked by the carbon-pricing regime.

I'm rambling, but hopefully have answered your question.  On to the rest that came on overnight!

Markets don't create "maximum value at the lowest cost" - they generally create either predetermined value at lowest cost, or maximum value at predetermined cost.

This seems a very strange definition of markets to me.  15 years ago, only the highest end (>$50K) cars on the road came with CD players.  Today, $20K cars - in current dollars -  is increasingly likely to come with a CD player, an iPod hookup, voice-automation and a GPS.  I guarantee you Ford isn't adding those options because they have predetermined the value, or that they are trying to build a lowest-cost car.  They're adding those features in downmarket cars because the market is forcing them to.

That's why I say that markets create the maximum value at the lowest cost.  Recall the old Dilbert cartoon about customers always demanding the maximum quality at the minimum price as soon as possible, and Dilbert assuring them that this was technically impossible.  Engineering humor notwithstanding, that's what customers always demand.  And so long as they ask those questions in the context of a competitive market, the suppliers are forced to deliver a product that is as cheap, as good and as timely (or better, on all three counts) as their competitor, or else they go out of business.  Every company does the same, and gradually ratchets down on all three... such that 15 years from now, we will undoubtedly see today's luxury car features in new end cars, without any substantial appreciation in price.

Top down models never provide this level of creative destruction and innovation.  Compare the rate of change and improvement in the "options package" included in our medicare or social security packages to those of autos (or any other competitive market).  For that matter, compare the level of innovation (hint: damn near nil) in the top-down regulated electric sector over the past 50 years with the same in the computer industry.

Bottom line: I agree with you that companies (not markets) would like to be in a position where they can predetermine value and set the price.  Hell, I would to.  The trouble is, markets don't let us.  That's why - as I wrote here - the job of good policy is to ensure that those market conditions exist, and then get out of the way, no matter how many companies coming crying to do otherwise.

1. My roommate senior year in college, and today one of my best and longest friends is an absolute genius at getting people to bend to his will.  If any human alive today knows the Jedi mind trick, it's him.  (I once watched him not only convince his teacher that it was acceptable for him to turn in his term paper a full month late, just before grades were do, but that he deserved a grade on the paper to get him to make Dean's list that semester.  Genius.)  Anyway, I raise that because he had a fascinating insight on human nature that I find also applies to much of our policy debate.  Namely, that people will, by and large, live up to your expectations of them.  If you treat your kids as if they are athletic geniuses, they will join sports teams, study hard and become more athletic and smarter than they otherwise would have been.  Meanwhile, if you treat someone as if they are an idiot, they will do they opposite.  Here's why this matters to this conversation: we have framed our entire CO2 conversation as if CO2 reduction will be expensive.  If our goal is for CO2 reduction is to be expensive, that's an appropriate framing.  But I think that's an awfully dumb goal, especially when there are so many massive opportunities - mostly under-acknowledged - to reduce CO2 at negative cost.  This isn't magic - it's simply a function of the fact that CO2 comes from fossil fuel, and fossil fuel costs money.  CO2 reduction is only expensive if there are not opportunities to reduce our fossil fuel use without sacrificing comfort.  Which  is transparently not the case to anyone who's spent time in a factory (or, for that matter, ever debated between R-12 and R-18 insulation at Home Depot).  So the core issue with a price floor is that it essentially starts from the expectation that CO2 reduction will cost money - and then gets exactly what it expects.  I would vastly prefer a regulatory model that remains open to the possibility that CO2 reduction might actually be profitable.  And again, I'm arguing against my own self-interest here: if a price on CO2 provides windfall profits to CO2 reducers, I'll be one of the beneficiaries.  But for the sake of society, I think we're better off allowing the price to go all the way to zero if it must.

2. Re: certainty.  Don't confuse the price certainty at the top of the market with the certainty at the bottom.  A tax has a fixed price for an unknown duration (since I cannot trust Congress not to change the laws at some point during the next 20 years).  A cap & trade has an unknown price for an infinite duration (since it's really hard to unpack a cap & trade structure without undoing all sorts of contracts).  But that doesn't mean I can't get certainty in a C&T market, since both buyers and sellers want certainty.  Indeed, look at any commodity market.  The first guy who sold a bushel of grain on the Chicago Board of Trade was selling a single bushel at a single price.  But as buyers and sellers came together, we evolved a whole set of financial instruments - futures, options, puts, etc. - to meet the desires of buyers and sellers to minimize their risk exposure.  There is no reason why the same wouldn't happen in a C&T environment, even in the wake of a declining cap and volatile pricing.  If you're a coal plant that needs to buy credits, you'd like certainty in your economics just as much as I want certainty in the pricing of mine.  So the two of us negotiate a deal.  We look at the current price, see what the experts are forecasting is going to happen to that price and then sign a long-term contract for my credits at a price that gives us both price certainty.  We settle upon delivery, and so our annual transactions over the ensuing years are still settled on the market, but it's at a known price.  If the price goes up, I settle with them for less, and they get a benefit.  And vice versa - but in exchange, we both get certainty.  This will happen - indeed, as it already has in Europe under Kyoto.
   

A tax is basically a fixed-price sale of emission allowances, while C&T auctions a fixed quantity of allowances. Otherwise, there is no significant difference between taxes and C&T. (Free allocation under C&T is not significantly different than auctioning because any allocation method can be applied equivalently to auction revenue.) The exact same options for revenue distribution - and attendant political concerns - exist with both taxes and C&T. (In CA there is some protection against misappropriation of tax or auction revenue, because the funds could not be used for some purpose unrelated to climate regulation without a 2/3 vote of the legislature.)

Comparing carbon tax to C&T, both based on the same target emission level (or the same target price), it is more likely that the cap will be breached than the tax reduced because C&T provides no price control. For example, California's AB 32 legislation would not have passed if it had not given the governor explicit authority to suspend the caps (indefinitely) under the "threat of significant economic harm".

Next post: Re "This seems a very strange definition of markets to me." It's not a definition, just a characteristic. The basic idea is that the market is like a seesaw with emissions on one side and costs on the other. If one side goes down, the other side goes up. Trying to "create maximum value at minimum cost" is like trying to push both sides down at the same time. Which will it be - maximum value or minimum cost? Take your pick.

But you (and Max) are right - In many cases you can actually do both (e.g., the current price of gasoline in CA is > $500 per ton-CO2). All of the industry's whining about high regulatory costs mainly applies to short-term costs. After they've made the initial capital investment in low-carbon energy, it's basically free money. In the case of transportation vehicles, an effective regulatory incentive need not involve any revenue transfers from high- to low-emission vehicle owners; all that is required is that differences in lifecycle fuel consumption be at least partially internalized in vehicle purchase prices.

Moving onto taxes though, you're right that government could relax the cap, but that's much less  of a concern to me due to contract issues.

Let's look at the tax case.  If gov't decides to lower the tax, they may face political fallout, but they have no legal difficulty.  Some might complain and some might cheer, but ultimately there is no contract that has been severed.

Now look at the C&T case.  At the moment when I enter into a long-term contract with emitter X where we transfer title to my tons of reduction to offset their source it gets really hard for government to then change the rules of the game without triggering 14th amendment lawsuits:

No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any state deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

Any legislative action which infringes upon the ability of an existing contract, written in compliance with previous legislation to fulfill it's obligations to the parties is essentially taking property away from the holder of the contract, and therefore triggers a "takings" violation of the 14th amendment.  As such, any such contemplated legislation thinks for 3 - 4 seconds about the lawsuits that would ensue once passed and elects not to change.  

This, in a nutshell is why all the sound & fury about "re-regulating" power markets in Ohio and elsewhere is such a load of nonsense.  You can't put that genie back in the bottle once there are parties and counter parties to contracts.

So could a cap & trade be changed post-implementation?  Yes.  Is it likely to be?  Nope.  At least not to a degree that would affect the ability of parties to a deal to realize the terms of their deal.  And remember - the goal here is not to satisfy contracts necessarily, but rather to deploy GHG-reducing capital.  A part of the reason a long-term contract in a C&T market helps me deploy capital is because I have a high degree of confidence that if the co-party or the gov't defaults on their contract obligations, I have legal recourse.  Not so with a tax.

(One note: an exception is if the initial legislation gives the gov't the right to tweak with the #s down the road, because any subsequent contracts are then made in cognizance of that possibility.  But even in that case, they can't change contracts between two private entities that were written in keeping with the prior law; e.g., if I'm getting paid $15/ton and a subsequent legislative change causes the price to fall to $15/ton, the entity that committed to pay me $15 still has to honor their contractual obligations, which the gov't may not abridge.)

Sean, I'm with you that there will be plenty of emissions reductions at negative cost.  I am also with you that trying to engineer a high cost is foolish and misses the point.  But I would point out that my emphasis on a price floor is not based on a thinking that all reductions will cost money.  In fact in large part the opposite - a price floor forces the economy to make ACTUAL reductions when the price is very low, instead of just bidding down the price of a permit, so extra permits are around to release when supply (of reductions) gets scarcer later, without compromising the cap.  Many of these reductions will end up in fact being profitable, but will not happen if you allow the price to be bid down during periods of excess supply (of reductions).  So if you want to argue against a (well-designed) price floor, you're not insisting that there will be reductions at negative cost, you're insisting that ALL reductions through 2050 will be at negative cost.    

Sean point 2:  I would just say that your point on this only applies if you have substantial allocation of permits to producers - allowing ones who don't need them to bargain them away to the ones that need more.  We probably don't want to get into our debate over this again but I'll just say that I don't support much allocation to producers, even in an output based standard like yours which is admittedly the way to do it if you must.  Which you don't.

You might still have a point that Congress might face increased political pressure because now certain companies will be obliged to deliver certain amounts of allowances forward, and those plans will be complicated by seeing their allocation diminished.  But Congress is all over the legal question.

When you talk about price ceiling, do you mean that the government will sell any number of credits at some high price, or only the same number that were purchased at the floor price? After that number of credits at the ceiling are sold, the price ceiling is eliminated?

Can companies bank credits for future use in your system?  

Also, you made a comment that you think there is a better way to allocate credits than output based standards. Could you briefly explain it or point me to another post?

"If gov't decides to lower the tax ..." Now that would be a first! (Any chance of them lowering my income tax?)

Re contracts, an emission allowance conveys a right to emit, which is not abridged if the cap is  relaxed - it just dilutes the allowance's market value. The only problem is if you try to tighten the cap before all of the banked allowances in circulation have been used. For example, if CAIR goes into effect its SO2 cap would not likely be met until well beyond 2015 because of all of allowances that were banked when they were cheap.

In the case of AB 32, contracts would not impede the governor from exercising his discretionary authority to suspend the caps.

Taxes have, in fact, been lowered many times. But lowering a cap would be politically much tougher if you had powerful interests crying wolf about economic hardship. It's the same forces that drove L-W to include allowance giveaways instead of auction.

Sean, I have a different question for you if you don't mind.  I'm curious about your take on CAIR going under...
...but more importantly I also want to go back to your endorsement of Bingaman's view that federal cap and trade legislation should nullify all the separate regional, state, and local action that has taken place.  Why rely solely on federal legislation that is always watered down by compromise, when tighter rules in particular states or regions often drive the market innovation that the whole country needs?

From a regulated entity's perspective, a tax is essentially equivalent to cap-and-trade without any price volatility. ("Allowance giveaways" can be implemented equivalently with an auction or a tax, and are not a bad thing if they are given away preferentially to low-emission producers.) Unless industry likes price volatility, there is no good reason why it would prefer cap-and-trade over a tax.

To some degree, it may hinge on who wins the upcoming election, since the language will have to be re-written by someone not named Bush.  Hard to read that one right now, but ask again in a week or so when I've had a chance to talk to folks & get their read.

Re: federal jurisdiction, my point really isn't one of where regs are likely to be better, but simply an acknowledgement that as a global pollutant, we need regulation at the highest possible level.  RGGI only applies to power plants  > 25 MW.  AB32 appears to be headed towards a model where some sectors are auctioned and others are allocated.  Voluntary markets are riddled with goofiness on the additionality front, and differential prices for "charismatic carbon".  I don't raise these to knock those markets, but simply to point out that it is really hard to reconcile those together.  

That's not to say that the only answer is federal legislation, though.  One could, after all, equally envision a scenario where RGGI builds bridges to AB32 with transferability, Kyoto links in as well and we end up with a de facto global standard built from the bottom up.  (People I have a lot of respect for in the field see that as the most likely outcome, for what it's worth.)  But when all is said and done, we do need a global standard, not just a patchwork of state ones.  

Soon, we will get a national GHG bill, and it is either going to have to preempt state bills or else tie into existing regs.  Tell me what the national bill looks like and I'll tell you where my preferences lie on that - but I'm not sure there is a universally ideal jurisdictional hierarchy.  I am sure though that we need a globally-consistent framework.

On the price floor, you ask would the government step in and buy credits?  The government owns the credits.  It's just a matter of not offering them all immediately for sale if the price is sufficiently low (meaning reductions are readily available) so that there are extra to be released if (when) the price unexpectedly jumps (when reductions are suddenly less available, or demand for CO2/permits rises suddenly, which could happen for any number of reasons).  

On the price ceiling, I definitely don't suggest any sort of "safety valve" or even B-L-W "offramp" that borrows them against the accounts from 2030-2050, which is ridiculously irresponsible.  In fact I don't even think I mentioned a "price ceiling," though that's one way to handle these extra allowances.  It probably wouldn't be my favorite way though.  Remember the price ceiling would have to be rising every year, from a predetermined formula at the time of passage.  So if permit prices started out below the ceiling, and rose slower, you could theoretically have a pretty significant jump and not hit the trigger.  The important part to me is mitigating short term volatility, and I think that would best be done with giving whatever extra allowances were unsold from the price floor to the Carbon Market Efficiency Board, allowing them to release them only under periods of short term price spikes, say a couple nuclear reactors come online a year late or something.  Or they could rise significantly, but maybe its not looking like theyre gonna come down anytime soon, like oil has done.  In that case a price ceiling does you no good, just like price controls on oil now wouldn't address the underlying issues.  A Board of members with 12 year terms (proposed under L-W) would have more incentive to be a bit more detached and make decisions based on underlying fundamentals, not any predetermined number.

Is it perfect?  No.  But if you've read the bills going around Congress (and RGGI) you know that the alternative is giving them the authority to increase the use of offsets, which I tend to be skeptical of, as well as other less responsible measures.

On allocation, sorry if I wasn't clear.  IF you are going to allocate these credits to industry I think an output based standard is the best way.  However, I don't think they should be allocated to industry.  Personally I think that they should be auctioned, with revenue going mainly for basic and advanced energy R&D, assistance for low- and middle-income consumers, and assistance for workers in affected industries and states that are especially carbon-reliant currently.  There are plenty of wrong ways to go about these measures but there are also some good ways.  

The output based standard would be great if it really was assured to prevent price increases.  It's not.  In wholesale electricity markets across the country, the clearing price paid to every producer of energy is the highest bid that is needed to meet demand and so accepted.  Those market-setting bids are always from fossil fuel plants - gas, and when no gas is needed coal.  So the electricity price is going to go up in most places because they're set by the highest bids, which will raise their bids to cover their carbon liabilities.  I also see a major need for research, some large scale demonstration projects, and likely some new transmission investment as well, because they would otherwise be undersupplied if left to the private market because they produce benefits that cannot be entirely captured by any single firm for profit (externality benefits basically).

Given the inevitable robust and liquid secondary markets for permits that will develop, permits are just cash.  Allocating permits is giving capital.  If you're going to do it an output based standard is the fairest way, personally I think a better way to free up capital for firms to invest would be to cut the corporate income tax rate with funds from extra auction revenue.  Its a wee bit more transparent because you don't have to compare apples to oranges, trying to ensure that production metrics are fair and equivalent across different industries which produce different products.

EU ETS, Phase 1:
The price of allowances increased more or less steadily to its peak level in April 2006 of about €30 per tonne CO2, but fell in May 2006 to under €10/ton on news that some countries were likely to give their industries such generous emission caps that there was no need for them to reduce emissions. Lack of scarcity under the first phase of the scheme continued through 2006 resulting in a trading price of €1.2 a tonne in March 2007, declining to €0.10 in September 2007.

Southern California's RECLAIM program for NOx:
A credit that carried the right to emit one pound of nitrogen oxide gas went for as little as 13 cents in 1999. By January, 2000, the price was up to $1.14, and in July, 2000 the same credit sold for $37. By September, 2001, prices settled somewhat, falling to about $13 per pound--100 times what they had been earlier.

There may be no reason why a well-designed C&T program need exhibit this kind of volatility, but industry opposition is based on the expectation (or fear) of high and/or volatile prices, and regulators bias caps excessively in favor of cost conservatism to allay industry fears.

I believe there are good arguments against that, but those arguments did not prevail.  So clearly new legislation for CO2 cap-and-trade is the way to go.  Here's hoping it will happen in 2009.  

What I do wonder is whether the CAIR decision will make Congress more likely to take up multipollutant legislation, and not a simple focus on CO2.  There have been cap-and-trade bills floating around in the last few years that would have covered SO2, NOx, and particulates as well as CO2.  I wonder if we will see their return, and whether we should or not.  

I'm not politically connected enough to know whether there will be lobbying for that, given that utilities had already begun investing in scrubbers and the like in anticipation of CAIR.  Those guys are going to want a level playing field, though.

Sean writes:   6:22 11.7.08  
As an interesting aside, Toyota did a study for CA back in the early . . . CA did nothing with the report, and

California has set guidelines and helped organized projects to buy junker cars and take them out of circulation since the mid '90s -  the VARV program.

I'm not in any disagreement with you that C&T can induce volatile spot prices.  I'm simply pointing out that a government-created spot market for carbon does not imply that the only way to enter into GHG contracts is on that spot market, any more than the government-created spot prices for power on PJM, ISO-NE, ERCOT or any other power market keep you from buying or selling 10+ year strips at a fixed price.

SO2 emissions from U.S. coal plants in the U.S. averaged about 9 lbs/MWh in 2006 (ranging as high as 40 lbs/MWh).

State-of-the-art scrubbers can reduce coal plant SO2 emissions to about 1 lb/MWh at a cost of $300/ton-SO2.

Quantifiable benefits of SO2 mitigation are estimated to be $7300/ton. This valuation is primarily reflective of 22,000 annual deaths associated with SO2 emissions. It does not account for evnironmental impacts of SO2 emissions, which are capped at a level about five times higher than the sustainability threshold.

In view of the relative costs and and benefits of SO2 reduction, should regulatory policy be constructed to (a) further reduce compliance costs, or (b) further reduce emissions? In either case, industry should be incentivized (and allowed) to employ least-cost compliance mehanisms, in the sense of minimizing dollars per ton-SO2; that is not the issue. The question is whether the benefits of technology advances and economies of scale should be applied to the benefit of industry or to the benefit of environmental sustainability.

The massive benefit/cost ratio notwithstanding, most cap-and-trade dogmatists are of the view that policy should focus incentives on further cost reduction, not further emissions reduction. For example, EDF's C&T tutorial boasts that "The expected market price for SO2 allowances was in the range of $579-$1,935 per ton of SO2; the actual market price as of January 2003 was $150 per ton"; as though the underinvestment in SO2 reduction were a good thing. What is your view?

1. Under your system, I assume credits would be auctioned every year (or three months or something). Companies would estimate how many they need and buy that number. The secondary market is needed if a company's estimated number of credits needed is off. Since all credits must be purchased, the long term strips that Sean talks about to remove volatility would not work. It seems to me that you need to have a predictable allocation for you to sell a long term credit contract. The result is that your cap and trade system would not subsidize clean technologies such as wind, solar or CHP (it would not give them "free capital"). It would only promote clean technologies once energy prices go up due to the cost of credits working its way to the energy u