Engineering News

Energy Legislation and the Cost of Cap-and-Trade
August 04, 2010

The Senate is about to debate an energy and climate bill known as The Clean Energy Jobs and Oil Accountability Act of 2010.  This bill was created by Senate Majority Leader Harry Reid (D-NV) after he concluded there were not sufficient votes to override a possible Republican veto of the Kerry-Lieberman energy bill.  Not only did Sen. Reid ditch the previous bill, but he also determined that his alternative bill would not include the cap-and-trade system for regulating carbon emissions so desperately desired by environmentalists.  What we have read, however, are statements from some key members of the House of Representatives that they plan to add the cap-and-trade plan back into the final legislation to be melded from the respective chamber’s energy bills.

There is one key determinant in the structure of the Senate bill as the House energy bill was passed months ago.  That determinant is the need for Sen. Reid to have an energy and climate bill with popular actions that can be passed before the election.  That will enable those senators up for re-election this fall to campaign on their positive vote.  Since the legislative calendar provides little time for action before the November vote, and is further compounded by the filibuster position of the Republicans in the Senate, the bill cannot contain any highly contentious issues.  Therefore, this bill deals with the oil industry and specifically BP plc (BP-NYSE), punishing both in response to the public’s outrage over the Gulf of Mexico oil spill.  There are provisions boosting natural gas for trucks and electric cars, full funding for the Land and Water Conservation Fund for the next five years, and money for home efficiency improvements that will create green jobs. 

While understanding the legislative strategy of Sen. Reid, we wonder what impact a cap-and-trade enhanced energy bill might have on the economy.  Well, fortunately, just as Sen. Reid was pulling the Kerry-Lieberman bill off the table, the Energy Information Agency (EIA) released its analysis of the American Power Act of 2010 (APA) in response to the request from the two senators to assess the bill’s economic impact.  The news was not particularly encouraging and has been attacked by proponents of cap-and-trade. 

The EIA’s report focuses on the impact that the policy proposals contained in the APA would have on the decisions of consumers and energy producers and what the implications are for the overall economy.  The EIA created a number of cases based on various assumptions and compares the results against the government’s base case forecast.  The conclusion from the study is that over the next 25 years the climate change, i.e., cap-and-trade, proposals in the bill would retard U.S. economic growth and reduce jobs.  Additionally, the pollution control mechanism would fail to reduce emissions as much as desired with the reduction targets being met largely through the purchase of offsets.  The bottom line is that the APA with its cap-and-trade system will hurt the economy rather than help it meet the goals of reducing oil imports, grow the economy and jobs and lower carbon emissions. 

The principle criticism of the analysis lies with the economic growth assumptions.  The EIA’s model calls for average annual gross domestic product (GDP) growth of 2.4% between 2008 and 2035.  The critics say that since GDP growth over the last 30 years averaged 5.9% and the growth rate since 1930 has averaged 6.0%, they find it hard to believe the future growth rate will be so low.  While this is an economic debate, most economists acknowledge that the future U.S. economy will not grow at anywhere close to its historical growth rate due to demographic changes and structural problems.  Our rebuttal would be, as long as we are comparing all the cases against a base case employing the same low-growth GDP then there is little to argue over. 

The critics also question the EIA’s assumption about the amount of electricity to be generated from nuclear power plants given their current age and the number of new plants that will need to be built merely to sustain current generation capacity.  Again the critics are targeting problems that they believe lie in the EIA’s base case.  Those issues are valid and should be debated, but they don’t negate the relative comparisons of the alternative cases.

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Probably the biggest disappointment with the analysis is the conclusion that purchased offsets will be the primary remedy (over 50%) for reducing carbon emissions.  As a result, pollution behavior would appear to be little changed under the cap-and-trade mechanism.  There is hope that it will impact behavior in the future, but that is dependent on a scenario where offsets are less available and clean-energy technologies are slow to develop resulting in much higher greenhouse gas allowance prices that would then push energy costs up and produce the desired environmental behavior.  In other words, to be successful a lot of things have to happen in concert.  In our experience, complex solutions to problems usually fail.  The key message from the EIA’s analysis is that the APA fails its primary goals raising questions about the validity of the cap-and-trade mechanism.  It also makes us leery of the post-election lame duck Congressional session.

Source: Parks Paton Hoepfl & Brown

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