by Dan Watkiss
Since 1994, when the U.S. Senate ratified the 1992 U.N. Framework Convention on Climate Change, the U.S. has remained one of the world’s biggest emitters of greenhouse gases and the single largest source of atmospheric greenhouse gases, but (other than product-efficiency and slightly improved CAFÃ‰ standards) has taken few steps as a government directly to reduce its greenhouse gas emissions. Notwithstanding the scientific consensus that anthropogenic climate change threatens severe and possibly catastrophic injury, since 2000, U.S. policymakers have vacillated between denying the peer-reviewed science and acknowleding it grudgingly while assuming no leadership in stopping climate change. Not until June of this year did the Bush administration announce its “ambitious strategy” of halting the growth in U.S. greenhouse gas emissions by 2025–a move widely perceived as intended to derail the Lieberman-Warner-Boxer bill, for which the Senate recently failed to muster the votes needed to proceed before the next national elections.
Winston Churchill opined during the opening act of World War II, “Americans can always be counted on to do the right thing ” after they have exhausted all other possibilities.” With hopeful expectancy that the next administration will be the first in 15 years to engage the pressing generational demands of climate change, it should do so mindful of the policy paradoxes that have dogged and presumably will continue to dog this complex challenge.
Paradox One: Locating fairness. Greenhouse gas emissions are an economic externality, the cost of which fairly should fall proportionately on those who contributed and continue to contribute per capita most to atmospheric greenhouse gases. On a country-by-country basis, this unambiguous proposition would have the U.S. and other developed countries lead in stabilizing and then reducing emissions, as well as funding the needed technological innovations in clean power generation, carbon capture and sequestration, and geological nuclear waste storage.
The EU, unlike the U.S., has shown leadership, even if sometimes spotty, in preparing for emission reductions through implementation in January 2005 of Phase I of an emissions trading system intended to achieve the Kyoto Protocol’s modest demand that developed countries cut greenhouse gas emissions by 5 percent during the protocol’s 5-year (2008-12) commitment period.
The next U.S. administration, under either major party, is expected to shoulder its responsibility for reducing greenhouse gas emissions through either a cap or a tax on greenhouse gas emissions. But neither the U.S. nor its sister developed nations can realistically expect comparable limitations on developing countries that in total and per capita have contributed comparatively little to atmospheric greenhouse gases, but whose economies will be able to converge with those of the developed world only in exchange for some increase in their greenhouse gas emissions. In the near term, the developed world cannot fairly demand more; instead of demanding a single standard for all, developed countries must instead aid developing countries to reduce the carbon intensity of their economies through improved processes and technological innovation.
Paradox Two: The venue of efforts to turn around climate change. The climate-changing effects of atmospheric greenhouse gases are the same regardless of where on the planet the gases are released, making the problem inherently a planetary one. It can be addressed effectively only through institutions such as the United Nation’s Intergovernmental Panel on Climate Change or International Carbon Action Partnership, and at the large nation level. Yet, in the U.S. nearly all focused efforts at directly stabilizing and reducing greenhouse gas emissions have thus far been and continue to be at the state and regional level. At the regional level is the Northeast Regional Greenhouse Gas Initiative, the Midwest Regional Greenhouse Gas Reduction Accord, and most recently the Western Climate Initiative. In addition, there are as many as 33 other state climate initiatives and programs in cities such as Boston, San Francisco and Chicago that are in the process of being implemented.
For the most part, these efforts are confined to areas with relatively small carbon footprints, excluding much of the Mid-Atlantic and South, areas with some of the nation’s highest emissions of greenhouse gases. While strong in symbolism, it is questionable whether these admirable efforts will make much of a contribution unless joined with nationally and internationally coordinated programs. Moreover, as the Investor Network on Climate Risk recently wrote to the majority and minority leaders in the Senate, “an increasingly complex patchwork of regulations at the state and local level” is deterring needed capital investment and risks competitively disadvantaging proactive states and regions as emitting enterprises race to the bottom.
Paradox Three: An insistence that solutions to climate change be “market-based,” while many of the proposed legislative solutions would cloud the transmission of price signals grounded in market fundamentals. A first-order choice for managing climate change is between a tax–the government sets the price and the market sets the quantity (price-based control)–or a cap–the government sets the quantity and the market sets the price (quantity-based control).
A revenue neutral tax would be set initially equal to an estimate of the damage per ton of CO2, could be adjusted over time to achieve the desired reduction in emissions, and its revenues used to lower other taxes or afford tax credits, such as making the production tax credit permanent. In contrast, a cap fixes the amount of emissions but not the cost or price, which ostensibly could swing widely depending on demand and other variables such as the pace of technological innovation in carbon controls and capture.
Because a tax would be a fixed cost, known in advance, many economists, businesses and some environmental activists prefer it to a cap. Due to anti-tax zealotry, however, many political experts have bestowed last rites on the tax approach. That leaves us with a cap–likely a cap-and-trade program in which the trade component would be market-based.
Yet, in the capped emission allowance component, many pending proposals do not sell allowances in an auction but rather distribute a considerable portion of them for free in proportion to the historical measures of the recipient’s emissions. Experience in the EU has shown that, except in the case of strictly cost-of-service regulated power companies, free allowance allocations do not promote investment in processes and technologies for reducing greenhouse gas emissions; rather, they create inflexible entitlements and sources of windfall profits since the recipient of a free allowance will tend to sell it for an opportunity-cost price given occasion to do so. To prevent entitlements and windfalls in the U.S., politically necessary free allocations should be phased-out quickly (e.g., within the lead time required for new capital investments) and confined to cost-of-service regulated utilities that are required to flow through to ratepayers the full value of the allowances.
Paradox Four: The simultaneous need for price certainty to promote long-term planning and investment on the one hand, and simplicity to ensure compliance and prevent gaming on the other. These objectives tend to conflict. To improve price certainty in the quantity-based regulation of cap-and-trade, a number of proposals have been put forward to cabin price volatility and price spikes (especially in the early years of cap-and-trade) while still maintaining a sufficiently high price to sustain the process and technological progress that is needed particularly in developing countries. The United States Carbon Action Partnership has made thoughtful suggestions to stabilize prices and improve price signals under a cap-and-trade regimen, such as allowing (1) international trading of allowances between countries with reasonably comparable measurement, reporting and enforcement regimens, (2) international project-based offsets, (3) unlimited banking, and (4) future allowances to be accelerated at a discount rate to early years when reduced emission requirements can be expected to outpace technological advances. In recognition of the 25 percent of total greenhouse gas emissions that come from deforestation, the Partnership also proposes that offsets be accepted for national forest carbon programs designed to provide an incentive to reduce carbon emissions by preserving or expanding forests. The trick will be to incorporate these flexible and price-stabilizing means of compliance and yet retain a transparent and enforceable cap-and-trade program.
Paradox Five: Maintaining economic growth (particularly convergent growth in the developing world) while reversing global climate change. This will require significant developed-world investment in sustained research, development and deployment (RD&D) to improve the processes and technologies we use to generate and consume energy.
According to Earth Institute director, economist Jeffrey Sachs, there is a need for approximately $30 billion annually in RD&D for advanced, non-carbon energy technologies, but only a couple of billion is currently being spent annually worldwide. And sadly, U.S. annual expenditures on energy RD&D are today only one third of what they were in 1978. Particularly inexplicable is the Department of Energy’s recent withdrawal of its 74-percent financial support for the congressionally authorized public-private partnership between the DOE and the FutureGen Industrial Alliance, a non-profit consortium of 12 U.S. and international energy companies. FutureGen (to be built in Mattoon, Ill.) would be the first facility of its kind to combine and test in a single facility coal gasification, emissions controls, hydrogen production, and carbon dioxide capture and storage to produce near-zero emission electricity and capacity from coal.
Without timely progress on energy efficiency, renewable generation, and integrated gasification combined cycle with carbon storage, it is hard to conceive how domestic and foreign economies can achieve the emissions reductions that the climate-change science shows to be imperative.
Whether climate change remains an arduous challenge or becomes unmanageable and potentially catastrophic will depend on how the next U.S. administration proceeds on these (and undoubtedly other) uneasy paradoxes.
Dan Watkiss is a partner with Bracewell & Giuliani in Washington, D.C., representing power companies, exploration and production and mid-market companies, natural gas pipelines, power and liquefied natural gas project developers and lenders, as well as government agencies and regulators. You many contact him at Dan.Watkiss@bgllp.com.