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Responding to Andrew Chamberlain

by Michael Levi
July 2, 2010

Andrew Chamberlain has responded at length in two blog posts to my critique of his study of Kerry-Lieberman for the Institute for Energy Research. He gives some useful examples of how utilities might try to game regulators that I’ll engage with below. I’m going, however, to take his points in order, which means that I’ll be negative for a while before I get to that point.

The bulk of our debate is over who will benefit from the “public purposes” allowances that are distributed through LDCs. I said that they’d go to public purposes. Chamberlain argues that they’ll actually accrue to Local (electricity) Distribution Company (LDC) shareholders, which would make the bill regressive.

I should start by tempering my original comment. I shouldn’t have been so unequivocal: I have no doubt that utilities will find ways to game the system at the margins. That’s life in the world of regulation. The question is whether they will be able to do so in a big way. I still doubt it. That said, I think Chamberlain’s analysis suggests a few ways that the bill could be improved without major changes in order to curb potential abuses.

I should also note – and this is very important for the IER bottom line – that while Chamberlain presents a case for why not all of the allowance value routed through the LDCs will necessarily go to public purposes, which is hard to disagree with, he proceeds to model the bill as if none of that value goes to public purposes, which is a far more extreme statement. He never even tries to justify this crucial assumption.

On to the specifics.

Chamberlain asks (in his first post):

“Why not distribute allowance values directly to electricity and natural gas consumers, rather than first granting them to utilities? […] Why not make the system as simple as possible, rather than leaving it open to the possibility of regulatory failure? As we make clear in our study, lawmakers did not follow this approach. That suggests there exists instead a political dynamic at work that has more to do with compensating industries for losses from cap-and-trade than actually compensating consumers, as claimed by advocates of the bill.”

The logic, as I understand it, was that distributing revenues through LDCs would correct for regional disparities. I’d personally much rather use the revenues to fund a lump sum rebate, a tax cut, or deficit reduction. But it’s wrong to pretend that no public interest case was made for this approach.

“Levi’s argument that shareholders will not economically benefit from free allowances is simply inconsistent with the fact that LDCs and their parent companies themselves have lobbied heavily for these provisions. U.S. Senate records show electricity LDCs have spent millions lobbying for provisions in cap-and-trade bills in recent years. […] If shareholders are expected to receive zero benefit from free allowances, what explains these tremendous lobbying expenditures?”

Last I checked, utilities got a lot of cash from the bill other than from free public purpose allowances. More importantly, the bill has huge consequences for their industry, regardless of what’s done with the allowance value. Millions of dollars on lobbying is chump change compared to the stakes involved when Congress is deciding the future of your industry. I don’t doubt that they had an interest in influencing the free allowances – after all, they lobbied for more. But the other impacts on their business is plenty of explanation for their lobbying efforts.

“The American Power Act leaves open the possibility that utilities could simply be forced to offer households a credit on a utility bill. That is, rather than allowing consumers to choose how best to spend these benefits, LDCs would have the ability to restrict it for use on utility bills only—guaranteeing LDCs additional revenue they wouldn’t otherwise enjoy. Thus, even in the unrealistic scenario in which regulators are able to perfectly force LDCs to pass benefits on to consumers, the bill does this in a highly inefficient way that favors utilities over consumers.”

This doesn’t make sense. Let’s accept the scenario where people received their allowance value in the form of a credit on their utility bills. Chamberlain seems to think that they’d be forced to use it to buy extra electricity, or maybe some widgets, from the LDC. Why wouldn’t they just apply that money to their next bill? Of course, if they did so (which is the reasonable response), the utility wouldn’t benefit at all. (Well, there are some psychological issues to do with framing of electricity consumption decisions, but that’s is not what Chamberlain is getting at.)

“In our study, we argue lawmakers cannot control the economic incidence of regulatory policy any more than revenue officials can control the economic incidence of business taxes. Levi argues this analogy is inaccurate since ‘those firms aren’t regulated.’ But from the standpoint of revenue officials, they are very much regulated.”

This intentionally misses the point. Businesses are regulated by tax officials like utilities would be regulated by the federal government under cap-and-trade in that they would both be able to insist that their regulated entities paid their bills. But LDCs are also regulated by the states, which control how much they’re allowed to charge customers, while most businesses are not limited by the government in how much they can charge their customers. That is why these two situations are fundamentally different. Pretending that these situations are comparable is wrong.

Now to the more interesting and constructive point:

“Levi argues that since regulators will know the dollar value of the subsidy granted to each LDC, they can simply verify that an identical amount has been spent on ‘public purposes.’ But this view is highly unrealistic. […] Consider a simple example. Suppose that an electric utility receiving $12 million of free allowances is required by regulators to increase expenditures on ‘public purposes’ by $12 million, as Levi argues. Suppose further that prior to cap-and-trade, this utility operated a $15 million energy conservation program, distributing energy-efficient light bulbs to households and conducting public education campaigns. What in the language of the American Power Act prevents utility managers from simply shifting funds internally, scaling back the energy conservation program to $3 million, freeing up $12 million of existing budget authority for ‘public purposes?’ “

There are enough moving parts here that I find it plausible that the utilities will get away with some slight of hand. But I can’t see anything this extreme happening.

Why not? One has to ask why the utility is spending $15 million on an energy conservation program in the first place. It is not usually out of the goodness of their hearts. Typically, it’s because of two things: first, it faces some sort of legal mandate to promote energy conservation, and second, its regulator allows it to pass on the cost of its program to ratepayers. If the utility decides to scale back its program to $3 million, the regulator will also make it scale back the amount it passes through to ratepayers. The total revenue accrued by the utility will still be the same, only this time, $3 million will come directly from the ratepayers, and $12 million will come from the value of the free allowances. Meanwhile, ratepayers will be getting the same energy conservation program. So nothing changes. (I should add that I’d rather not have to deal with such a mess, and a potentially inefficient one at that – it would be better if LDCs were forced to do cash rebates, which seems to be Chamberlain’s preference too.) Perhaps there’s another scenario that’s more persuasive. If there is, I’d be genuinely interested.

“Levi argues utilities can be forced to spend the value of free allowances for ‘public purposes.’ But what qualifies as a ‘public purpose’? The text of the American Power Act provides only vague guidelines, and does not require that utilities actually provide rebates to consumers as has been widely assumed by advocates of the bill. Does investing in clean energy sources qualify as a ‘public’ purpose? What if doing so leads to somewhat higher profit margins for utilities?”

I find it hard to believe that companies would be allowed to do this. That said, it should be easy to clarify in the bill that LDCs cannot spend the public purpose allowance value on capital investments.

“What if the value of free allowances is instead used to establish a ‘rate stabilization fund’ to shield consumers from rate volatility?”

This is kind of wacky. Everyone’s suddenly going to start a “rate stabilization fund” and the PUCs are going to allow it? In any case, LDCs aren’t supposed to provide rebates based on the quantity of electricity provided. It’s not clear how a rate stabilization fund could work except in this way. (Yes, the bill says “based solely on the quantity of electricity provided”, but the intent, and hence the likely legal interpretation, is pretty clear.)

“What if consumers are granted only a partial rebate check, with the remainder used to upgrade capital equipment that lowers costs and thus increases profits for the firm?”

First, if the upgrades lower costs in a way that increases profits, the regulator should force a rate cut. It is not at all clear that the net result of that would be increased profits. Second, this seems like another good reason to explicitly prohibit LDCs from spending the allowance value on themselves. And, by the way, this is decidedly not the sort of scenario that Chamberlain models, given his model assumption that 100% of the allowance value goes to shareholders.

On to Chamberlain’s second post, which responds to my concerns about his study’s calculation of employment impacts:

“As we make clear in our study, our figures for potential job losses are only order-of-magnitude estimates designed to give a general idea of the size of the employment effects we can expect from a policy that reduces GDP by the amounts predicted by EPA in various years. We don’t model the entire American Power Act bill. Instead, we show about how many jobs can reasonably be expected to disappear if GDP falls by a given amount, holding all else constant.”

Fair enough. But when you issue your study with a press release whose headline touts job numbers that include decimal places (and whose body uses three significant figures to talk about the 2015 numbers), the fact that you say something about orders of magnitude deep in the actual study (or use the word “roughly” in the press release) isn’t worth much. If you really mean “100,000-500,000”, then you should say that.

“In our study, we assume overall GDP reductions will be felt by industries in proportion to the fossil-fuel carbon intensity of their products. Levi is right that if industries are affected in different proportions than what we assumed, the pattern of employment losses — and potentially the overall total job losses — will differ from our estimates. But it’s easy to see that they won’t differ by much.”

Chamberlain then goes on to look at what would happen if sector-by-sector output losses where scaled by sectoral capital intensity, and concludes that job losses would be even higher. Perhaps I should have been clearer: I never said that this was the case. I said that the hardest-hit sectors tend to be more capital intensive. That does not mean that all capital-intensive sectors are harder hit. The impact on the economy is highly heterogeneous.

In any case, it’s not actually “easy to see” that the employment impacts “won’t differ by much” if the estimates are done correctly. Chamberlain derives his employment estimates for 2015 from the fact that EPA projects a $39 billion cut from business-as-usual GDP by then. Let’s take a look at a much more careful study of what a bigger $59B GDP cut due to cap-and-trade (ie an even bigger one) might mean for employment: the EIA modeling of what happens in 2020 under Waxman-Markey. What does the EIA project? On the order of 100,000 jobs lost – way less than in the Chamberlain study. (In 2019, by the way, it projects roughly zero jobs lost, despite a bigger hit to GDP than the Chamberlain study works off for 2015.)

Why are the numbers so different? Because of how the economic impacts are distributed. In the EIA modeling, energy-intensive sector job losses are largely offset by service sector job increases. Take a look at the Chamberlain Economics sector-by-sector jobs numbers. Every single sector sees a loss. This is implausible, and suggests that there is something wrong with the modeling.

In any case, I hope we can keep this conversation going. It’s too rare in the climate world for people who disagree over big picture policy decisions to engage on actual substance, and I appreciate Andrew Chamberlain’s long responses to my original post. I’ll look forward to some replies to this one.

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