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Why Letting Manufacturers Opt In to Cap-and-Trade Could Increase Emissions

by Michael Levi
July 14, 2010

Senators from manufacturing states have been among the most skeptical of cap-and-trade legislation. One would expect, then, that they’d be thrilled by the prospect of utility-only cap-and-trade, which would explicitly exclude manufacturing facilities. But not so. Here’s E&E Daily this morning:

“Sen. Sherrod Brown (D-Ohio), meanwhile, stressed earlier this week that manufacturers must have the choice to opt in to a carbon pricing system and that he is working on legislation that would allow them to do that under a utility-only bill.”

Why, after resisting cap-and-trade, do manufacturers suddenly want in?

Utility-only cap-and-trade would, like economy-wide cap-and-trade, increase the cost of the electricity used by many manufacturers. Under previously proposed economy-wide schemes, many manufacturers would have received rebates equal to or greater than those increased costs. Under most plausible utility-only schemes, most energy-intensive manufacturers will receive substantially smaller rebates, and some (such as those who are in states where electricity prices are not heavily regulated) may receive nothing. Utility-only is thus not a free pass for manufacturers.

These manufacturers are looking for “opt-in” provisions that would help cover some of their increased electricity bills. Yes, by joining the cap-and-trade system, they would see their costs increase further (because they’d pay for their own direct pollution too). But they’re looking for a deal that more than pays them for that extra cost. Hence the sudden interest in being part of the system.

What does this all mean environmentally? An well-designed opt-in scheme would probably strengthen the headline target of a cap-and-trade bill. That’s because the cap would be increased only by a fraction of the emissions of any facility that decided to opt in. Imagine, for example, that a plant with 100,000 tons of annual emissions chose to join. The 2020 target would probably increase by only 83% of that, or 83,000 tons. That would force 17,000 tons of reductions under the cap, either at the manufacturing plant, or in the (already covered) utility sector.

That said, to the extent that an opt-in scheme preferentially attracts those plants with the easiest potential reductions (which the most likely outcome), those reductions might be meaningless (i.e. they might be reductions that would have occurred anyhow, even without cap-and-trade). Indeed it is very possible that some of the opt-ins would actually weaken the environmental result.

Imagine, for example, that the 100,000 ton plant expects its emissions to drop by 20,000 tons by 2020. It opts in to cap-and-trade and follows through with its plans. The utility-only cap is about 2 billion tons of CO2 in 2020. The opt-in expands that by 83,000 tons, to 2,000,083,000 tons. 80,000 tons of permits are used up by the manufacturing plant. That leaves 2,000,003,000 tons of permits for the utilities, which is more than they started with. As a result, the carbon price drops, and emissions are reduced by less than they would have been without the opt-in.

Will this sort of thing happen? It depends entirely on how any opt-in provisions are designed. I have been skeptical of claims that badly-designed cap-and-trade could increase emissions. (Perhaps hostile is a more accurate word than skeptical.) Those claims tend to ignore economics. But a badly designed opt-in scheme could be an exception. Legislators should be careful to ensure that it isn’t.

Post a Comment 3 Comments

  • Posted by Diego Villalobos Alberu

    Mr. Levi,

    I liked your insightful and topical piece. Just thought of sharing a couple of ideas that I find interesting, and were not mentioned.

    (1) If the national commitment to reduce GHG emissions are to be achieved solely through a utility-only cap, then emissions cuts in this sectors will have to be substantially higher (and likely more costly) than if an economy-wide cap was implemented. This will result in even higher electricity prices.

    (2) To the extent that electricity prices are high enough, some intensive electricity users, like manufacturing plants, may be incentivized to procure their own power on-site with dirtier technologies. This would increase emissions, and tend to offset any gains in the utility sector.

    A utility-only cap is like trying to squeeze an air-filled balloon, you put pressure on one side to see the other side expand.

    Regards,
    Diego

  • Posted by Jon

    a couple of excellent points Diego. On site power generation, which more than likely would be of renewable sources, in order to be able to factor fuel prices out of products sold, seems as though it would have a counter-productive result on government revenues derived from power generation. As we are seeing in experiments in several states, fuel efficient vehicles are affecting government revenues to such a degree that those states have begun “taxing” miles driven, as well as gasoline, in order to compensate for said lost revenues. These various points seem to suggest that cap and trade could lead to individual energy independence, and ultimately to a corporate tax rate….which of course will be forwarded to consumers. (In this comment, I am neutral on the tax issue)

  • Posted by Sallan Foundation

    Strong piece, including the caveats that end it. However, it is surprising that you accept offsets as credible carbon management tools. The EU ETS experience combined with recent research from US groups like Resources for The Future should set caution lights flashing.

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