This story was updated at 2:38 p.m. EDT.
A massive climate bill has taken its first step forward in the House, its path paved by the giveaway of allowances -- free greenhouse gas emission permits designed to mute the economic impact of a carbon cap-and-trade program.
Free allowances -- each conveying the right to pump a ton of greenhouse gases into the atmosphere -- were the glue that held the sprawling bill together for Reps. Henry Waxman (D-Calif.) and Ed Markey (D-Mass.) and fellow Democrats on the Energy and Commerce Committee last week.
The "cap" of cap and trade would impose steadily tightening limits on greenhouse gas emissions. Companies covered by the bill whose emissions exceeded their caps would have to purchase emission allowances, or buy offsets -- for example, by investing in rainforest preservation. Some allowances could be banked or borrowed to ease transitions. But the decisions would affect firms' choices of fuels, introduction of new technologies, and decisions to hire, fire, expand, shrink or move operations overseas.
The bill's allowances help lessen its economic impact on parts of the country with industries threatened by trade or heavily dependent on coal to generate electricity. Even so, the climate legislation will create major winners and losers. "Some will have zero costs, some will have extremely high costs," said Harvard University economist Robert Stavins. "It's very hard to estimate who will be the most burdened."
Washington state, with its plentiful hydroelectric power, emitted 0.15 ton of carbon dioxide per megawatt of power it produced in 2005. Indiana -- a center of coal-based power generation -- emitted nearly 1 ton of CO2 per megawatt, Stavins noted.
A computer model run by ClearView Energy Partners estimates that greenhouse gas limits will hit three times as hard in West Virginia, Kentucky and North Dakota, for example, as in Washington state, California or Oregon.
Oil refiners and manufacturers of chemicals, paper, cement and metals will be vulnerable. So will companies that face tough U.S. or foreign competition that makes it hard to pass on higher energy prices.
"The firm makes a choice," said Kevin Book, a ClearView partner. "You can adapt. You can accept lower profits to retain customers, or, if you can jack up prices, you will. We don't know what the industrial players will do." Electric power prices would still come under the eyes of public utility commissions.
The different regional burdens required Waxman to parcel out allowances to benefit coal states -- whose economies would feel more pain -- in order to get a majority of Democrats behind the bill. "You can leave it up to Congress to do what it does well, and that is to build a constituency for the program," Stavins said.
Closing the gap
The bill's burden is the difference between expected annual U.S. greenhouse gas emissions and limits set by the cap, which squeeze harder each year of the program. Point Carbon estimates that gap would start at 205 million tons of CO2 and rise to 1.4 billion tons in 2020. Other energy policy actions could shrink the gap.
Shortages of available offsets would widen it.
The U.S. EPA's analysis of the "Lieberman-Warner Climate Security Act of 2007" said that the price of allowances would rise by 34 percent if international offsets were not allowed, while barring all offsets would increase the price by 93 percent. The House bill permits domestic and international offsets. But it does not spell out how allowances will be defined and regulated, leaving that to EPA, and thus leaving a potentially big question mark over the policy's ultimate cost, as well.
In 2016, the U.S. economy would produce an estimated 7.3 billion tons of CO2, based on current growth forecasts. Power generators and other business sectors covered by the Waxman-Markey bill would put out 6 billion tons of emissions under business as usual.
But the cap would restrict their emissions to 5.3 billion tons. Companies could close the gap, 784 million tons, by reducing emissions, shutting down some operations, switching to cheaper fuels, buying allowances from companies that did not need them, or making carbon emission offsets.
Allowance trading could result in a price of between $15 and $20 per ton of carbon emissions in 2016, various analysts predict, making the value of allowances that year between $80 billion and $108 billion.
In that year, all of the allocations would be given away: The electricity industry would get 35 percent; local natural gas distributors, 9 percent; "trade exposed" industries, 14.2 percent; oil refiners, 2 percent; automobile manufacturers, 3 percent; and energy companies investing in carbon capture and storage, 2 percent.
A sizable share of that year's allowances would go to others in the economy that were not considered greenhouse gas sources, including 15 percent for low- and moderate-income households, 1 percent as research grants to universities, 5 percent for tropical forest preservation, and 0.5 percent for worker assistance and job training. These carbon emission permits could be also sold to industries and power generators that need them.
The probable cost of the cap-and-trade program has been sharply disputed.
U.S. EPA's computer model forecasts a trivial increase for U.S. households. The growth of household spending would be about 0.2 percent lower in 2020 under the Waxman-Markey plan, compared to a business-as-usual scenario with no new climate legislation. Average household spending would drop by about $140 a year, in current dollars.
Gasoline prices would be 33 cents a gallon higher with the climate bill than without it in 2030. That is compared to the doubling of gasoline prices to $4 a gallon in 2007-08.
Critics of the program claim that the costs will be higher and the intrusion by government would be unprecedented in the post-World War II period.
The Republican staff of the House Oversight and Government Reform Committee said the cap-and-trade strategy would cost the average U.S. household an extra $1,600 a year. Myron Ebell of the Competitive Enterprise Institute testified to Waxman's committee that cap and trade would be "legalized plunder" by government.
"It takes the most important economic decisions out of the hands of private individuals acting in the market and puts them in the hands of the government," Ebell said.
Stavins said the high estimates of the bill's impact are off base, because they include the total costs of carbon allocations issued, but most of these will be traded back and forth and so won't hit households directly.
"Are we pushing this too fast? It seems like a reasonably prudent pace," Book said. "There isn't a good business in the world that can't adapt if you give it 15 years. If it can't, it will be replaced by someone else who can."
Said Mark Zandi, chief economist of Moody's Economy.com, "I think the economy can digest it if it is done in a clear, concerted and measured way."
Carbon allowances in the Waxman-Markey bill may have been the third choice in the climate policy debate.
"If you were king for a day, from a macroeconomic perspective, you wouldn't do it this way," Zandi said. "Most economists would say the best approach would be a carbon tax, not cap and trade."
But a tax was politically toxic. If a cap-and-trade plan was to be the strategy, better to do it by auctioning all allocations, putting them into the hands of people most willing to pay for them. That would generate tax revenues that could be put back into the hands of the people, Zandi added.
But cap and trade, Zandi said, was "as good a second-best as policymakers can get."
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