Obama erred on key cap-and-trade features, economists say

President Obama's comments yesterday in support of climate change legislation included two errors on the fundamental design and history of the cap-and-trade approach that his new administration intends as the centerpiece of its global warming policy, according to several experts tracking the Capitol Hill debate.

Appearing before CEOs at the Business Roundtable in Washington, Obama fielded a question about his campaign pledge to distribute allowances for emissions of greenhouse gases via a 100 percent auction.

The president replied with a warning against giving away too many free allowances to industry for compliance with a cap-and-trade system.

"Now, the experience of a cap-and-trade system thus far is that if you're giving away carbon permits for free, then basically you're not really pricing the thing and it doesn't work, or people can game the system in so many ways that it's not creating the incentive structures that we're looking for," Obama said.

A pair of leading climate economists say the president's comments glossed over a key point in the cap-and-trade debate.


So long as the government caps emissions, companies will see a price signal and be forced to act, Harvard University's Robert Stavins said.

"If you give permits away for free or sell them, either way, allowances will be priced and the system will work," Stavins said in an interview. "There may be sound arguments that the administration wishes to make for auctioning allowances, but the functioning of the price mechanism and the environmental performance of the system is not one of them."

Dallas Burtraw, a senior fellow at the nonpartisan Resources for the Future think tank, agreed with Stavins' assessment.

"The way that the allowances are distributed matters hugely for the success of the program," Burtraw said. "But for the most part, it does not matter directly for the kinds of emission reductions you're going to see. The primary influence is the existence of an emissions cap."

Obama also erred in overstating the role of emissions auctions during the implementation of the sulfur dioxide trading program created through the 1990 Clean Air Act Amendments.

"We put in an auction system and a trading mechanism and, lo and behold, American ingenuity and American entrepreneurship and inventiveness created options that ended up being much cheaper than anybody had imagined -- much cheaper than anybody had imagined," the president said.

But the 1990 law signed by President George H.W. Bush required U.S. EPA to auction about 3 percent of the cap-and-trade credits. Electric utilities got the rest for free based on their historical emission levels.

"I'm not sure that's the example one wants to give," Stavins said, citing instead the Northeastern states' Regional Greenhouse Gas Initiative, which so far has required electric utilities to purchase credits via auction.

Both Stavins and Burtraw insisted that they were not being critical of the president for his remarks.

"It's a technical issue that's difficult for people to understand unless they're thinking about this all the time," Burtraw said.

Stavins added, "I certainly don't think the president made an embarrassing comment or statement. I'm simply saying that I hope as the congressional debate moves forward that the debate on the allocation happens on a technically sound basis."

'Extraordinarily complex issue'

A White House aide today defended Obama's comments at the Business Roundtable event.

The staffer explained that the president was referring to the pilot phase of the European Union's trading system between 2005 and 2007, when credits were given away to electric utilities for free.

"And, in fact, too many were given away," the aide said. "This excess allocation caused the price of allowances to collapse in 2006 and trade at such a low level in 2007 they were, in essence, not creating a price signal."

The White House aide did not dispute the small role of an auction in EPA's acid rain program. But the staffer noted, "As the first major pollutant cap-and-trade program, EPA worked to hold periodic allowance auctions to facilitate price discovery."

Several others engaged in the climate debate also came to Obama's defense.

"I think the key here is to understand that this is an extraordinarily complex issue on many fronts," said David Ratcliffe, the president, chairman and CEO of Southern Co. "And to expect him this early in the discussion and this early in his focus on this to be able to understand all the details on this is a push in my judgment."

Ken Connolly, who served as staff director to former Senate Environment and Public Works Chairman Jim Jeffords (I-Vt.), said Obama deserved credit for speaking as extensively as he did in support of global warming legislation.

"The fact that President Obama is engaged to this level of detail is impressive in its own right, and his statement is more substantive than any previous president," said Connolly, a vice president at Goldman Sachs. "It actually displays what a significant priority it is for him."

Joe Romm, a senior fellow at the liberal Center for American Progress, argued that while Obama's response may have been incomplete, it was not inaccurate. "If this is what passes for something that economists worry about," he said, "I have to think they're taking their eye off the ball."

And Nathaniel Keohane, director of economic policy and analysis at the Environmental Defense Fund, said Obama was nonetheless hitting on an important point when it comes to the free credits in Europe, where companies nonetheless passed along costs for the allowances to consumers and reaped a windfall profit.

"That's an outcome nobody wants," Keohane said. "The administration doesn't want it, Congress doesn't want it, environmental organizations don't want it, and frankly, the business community doesn't want it, either."

Utilities pressing for free credits

Aware of the windfall profit concerns, a collection of investor-owned electric utility companies have been pressing Congress and Obama to give them 40 percent of the cap-and-trade system's emission credits for free, with the allowances handled by regulated, retail local distribution companies that deliver electricity to households across the country.

Under their approach, the power companies insist that they would not make windfall profits because the distribution companies all must deal with strict oversight from state regulators.

"We want to make sure we mitigate the cost impact on our customers," said Ratcliffe, the Southern Co. chief who has signed on to the position of Edison Electric Institute and the other electric utility companies.

House and Senate Democratic leaders are now sifting through details of many different legislative proposals with plans to move on the global warming issue this spring.

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