Editor’s Note: Please bear in mind that this is a “first read” of a very large piece of legislation. It was researched and written within 24 hours of the bill’s publication.
The Kerry-Lieberman climate bill emerged yesterday mid-morning, weighing in at 987 pages. (Hey, changing the entire energy economy ain’t easy.) Like the Waxman-Markey bill that passed the U.S. House of Representatives last summer, the American Power Act is a comprehensive energy and climate bill. That means it touches a wide range of issues, from nuclear energy development to electric vehicles to offshore oil drilling. To find the full text of the bill, as well as several summaries, go to Senator Kerry’s website.
As I examine the nuts and bolts of the bill, I’ll post updates for readers. I am not, however, going to weigh in on every element in the bill. Instead, I’m going to focus mainly on the bill’s climate centerpiece: its cap-and-trade program. And I’m not going to focus on the politics – you can find armchair pundits all over the blogosphere – but rather on the policy itself.
If that’s political commentary you’re looking for, here are my recommendations:
- Joe Romm’s Climate Progress (which he continues to update with alarming speed)
- Dave Roberts at Grist
- Senator Kerry, also at Grist
Oh, one more thing: this blog post is not going to be Cap-and-Trade 101. If you’re looking for an explanation of how cap-and-trade works, and how to do it right, please see Sightline’s Cap-and-Trade 101: A Climate Policy Primer.
Please do send comments or questions.
The basic architecture
The structural elements of the cap-and-trade program are fairly straightforward. The bill sets out a declining cap on carbon emissions that aims to achieve a 4.75 percent reduction below 2005 levels by 2013; a 17 percent reduction by 2020; 42 percent by 2030; and finally 83 percent by 2050. (Nota bene: Although these targets are consistent with other major pieces of legislation, they are not terribly ambitious. U.S. domestic emissions are 10 percent below 2005 levels right now. An additional 7 percent reduction should be easy, even factoring in an economic recovery that will stoke demand for carbon.) The reduction goals for the overall economy are the same as the targets in the capped sectors.
The program’s cap starts in 2013 for the electricity and transportation sectors, which together constitute an estimated 66 percent of total domestic emissions. The industrial sector joins in 2016, bringing the total up to almost 85 percent. The remaining 15 percent of U.S. emissions are treated separately from the cap-and-trade program with a range of targeted policies and regulations, most of which seem appropriate, and most of which I will not describe here.
The cap is implemented reasonably far “upstream” – at the electrical generator, refinery gate, and industrial smokestack – meaning that only about 7,500 entities are regulated under the bill. This design will radically simplify the program’s administration.
What’s the deal with transportation fuels?
The pre-release rumor mill produced a number of criticisms that were, frankly, off base. It’s true that the bill’s treatment of transportation fuels is something new under the sun, but it turns out to be a benign alteration.
Here’s how it works. The first-sellers of refined petroleum products (generally, refiners and importers) must purchase carbon permits that are withdrawn from the total supply available under the cap. Yet these permits are somewhat different in two important respects: 1) they are purchased at a fixed priced, which is the “market price” established in the cap-and-trade program for the other sectors; and 2) the permits cannot be sold or traded, banked or borrowed; they can only be used for compliance. (As a practical matter, the program administrators simply forecast the quantity of permits needed for the transportation sector and set aside that amount from each quarter’s distribution. If the administrators over- or under-estimate, adjustments are made to the next quarter’s distribution.)
In other words, for the transportation fuels sector, we have a program that is, essentially, cap-and-no-trade with full auctioning. It’s like a carbon tax, except that the total supply of carbon is fixed. It’s in some ways similar to the managed-price cap-and-trade program floated last year by Congressman Jim McDermott of Washington. (And another post on this that I wrote is here.)
My take on the treatment of transportation fuels? It’s pretty good. All of the allowances are sold, not given away. Transportation fuels are (almost) all under the cap, meaning the petroleum industry doesn’t get a free ride. Yes, making oil companies buy permits at prices set in an auction in which mostly electric utilities participate will have a few unwanted consequences. The nation may not always get the very cheapest emissions reductions first, for example. But I submit that these distortions will be minor and mostly affect the sequence in which emissions-reduction actions are taken.
Oh, there is one other feature for the transportation fuels sector worth mentioning. For some reason, the program exempts the carbon used in international commercial aviation, pending future international agreements on the matter. (Technically speaking, the program provides “compensatory allowances” for these fuel users.) I don’t know any of any practical or principled reason for this exemption. This provision is an irritant, but it’s hardly a deal-breaker.
How does the carbon market work?
Carbon permit auctions are conducted quarterly and they are limited only to the carbon emitters who are required by law to hold permits, as well as a small number of designated brokers who can provide liquidity for smaller firms. The secondary market for allowances is open, meaning that firms can trade permits with one another or with brokers or other entities.
An open secondary market also means that charities and voluntary offset sellers can purchase permits and toss them in the trash (or, rather, the recycling bin) in order to reduce total emissions below the cap. Want to genuinely offset the emissions from your flight to Hawaii? Just tally your trip’s carbon emissions and purchase the corresponding number of permits. By allowing real carbon permits to be sold on a secondary market, the program would allow for take-‘em-to-the-bank offsets for nonprofits, or Pearl Jam tours, or Super Bowls, or what have you, thus alleviating at least one worry from folks like Jim Hansen who are very concerned with personal action.
Under the bill, emitters are free to “bank” permits (aka, save them) indefinitely (a good thing for both the atmosphere and for firms’ financial security). Firms also get a two-year rolling compliance period. This means that they have up to two years to acquire, and then turn in, permits for their emissions. This policy will help stabilize carbon prices. They can also borrow a portion of their permits from future years, up to 5 years out—another protection against carbon price spikes. When they borrow future permits, they must pay an 8 percent annual “interest rate” in permits to do so. Kerry-Lieberman’s banking and borrowing provisions are nicely balanced: they will provide energy companies with stability and predictability without compromising the law’s climate and clean-energy benefits.
The bill provides a tightly-regulated derivatives market on a regulated exchange in which carbon futures will be treated just as agricultural derivatives are. In fact, the bill hands market management to the same agency, the Commodity Futures Trading Commission (CFTC), under the same authorizing legislation. While this tight regulation does not, strictly speaking, completely eliminate the possibility of market manipulation, it will make the carbon market about as risky as the markets for hog bellies and soybeans.