Waxman-Markey is a big split personality of a bill. Its efficiency and renewable requirements would make a dent in greenhouse gas emissions, even if not a very big one. But the cap-and-trade at the heart of the legislation is another story.

Why do we need cap-and-trade or a carbon tax or something similar? If we could just flip a switch and turn off emissions quickly, there would be no need to discuss complex schemes. In that case, the best approach would just be to notify everyone they were required to stop polluting a year or three from now. Because greenhouse gas emissions are so interwoven into our infrastructure, we have to phase out this type of pollution slowly, over decades.

Waxman-Markey’s approach to this is to issue permits each year for a total amount of pollution we will allow. Polluters must obtain permits for every bit of smoke they belch. The idea is to allow pollution very close to the current level the first year, then issue fewer permits every year, so the amount of pollution allowed gradually falls. The total number of permits is the cap. As that total drops the cap is said to tighten. Sale of those permits is the “trade.”

Now, it is easy to argue over whether this type of system can be implemented properly, but whatever your stand on the theoretical issue, it is pretty obvious that Waxman-Markey’s implementation is a series of disasters.

Downstream Permitting

Waxman-Markey issues a large percent of permits to the final emitter of pollution, rather than those who first extract or import oil or gas or coal. This is referred to as downstream permitting, and Peter Dorman at Econospeak explains why downstream permitting is a disaster.

The single biggest flaw, one which is fundamentally not fixable, is the decision to issue permits on an industry-by-industry basis — to cap the uses of carbon fuels rather than their sources. This is an invitation to never-ending bickering over who is allowed to emit how much. Every little tweak of the system — whether to include freight transportation or agriculture (which crops!) — has to be hammered out separately. Reductions are calculated from a baseline, but there are acres of wriggle room about how to measure who emitted how much in the base year and therefore how much should be reduced tomorrow. Enforcement is complex, expensive and full of loopholes. Only lawyers (and politicians with extortionary campaign finance strategies) could love this

In a comment he explains further:

1. You have to measure all this combustion. Enforcement is complex and expensive, and lots of small emitters will slip through the cracks.

2. The issue of coverage, which sectors need permits and which don’t, is always on the table. And it’s not just either/or; there are lots of fine-print details to be haggled over. Check out any of the existing systems that use this approach, like the ETS or the Western Climate Initiative.

3. All of the above is an open invitation to perpetual rent-seeking.

4. In the end, all the carbon in fossil fuels either goes into the atmosphere or some other component of the “fast” carbon cycle, or it is returned to the lithosphere. No long-term sequestering currently happens, so at the moment you can regulate emissions by regulating extraction and importation of these fuels. In the future, if technologies emerge that can sequester carbon on a geological time scale, you can give people extra extraction/importation permits in the amount of their sequestration.

Offsets

The bill’s use of offsets is another disaster. Dan Welch defines an offset as “an imaginary commodity created by deducting what you hope happens from what you guess would have happened.” The Kyoto Clean Development Mechanism (CDM) generates offsets. For example, Chinese hydropower plants want to issue and sell carbon credits for power generated. They hire expensive consultants that claim the dams would never have been built if the builder had not hoped to sell carbon credits, in spite of the fact China is building new electrical generation as quickly as possible. (In fact, almost all hydro projects submitted under CDM were already approved for construction by the time they begin the application process.)

Since credits generated by CDM are used as permissions to burn coal inside the EU, credit granted for a project that would have happened anyway increases net emissions. Credits for such projects are called “non-additional” and are to a cap-and-trade system what counterfeit money is to a banking system. International Rivers has documented (PDF) the predominance of such counterfeiting within the CDM system.

Waxman-Markey allows three kinds of offsets.

One type of offset is basically CDM with a few additional criteria. (In fact, existing CDM credits with an added review process may well qualify.) These criteria sound good. The credits must be additional, existing, and permanent. But fundamentally this kind of offset will still depend on how a good a story a consultant can come up with. We still are measuring against a guess about what might have been.

A second is emissions reductions via agriculture and forestry. Land use (including animal husbandry, row crops, tree harvests, and forest fires) is second only to fossil fuels as an emission source. However, the same problem that prevented land use from being included in cap-and-trade in the first place makes it a poor source of credits — difficulty in measuring emissions precisely. Farms, grasslands, and forests store carbon in the parts of the plant visible above ground, in the roots and surrounding soil, and in the ecology of fungi and other micro-organisms established in the roots and surrounding soil. Carbon is tough to measure below the ground. Even combining satellite pictures with expensive extensive in-soil equipment measures ecosystem carbon within plus or minus 5%.

This is only feasible on a small scale. If large-scale changes are to be made in the forestry and agricultural sectors as a whole, measurement will be mainly via satellite and other types of remote sensing, with modest amounts of local measurement used to correct and improve modeling. That equipment limitation means the best feasible large scale measurement of carbon content will be plus or minus 10-25%. Since biological sequestration of this type can only take place at rate of 2% to 3% annually, the precision is too low to provide meaningful numbers for credit generation on a year to year basis.

In addition, biological sequestration isn’t really sequestration. Carbon removed from the air by plants, unlike fossil fuels left in the ground, is still part of the living carbon cycle. Plants absorb carbon they way we breathe oxygen. Carbon embedded in plant ecologies varies constantly, from day to day, month to month, season to season and year to year. This brings up a real problem of additionality. (And no, netting it out on a short time scale does not solve the problem. We are trying to provide incentives to change human behavior. Giving someone a dollar every time the sun goes up, and taking it away again every time the sun goes down is source of confusion, not a reasonable incentive for behavior changes.)

Offsets under Waxman-Markey are supposed to be permanent, but permanence in a dynamic system like a farm or forest is really hard to measure — especially with possibilities of fires, floods, storms, and pest damage. Because biological sequestration is a long-term process not subject to precise measurement it is unsuitable for inclusion in either trading or emissions taxing systems. Control has to be based on the sign and rough scale of long term changes.

The last type of offset WM promotes is something called sectorial offsets. The idea is to guess the future emissions of a sector in a nation with no cap. Consultants construct a Business As Usual (BAU) scenario for, say, a sector within Indonesia. This sector can then generate carbon credits to the extent it lowers emissions below that baseline.

The problem here is the same as with individual CDM projects. Both developing nations that would generate credits and potential buyers of those credits have enormous incentives to make high projections and thus create counterfeit carbon credits. Large corporations would put the pressure on to approve such scenarios because the credits generated would be a cheap alternative to investing in real emissions reductions, or purchase of limited non-counterfeit credits. The State Department would probably add to this pressure as a cheap pay-off for support in whatever the latest ill-advised U.S. military or economic venture was. How likely to do you think decision makers would be to make a stand and defy such forces over an issue as wonky and obscure as the slope of a BAU scenario? Can you say “regulatory capture”? I knew you could.

Lastly, WM tries to address offset flaws by deflating offset value 20%. Unfortunately there is no reason to believe offset inflation is anywhere near that low.

Giveaways

Another flaw is that 80% of the permits are given away rather than auctioned. (The number 85% is bandied around a great deal, but seems to ignore the “unallocated” permits whose preferred use is deficit reduction.) This is an obvious justice issue, since it means the creation of a new property right which is then turned over to the very rich. (If the remaining 80% were auctioned, the revenue could be returned to the public in various ways, instead of being a windfall for wealthy utilities.)

However, I’m fairly confident that the climate justice issues with giving away permits will be written about. So I want to concentrate on how giveaways undermine effectiveness.

Giving away a large number of permits increases volatility. This results in higher highs and lower lows in permit prices. This would not happen if 100% of permits given away were then sold. Markets won’t care whether some government agency or large corporations sell these pollution permits. But inevitably, some of the permits will be kept by those gifted with them. The whole reason for a gradual phaseout is that emissions cannot be eliminated overnight. It would very strange therefore if electric utilities did not have to keep a fair percent of the permits they are given, especially in the early phases.

Similarly, energy intensive industries will probably continue to use significant amounts of fossil fuel and keep many of their permits. And so on.

With 80% of permits given away it is not unreasonable to assume that 25% of all permits (less than one third of those given out free) will be kept on a continuing basis, that the percent kept won’t fall below that during the early stages. That portion of free permits that are steadily used would otherwise have to be steadily bought. In short, by giving away almost all permits for free, we are removing a significant portion of steady, predictable demand from the permit market. That increases volatility of the price for those permits that remain on the market. High prices will be higher, low prices lower.

So how does volatility affect emissions? Well remember that proclaiming a cap, and selling permits does not magically lower emissions. People have to comply and not emit greenhouse gases they have no permit for. Like most laws, enforcement of carbon rules depends on widespread compliance, so that enforcement is only needed against rare exceptions. Volatile permit pricing discourages capital investment for future reductions. When the cap tightens, we end up with a situation such as happened with the RECLAIM system in Southern California. Power plants and manufacturers were supposed clean up their SOx and NOx pollution. But too many permits were issued, and 100% of permits were given away. Almost no capital investments required to implement the second phase were made. Firms assumed cheap permits would continue to be available for the second phase. Implicitly, everybody counted upon everybody else to cut emissions.

As a result, when the cap actually did tighten the ability to comply just was not there. Equipment changes that would have reduced production of pollution, and filtered out much of what remained had not been made. Compliance with the second phase was delayed by several years. Volatility undermined compliance.

• Giving away permits also adds to the pressure for issuing too many credits. Increasing the number of permits always lowers the price to polluters. But issuing more permits when most are given away also increases the number of permits polluters have to sell, often by much more than the total percent increase. As an extreme example, consider a company that will use 90% of their free permits for their own pollution and sell 10% to others. A 10% increase in the number of permits issued will double their excess credits, double the number of permits they can sell. That 10% increase in free permits doubles their cash flow from carbon trading.

It is really difficult to give away permits without the kind of downstream distribution Dorman criticizes. The point of giving away permits is to buy potential opponents in a way that is not obvious. For example, instead of giving away 80% of permits, Waxman-Markey could auction 100% of permits, and then distribute the resulting money to the same people the permits are going to in the same ratio. Why wasn’t this considered? Because it would be more obvious that what was going was a buy-off.

This is the same reason that nobody ever considered requiring permits upstream (mostly fossil fuel production and import), while giving them away to downstream users like power plants who could then sell them to fossil fuel companies. Giving permits to people who keep some of them looks more “costless” than giving them to people who sell 100% of them.

In short, while one can model giveaways combined with upstream permit requirements, the politics of giveaways meld them pretty inseparably with downstream sectorial caps. This, in turn, makes enforcement and tightening of caps more difficult.

Politics

The usual argument for Waxman-Markey is that, though imperfect, it is better than doing nothing. The cap-and-trade portion is worse than doing nothing. Because of the flaws I’ve mentioned, it essentially requires no emission reduction in practice for at least a decade. Any short term benefits come from non cap-and-trade provisions, such as the Renewable Energy Standard.

The long-term effects are even worse. The point of supporting a weak bill in area like this would be to build political infrastructure. Even if the standards were low, we could fight to plug better numbers into existing regulations. But with Waxman-Markey, we not only have to fight to change the numbers. We have to replace most of the architecture — downstream caps with upstream ones, offsets with requirements for real reductions, giveaways with auctioning. If we pass Waxman-Markey, we still end up with a whole climate bill to pass. And that climate bill will need to be fought for under worse conditions than starting from scratch. We will have to win auctions when powerful political actors are accustomed to free permits. We will have to repeal offsets against the opposition of the entire corporate and foreign policy establishment. We will have to fight to move downstream caps upstream over the objections of a large establishment who will have made huge investments in gaming the complicated loophole-ridden structure.

Given the weakening of non cap-and-trade provisions (such as Renewable Energy Standards) as the price of including cap-and-trade, Waxman-Markey in its present form is a net loss for the climate. The renewable and efficiency standards without the cap-and-trade provisions would provide a small net gain for the environment. But the addition of this particular cap-and-trade turns this bill into a large net loss. If cap-and-trade is the heart of Waxman-Markey, then this is a piece of legislation that would be improved by having its heart torn out.

I’ll let Peter Dorman have the last word:

Mainstream environmental groups are … soooooo happy that climate deniers are not in command of politics any more. They are fighting yesterday’s battle, to get general agreement on the principle that climate change is caused by people, and people need to do something about it. They like the nice feeling that comes from all of us raising our hands and pledging, scout’s honor, to achieve sustainability by 2050. But they are losing today’s battle to put into place a viable means to get from here to there, and judging from their public statements they don’t even know it.

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References

Tom Athanasiou, Patrick McCully and Carl Middleton; Bad Deal for the Planet: Why Carbon Offsets Aren’t Working and How to Create a Fair Climate Accord (PDF), 2008,

Peter Dorman, Why Environmentalists Should Oppose the Waxman-Markey Bill, May 14, 2009

Gar Lipow, Cap-and-trade permit giveaway hurt Waxman-Markey effectiveness: Permit giveaway lowers carbon price, increases volatility, reduces capital investment, May 15, 2009

Gar Lipow, Emissions trading: A mixed record, with plenty of failures — Regulations work better. February 19th, 2007,