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Pricing Carbon Emissions

A bill before Congress may prove a costly way to reduce greenhouse gases.

Experts are applauding a sweeping energy bill currently before the United States Congress, saying that it could lead to significant cuts in greenhouse-gas emissions and improve the likelihood of a comprehensive international agreement to cut greenhouse gases. “It’s real climate-change legislation that’s being taken seriously,” says Gilbert Metcalf, a professor of economics at Tufts University. But many warn that the bill’s market-based mechanisms and more conventional regulations could make these emissions reductions more expensive than they need to be.

The bill, officially called the American Clean Energy and Security Act of 2009, is also referred to as the Waxman-Markey Bill, after its sponsors, Henry Waxman (D-Ca.) and Edward Markey (D-Mass.). The legislation would establish a cap and trade system to reduce greenhouse gases, an approach favored by most economists over conventional regulatory approaches because it provides a great deal of flexibility in how emissions targets are met. But it also contains mandates that could significantly reduce the cost savings that the cap and trade approach is supposed to provide.

In a cap and trade system, the government sets a cap on total emissions of greenhouse gases from various industrial and utility sources, including power plants burning fossil fuels to generate electricity. It then issues allowances to polluters allowing them to emit carbon dioxide and other greenhouse gases; total emissions are meant to stay under the cap. Over a period of time, the government gradually reduces the cap and the number of allowances until it reaches its target. If companies’ emissions exceed their allowances, they must buy more.

Economists like the system because companies can choose to either lower their emissions, such as by investing in new technology, or buy more allowances from the government or from companies that don’t need them–whichever makes the best economic sense. It is meant to create a carbon market, putting a value on emissions.

In the proposed energy bill, the government will set caps to reduce greenhouse-gas emissions by 17 percent by 2020 (compared with 2005 levels) and by 80 percent by 2050–targets chosen to prevent the worst effects of climate change. Setting caps will make electricity more expensive, as companies turn to cleaner technologies to meet ever lower caps or have to spend money to buy allowances from others with lower emissions. But the bill has some provisions for cushioning the blow, especially at first. For one thing, it gives away most of the allowances rather than charging for them, and it also requires that any profits gained from these free allowances be passed on to electricity customers. It also allows companies to buy “offsets” that permit them to pay to reduce emissions outside the United States.

If the program is designed right, there are fewer allowances than the total emissions when the program starts. At first, when the caps are relatively easy to meet, the prices for allowances on the carbon market will be low. But eventually, they will get higher as the allowances become scarcer. In an ideal world, companies will predict what the price of the allowances will be, and plan accordingly.

Some experts believe that the price of the allowances will be enough to prompt investment in new technology. According to Robert Stavins, director of the Environmental Economics Program at Harvard University, companies will make decisions about what research to conduct and what power plants to build–plants that can last for decades–not based just on today’s price, but also on what it will be later on.

But David Victor, a fellow at Stanford University’s program for energy and sustainable development, isn’t convinced. Overall, the price for allowances, especially early on, will not be enough to convince companies to invest heavily in the technology that will be needed in the long run. One likely scenario is that utilities could rely only on switching from coal to natural gas, which emits far less carbon dioxide–a strategy that might work until 2020–and then they might not invest at all in technologies such as solar power and ways to capture and permanently store carbon dioxide–technologies that likely will be necessary to meet the far stricter caps in 2050, Victor says.

This is where the other parts of the energy legislation become important. For example, it includes a renewable electricity standard that will require states to get 20 percent of their electricity from renewable energy sources (such as wind and solar), or they can get credit toward this by reducing electricity consumption. There are also incentives for developing ways to capture and store carbon dioxide.

These mandates and incentives will indeed prompt investment in new technology. The problem is that mandates can be expensive. Renewable sources of energy could cost more than other options for reducing carbon emissions–such as improving efficiency. Even if the technology costs far more than other technology, companies will be forced to pay the higher prices to meet the mandate. Victor says that right now, these costs are hidden within the bill. He says that the bill should include provisions for monitoring and disclosing these costs, so that if they get to be too much, the rules can be changed. He also says the government should be funding clean energy research directly. The bill funds some basic research by giving away allowances, but the value of these allowances depends on the carbon market, so this can be an unreliable source of funding, he says.

Congressional leaders have said that they hope the House of Representatives will pass the bill before December, when world leaders will discuss a follow-up to the Kyoto climate-change agreement in Copenhagen. If so, it might help convince other countries such as China and India to agree to emissions limits. Ultimately, international cooperation will be essential to preventing the worst effects of climate change. “The bill will send a strong signal to the international community leading up to Copenhagen,” Metcalf says.

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