Monday, October 12, 2009

Collaring cap and trade

Today’s joint editorial in the NY Times by Senators Kerry and Graham,Q5C8KyeRZyy2585Q3DQ3Dt8Q5EQ3D8Q5EQ5E8yPkFkyF8Q5EQ5Em,ZZjSZcQ3EcM1Q3E2Mn is good news – a “deal” is evolving. Any such deal is going to involve (a lot of) compromises. It should be no surprise that things like nuclear energy and off shore oil exploration would end up coming into the negotiations. But Kerry and Graham also raise another issue which may seem innocuous but needs to be tracked with care. They write: “finally, we will develop a mechanism to protect businesses — and ultimately consumers — from increases in energy prices. The central element is the establishment of a floor and a ceiling for the cost of emission allowances. This will also safeguard important industries while they make the investments necessary to join the clean-energy era. We recognize there will be short-term transition costs associated with any climate change legislation, costs that can be eased. But we also believe strongly that the long-term gain will be enormous.” The use of such a price “collar” in a cap and trade system has been much discussed as a way of smoothing price changes and avoiding dissociative price shocks. But, and it is a big but, to speak of such collars as a way of “protect businesses — and ultimately consumers — from increases in energy prices” would be completely self-defeating if the goal of a cap and trade system is to use prices to limit carbon output! There simply is no free lunch here. And the fact of the matter is that to get the changes in carbon output we need prices will have to go up substantially above and beyond the push from increasing demand – especially as competition for energy (especially oil for petroleum) from China and India. Now maybe the talk of protecting businesses and consumers from increases in energy prices is just talk – designed to grease the way for a bill to pass. The bill can be far from perfect. But what it needs to do is put in place a mechanism that can reduce carbon even if its initial targets turn out to be far too low – like the current 2020 target in the House bill. The targets can be changed, as can the allowances under cap and trade. But to do all that, the collar mechanism needs to be a real collar – one that moves up with prices. In doing so, it can’t protect consumers from price increases, nor should it. All it can and should do is to smooth the upward path of those prices.

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