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Obama’s Blueprint for a Secure Energy Future

Last week, President Obama unveiled his Administration’s “Blueprint for a Secure Energy Future”.

Like most big-picture strategic summaries of complex subjects, a whole lot of content gets reduced to a few simple phrases that have become almost devoid of meaning.  In this case, the Obama Energy Blueprint distills into three priorities:

  1. Develop and secure America’s energy supplies
  2. Provide customers with choices to reduce costs and save energy
  3. Innovate our way to a clean energy future

How can anyone object to these motherhood and apple-pie themes?

At the next level of detail, the Obama Energy Blueprint  proposes a long list of individual recommendations, such as incentives for more domestic oil/gas development, programs to facilitate the transition of the vehicle fleet away from petroleum fuels, tighter energy efficiency requirements, and a national clean energy standard.

One by one, most of the listed initiatives have merit.  Unfortunately, some are probably pretty ineffectual, each has its own set of unintended consequences, and there is considerable potential for interference among programs in such a voluminous mixed bag of policy items.

Alas, this is what happens when government is forced to accept suboptimal solutions because the optimal approach is foreclosed due to political realities. 

At a fundamental level, with this Blueprint, the Obama Administration is seeking to simultaneously (1) end American reliance on foreign oil for transportation, (2) reduce U.S. greenhouse gas emissions caused by burning fossil fuels, (3) ensure that the U.S. profits from development and adoption of next-generation energy technologies, and (4) accomplish (1)-(3) without costing U.S. citizens more money on energy expenditures.

The challenge is that all four of these objectives cannot be achieved simultaneously, especially in the near-term. 

Actually, objectives (1), (2) and (3) can be achieved pretty quickly, say within a decade or so, if you’re willing to ignore the fourth objective about reducing energy costs to citizens.  But, alas, the fourth objective is really the only one that most Americans care about with any intensity, and if the U.S. is going to focus on the fourth objective, the first three are hard to tackle in any meaningful way.

To achieve the first three objectives, all that’s required is some fairly simple — if broad-reaching — policies:  namely, higher taxes on oil imports and a carbon tax.  With higher energy prices facing consumers, the millions of economic actors across the U.S. will make investment and consumption decisions that will spur the development and deployment of alternative energy approaches to displace oil and reduce emissions while fostering U.S. leadership in the clean energy industries of the future. 

But, of course, such taxes — for that mattter, any taxes — are anethema in Washington these days.  Having spent all of his political capital (and then some) over the past two years on health care reform and economic stimulus, Obama does not have the strength to propose a straightforward energy policy to achieve the goals that implicitly underlie his Blueprint. 

Frankly, I think the energy policy imperative is a great opportunity for a politically bold leader to take on the issue of restructuring U.S. taxes so as to boost economic output.  Maybe I’m naive, but I don’t see why increased taxes on energy cannot be enacted as part of a quid pro quo for reduced taxes on income and capital gains — which would be unquestionably a tonic for the economy. 

I know that a common rationale for opposing such a change is that a shift in taxation of this kind would be regressive (i.e., fall disproportionately highly on lower-income citizens), but it shouldn’t be all that difficult to come up with some mechanism for providing rebates on increased energy tax burdens borne by the poor.  In other words, there should be an answer that reconciles higher energy taxes among the populists on both the left and the right of the political spectrum.

Actually, I think the real reason that higher energy taxes don’t get any traction in D.C. is that the major incumbent energy companies would be unambiguous losers, and they simply won’t allow that to happen.

As a result, President Obama must resort to issuing documents like the one released last week:  a blueprint that looks like a building designed by a hundred architects each working on a different room.

Cap-and-Trade: How it works and why it’s the been the option of choice

In the run up to Copenhagen and the debate over Waxman-Markey, I think it’s worth laying out some of the key debating points on how cap and trade works and why it’s been our weapon of choice to date in the climate change fight.

I like to think of our carbon and energy problem as follows. We built the first industrial economies and long term economic growth model in all of human history in the last 200 years on a cheap, available energy base, in part by effectively running down our existing inventories of energy stocks from the least cost to the most expensive. We now need a lot more inventory each year (since we’ve been successful and are a lot bigger), and we’re into the expensive layer of our inventory, so it’s hitting our global cost of goods heavier than before. And we know we need to find more sources to replenish inventories, and we know that if we move immediately to higher cost sources we’ll pay the price in GDP.

We also know that producing and using those inventories had a non zero (and we argue about the level) cost to our environment that we have not measured well, but have been working on reducing for the last three decades. But we’ve now run into a new part of that cost with carbon or GHGs that’s very large, and is going to take a much larger and bigger hit to take care of, and depending on your view, has an aggressive time fuse on it. Essentially this means pricing carbon into our economy – which will basically add a whole new cost in all of our supply chains, a cost that varies from country to country and industry to industry, and will shake up comparative advantage in trade. And because it’s global, as far as the environment is concerned, for carbon, unlike most environmental pollutants, it doesn’t matter where in the world it’s emitted or reduced. So our problem is China’s problem is Europe’s problem is our problem.

So we start with a first climate change goal: to reduce the carbon emissions levels in the economy, by a level that we all debate by a point in time that we all debate. But we have to realize that while we do this, we do need to replace those energy supply inventories to both keep us where we are in GDP, and find new ones to sustain growth, or we’ll solve our GHG problem simply by being really poor. And we have to remember that adding costs has to be paid for, and it isn’t “business” that pays for it, it’s us, with business as our proxy.

So my corollary is the goal should be to squeeze carbon emissions out of the global economy in the fastest, least cost path, and as fairly as possible. Sorting out what that means and how to do so is the rub. But part of fair should mean a “do no harm” principal for the economy as well as the environment – meaning that when we start, as far as possible no country or group or industry or company within industries gets penalized out of the gate without either compensation or enough time to adjust. Think of it like eminent domain. If we give something up to the greater good, we deserve to get paid for it.

We have two main ways to go about it, place a tax or penalty on the emissions, or constrain the emissions factors (like power generation, driving, etc.) Cap and trade is essentially a hybrid of the two. The cost of such carbon reduction, because of the ubiquitous nature of carbon, and typically inelastic demand curves for most energy and carbon intensive products, is spread across all consumers in any scenario, but depending on system design can be borne disproportionately by some groups, industries or countries. Our special challenge is because of that global nature, we literally HAVE to have a solution that can engage and work in every country. Unlike cleaning up a local toxic spill, where we can fix ours without our trading partners, in carbon, if China fails, we fail. So if we try and succeed, and China does not try, the environment loses, and we lose worse.

Carbon Tax – Basically with carbon tax the government picks a series of carbon intensive industries or products, assigns a carbon value to them by one of a number of methods, and levies a tax on them. It’s often touted by economists as theoretically the cheapest method, and generally an industry favorite because they know how much they’ll have to pay and can plan.

But carbon taxes have big drawbacks. You can’t be sure you’ll actually get the level of reductions you want, because the tax fixes price, not volume. Worse, carbon is a global problem, and getting global tax codes to mesh together is virtually impossible (we can’t even do it inside the US), which means we may end up with everybody paying a different price of carbon and a complete mess. That certainly would throw the efficiency argument out the window. The next big disadvantage is that if you don’t get the tax level and structure exactly right, businesses and consumers get hurt in unpredictable ways, and have little room to adjust if we get it wrong. So while theoretically better, it’s not a very “fault tolerant” plan.

Main advantage is that you have a known cost to industry (which is why most industry prefers tax to trade or command and control). Next main advantage is that the the government gets lots and lots of revenue, which is why many politicians favor it.

The second option is classic environmental “command and control”, if you’ll excuse the perjorative sounding nature of that term. Esstentially the EPA or equivalent simply regulates every one who produces GHGs, and tells them how much they can produce through a permitting process.

The advantage is that you know exactly how much emissions reduction you are going to get. The disadvantage is that you may pay much more than you thought, and sink your economy, especially if your trading partners are more lax on either regulation or enforcement, and you let the EPA pick the winners and losers. The other disadvantage is that there is no upside. Under no circumstances will you ever get more reductions than you thought, unlike cap and trade, where done right, you may.

Cap and trade is the middle ground (which is why it keeps coming up). With cap and trade, the system operator (UN, EU, EPA, CARB etc) designates how many credits can enter the system, and prints, them like money. It then designates how many credits a company must turn in each year or period per unit of production (ie 0.5 tons/MWH of power produced), and penalizes or shuts down the company if they don’t turn in enough to meet their obligation. So no more emissions from a regulated sector will occur than credits (often called allowances) exist.

Then the regulator decides whether to sell the credits to the industry that needs them, or to simply allocate them (often based on some measure of current production). Both methods have pros and cons, and in practice have nothing to do with environmental protection or the price of carbon (the total level of credits and the relative level of credits to demand sets that) and more with subsidizing one industry vs another, or collecting revenue for the government.

Finally, the regulator can let offset credits be produced from the remaining unregulated sectors (or from inside a regulated or “capped” sector if appropriate adjustments are made), and sold to the emitters (it simply adjusts the cap so that the total level is where we want it to be). The advantage of this is that the regulations can be phased in easier, and we get a more equal price of carbon.

And what happens is that in unregulated sectors any time potential reductions exist (eg, a very inefficient emitter that could be shut down or run more efficiently), carbon developers pay up for the rights to the reduction, and that emitter finds it’s more profitable to do the right thing. The downside is that it looks like emitters are getting a profit off emissions. In reality, they are getting paid to reduce emissions for you and I, at just the right price.

Then emitters and financial parties buy and sell these credits from the government or each other or develop offset credits in a race to pay the least. And since the regulator starts reducing the number of credits it puts into the system, it’s kind of like musical chairs, the slowest, most carbon inefficient company gets left out and has to shut down, or shifts to a lower carbon production in order to stay in business.

The main advantages of cap and trade – 1) it assures us that we will meet our target goals like command and control 2) but it allows industry the flexibility to figure how to meet them cheapest (which is good for all of us), 3) it tells us what the real price (or cost) of carbon actually is, 4) and it’s better at equalizing the price of carbon so everyone pays the same across different industries and geographies, 5) in practice it costs less, and is easier to implement in a multicountry environment than command and control or tax.

Main disadvantages, it takes some time to get up and running, and makes it look like (not really true), that emitters are making money off it. Trust me, if they thought it was a profit center, they’d be all over it. The final disadvantage is it depends on the government operator to manage a market, something where we’ve had some good success (like NOX and SOX trading and up until recently the Fed), but can be susceptible to politics as usual.

In essence, you can think of cap and trade as a carbon tax with a tax rate that varies with the market (going up if industry is worse at producing carbon reductions than the government thought and down if they are better, and similiarly going down when the economy is bad and we can’t afford it and up when the economy is strong) and a tax base that is higher for emitters and emissions intensive industries than for those more efficient.

In any case, all three options need a lot of money spent on new technology and good measurement and verification. All three options will be expensive, and will be paid for by you and I at somepoint. And in practice, we are doing all three options to varying degrees right now.

Neal

The T-Word

by Richard T. Stuebi

One of the bummers of having been in the energy/environmental field for so long is that rarely do I read or learn something I haven’t heard of before. It’s hard to for me get excited anymore.

Perhaps one of the silver linings of the current economic malaise is that thought-leaders are coming with novel and interesting ideas for the public sector to raise revenues. Yes, that’s right, new taxes.

Two recent examples. First, an intriguing idea put forth by Ian Ayres and Barry Nalebuff in the March 16 Forbes: a voluntary gas tax. This brings back, in different clothing, the concept of war bonds that could be marketed as a matter of patriotism to promote energy independence: citizens can optionally buy an advance tax rebate in exchange for paying an extra amount per gallon of gas purchased at the pump. If you drive little, or drive a fuel-efficient vehicle, you can actually profit from this transaction.

Second, Seattle city officials are considering a $0.20 charge per plastic or paper shopping bag. The idea is up for referendum in August, but unfortunately, it seems that the idea is on the ropes. It’s too bad, because the same idea has been in place (unbeknownst to me) in Ireland since 2002, and appears to be working well.

Although four-letter words are considered nasty, there’s no worse word in the American lexicon than that little three-letter devil. No politician can afford to raise the specter of new taxes, even when they’re desperately needed to balance budgets while encouraging more responsible behaviors.

The cap-and-trade legislation is being threatened by opponents who claim it is nothing but an energy tax (see, as an example, the March 9 editorial by the Wall Street Journal). The dirty little secret is that they’re right: cap-and-trade is a tax. Does the mere fact that something is a tax mean that it shouldn’t be adopted?

Richard T. Stuebi is the Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc. Later in 2009, he will also become a Managing Director at Early Stage Partners.

Carbon Taxes…Sorry, I Meant, "Fees"

by Richard T. Stuebi

For a long time, I have been assuming that U.S. regulations to reduce carbon emissions, when they come, will be in the form of a cap-and-trade program, similar to what is in place in the U.S. for limiting sulfur dioxide emissions.

Even though a cap-and-trade system for carbon emissions is probably workable, it is still (in my opinion) a less direct mechanism for reducing carbon emisisons than the more obvious: a carbon tax, priced on a $/ton emitted basis.

Carbon taxes have not found much favor because…well, they’re a tax, and no politician wants to implement a tax, as it’s deadly to one’s career ambitions. (Remember “Read my lips”?) More substantively, some have argued that a carbon tax would be harder to administer, though I would think that a cap-and-trade system would be much more cumbersome (all those allowances to track!).

For certain, a tax is a better structure dealing with emissions from all sources, large and small, whereas a cap-and-trade system is only manageable for large point source emitters — such as utility powerplants. Not surprisingly, therefore, oil and auto interests generally favor cap-and-trade as the carbon mitigation approach of choice. Perhaps somewhat surprisingly, those utilities that have gone on record in support of climate legislation are OK with a cap-and-trade approach, probably because of accumulate utility experience with cap-and-trade for sulfur dioxide.

However, FPL Group (NYSE: FPL) has cast their lot in arguing for a carbon “fee” — a tax by any other name, but a much more acceptable term. (Policy statement here) This is the first big company that I’m aware of that has gone this far out on the carbon tax limb.

True, FPL is not among the leading carbon emitters: with a large emphasis on gas, nuclear and wind for their electricity generation, they can better afford to adopt a bolder climate stance than other utilities.

But I wonder if other utilities — Exelon (NYSE: EXC) comes to mind, maybe Duke Energy (NYSE: DUK) — can be far behind? And, if so, will the pendulum swing away from cap-and-trade to carbon taxes…er, fees?

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc.