The sting was revealed but the hook is not yet set by the January 11th exposure of a “dispute” among the 16 member California Economic Allocation Advisory Committee (EAAC) whose purpose is to figure out how to spend the money from carbon taxes envisioned by AB32, the California Global Warming Solutions Act.
The Set Up
On January 11th the EAAC presented final allocation recommendations to the State. So this is a trial balloon to see how much angst this approach stirs among the politicians, special interest groups, and seeks to avoid enraging voters before the next election. By framing this “dispute” among members, the EAAC is setting up the potential for a sting of California consumers depending upon how the rest of the process plays out.
The timeline for the rest of this process is that a final public conference call will be held in February 2010 to adopt its economic impacts report. EAAC Chair Goulder will present both reports to the California Air Resources Board February 25th. In Fall of 2010 along with the final proposed cap and trade rules, the CARB staff is expected to recommend a final allocation approach which will purport to balance EAAC recommendations and public input. This is when the hook will be set if the political will exists to do so. There is the minor problem of the November 2010 election looming and voters in California as elsewhere are growing surly.
The committee imported a Harvard environmental economics professor, Robert Stavins, director of Harvard’s Environmental Economics program, to testify that the California approach complies with the AB 32 intent and that the proposed carbon taxes should not fall heaviest on poorer people. He opined that a cap-and-dividend approach produced fewer benefits than cutting taxes on labor and capital.
The much maligned Waxman-Markey Bill passed by the US House uses most of the proceeds from sales of emissions allowances to reduce power company costs of compliance by essentially awarding them free permits to reduce the expected spike in utility rates. This approach sidelined a number of major utilities who fatalistically decided to get the best deal they could rather than be painted as obstructionists. There is a Senate bill by Senators Boxer and Kerry which is closer to the approach being used in California, but it has gone nowhere as yet on Capitol Hill.
Placing the Hook
At its January 11th meeting, the CEAAC members endorsed a “cap-and-dividend” approach which would set prices for CO2 emission allowances as a tax on producers and then use the money raised as a “dividend” to consumers to help reduce their burden of paying all those higher prices for everything that uses energy. The discussion by staff presenting ideas to the committee suggested an annual energy “dividend” for a family of four might be about $1,000.
Sounds good, right?
Not so fast, the committee was divided on whether the best way to use this pot of gold at the end of the global warming rainbow was to give it back directly to consumers or instead use it to create “tax cuts” in state income taxes or sales taxes that will have to be raised to balance the state budget!
The timing was subtle but perfect. Waxman-Markey has stalled in Congress and COP15 turned into a food fight between developed and developing countries and resulted in egg on all their faces. So California with AB32 safely adopted has the opportunity to recapture the leadership flag and show the world how things are done in the Golden State.
Meanwhile, the State is facing another $22 billion deficit because of the recession thus the convenient convergence of the need to develop an implementation plan for AB32 and address the growing California budget deficit sets up the “the sting” that should earn the State an Oscar for best supporting actor in a political drama. Nothing tops the Federal Governments hubris for spending, taxation and income redistribution for Best Actor nominees this year.
Perfect Sting or Fatal Error?
So will California use Carbon Taxes to fill the hole in its state budget? The perfect cure it seems to state politicians. Will they save the world and save their behinds at the same time all while calling these new carbon allowance revenues “dividends” or using them to “reduce taxes” that they must raise rather than reduce spending to close the budget gap? Or will this fatal attraction and sleight of hand turn into a fatal error in the November 2010 elections. High stakes!
But I saved the best part for last, his vast income redistribution scheme would not require the Legislature to actually vote for any nasty tax increases since the California Air Resources Board would administratively each year set “carbon allowance fees” sufficient to raise the revenue needed to meet the Legislature’s spending desires and balance the budget and then the Legislature would declare a “dividend” to give a modest portion of the revenue back to consumers while taking credit for being fiscally responsible balancing the budget by keeping the lion’s share for budget spending. This has the added political benefit of reducing the hostage taking behavior over the need for a 2/3 vote to raise revenue or reduce expenditures each year in passing the state budget. The debate among the 16 members of the California Economic Allocation Advisory Committee is not really what to do but how little of the revenue must be given back to consumers.
After the collapse of the COP15 treaty prospects, proponents of curbs on emissions are scrambling to find Plan B. It is not an easy thing to do. In the US the best prospect to breathe life back in the emission reduction campaign, the Waxman-Markey cap and trade bill, is dying a slow death in Congress where fears about another hit on the economy in the face of persistent 10% unemployment has sent members running to the exits.
Carbon Allowance Prices Fall
Meanwhile, in carbon markets in Europe and the US carbon credit prices are plummeting and with them hope that cap and trade will provide the incentive for significant reductions. EUA (European carbon allowance) futures ended 2009 at 12.53 euros/tonne, down 21 percent from 2008 closing prices as reported by Reuters. The Regional Greenhouse Gas Initiative covering the Northeastern states held an auction for CO2 allowances and the price came in at a little over $2.00 per tonne.
On voluntary carbon markets, where allowances are traded based upon bets about demand for them in the future prospects for passage of Waxman-Markey were not good and futures prices for allowances fell. 2010 vintage carbon futures on the Chicago Climate Exchange fell from $1.65/tonne to only $0.15/tonne in 2009. Reuters reported that 2009 volumes for voluntary carbon offsets were 40-50 percent below 2008 volumes, and demand fell substantially in December, which is usually a busy month is that market.
Going into 2010 the futures markets in allowances was horrible. European industrial firms were busy estimating their emissions output for 2010 in order to sell excess EUAs early while prices were higher than forecast for later in 2010. Not a good sign for the allowance market or policy makers who expect dumping EUA early will lead to even lower prices later in 2010.
The Ticking Time Bomb in Cap n’ Trade Models
That allowance price problem was the context for the questions put to Dr Severin Borenstein, Director of the UC-Berkeley Energy Institute. Severin is a very smart, very savvy guy who has been at the front lines of energy research long enough to know a few things about policy analysis. Speaking recently at a meeting of private equity players focused on the clean tech and energy space he commented on allowance prices and whether cap and trade legislation could revive prospects for effective green house gas emissions reduction policies.
“There is a ticking time bomb under these cap and trade models. Most studies ignore the supply elasticity of fossil fuels. Analysis to date hasn’t focused on resource price change in response to cap and trade – resource scarcity and price changes are likely to be central,” he said. 
He went on to say that he felt that it would require a carbon allowance price of between $80 and $100 per tonne to displace coal. Achieving significant reductions in greenhouse gas emissions needed to focus on that coal displacement goal or market participants would simply pay a lower carbon tax and make only modest changes in their behaviors.
Coincidentally, this is almost exactly what the California Energy Commission and California Public Utilities Commission said in their implementation report on AB32 the California Global Warming Solutions Act to the California Legislature. In short, these state agencies charged with implementing GHG emissions reduction concluded that natural gas prices would need to be $13.87 or higher per MMBtu and the applicable carbon tax would have to be $100 per tonne or higher for the program to be effective in achieving its goals for emissions reduction.
The BIG PROBLEM Waxman-Markey supporters and environmental advocates face is to get their policy goal implemented they must raise gas prices and carbon taxes so high it will crater the economy and keep them there long enough to drive a stake through the heart of the coal industry once and for all so it cannot be resurrected.
If you think the greenmail price was high for a vote for ObamaCare in Nebraska and Louisiana wait until you see what it will cost to buy off enough politicians to get 60 votes for this cap and trade program in an election year.
And if Waxman-Markey cannot find 60 votes, then Plan B logically would be to unleash US EPA with its endangerment finding to wreak havoc on the coal and utility industries. The problem with such blunt instruments of torture as regulations is that a lot of unintended consequences can happen along the way.
US DOE’s Short Term Energy Outlook (STEO) is out. Not surprisingly, total U.S. electricity consumption was down 4.4% in the first half of 2009 compared to 2008, because of the impact of the recession on industrial electricity sales—we made less stuff!
As a result, carbon dioxide (CO2) emissions from fossil fuels are down by 6.0% in 2009 (U.S. Carbon Dioxide Emissions Growth Chart). This is the second year in a row that CO2 emissions have fallen in the US. But as the economy recovers and natural gas prices rise, the Department expects 0.9-percent increase in CO2 emissions in 2010.
US DOE said CO2 emissions from coal-fired power plants fell almost 10% because low natural gas prices encouraged fuel switching. EIA projects monthly Henry Hub natural gas spot price will average $2.32 per thousand cubic feet (Mcf) in October 2009, the lowest monthly average spot price since September 2001. And, as you might expect, such low gas prices are causing new record highs at the end of this year’s injection season (October 31) to more than 3.8 trillion cubic feet (Tcf) in an effort to lock in the cost savings ahead of the expected rise in natural gas prices. The STEO projects Henry Hub annual average spot price to rise from $3.65 per Mcf in 2009 to $4.78 in 2010 but how much it will go up depends upon the fuel demand for power generation and the pleasantly surprising continued growth of U.S. natural gas production from unconventional gas sources like shale formations.
Lower fuels costs should result in lower electricity retail prices year-over-year for the first time since early 2003 with the STEO projecting annual average 2010 residential electricity price of 11.4 cents /kWh or about 2% lower than the 2009 average.
Other factors helping to reduce both fuel consumption and emissions include the addition of 102 wind farms totaling 8,400 MW with another 300,000 megawatts of wind projects are proposed.  Solar projects also grew rapidly but the solar industry hit a financing speed bump during the recession because of limits on capital access.
While the growth in renewable energy capacity was impressive, don’t forget that those 8400 of wind capacity that came on line are the equivalent of only 8 typical sized coal plants. And that represents the biggest challenge to renewable energy today. Can we scale the additional of renewable energy sufficiently—and cost effectively enough—to continue the emission reduction process without more onerous government mandates?
But remember, our insurance policy is natural gas combined cycle generation along with the growing supply of domestic gas from unconventional sources.
If the US is truly serious about reducing greenhouse gas emissions, it can be accomplished by the continued growth in renewable energy. But we also need to see growth in construction of baseload nuclear power and the use of natural gas fired combined cycle generation to reduce the market share of coal in the overall fuel mix.
Waxman-Markey is primarily driven by imposing a political solution to a market economics problem. It is industrial policy of the worst kind locking the US into a rigid Washington-driven formula rather than letting the market adapt to changing conditions with a fuel mix and technology mix that works.