Debate Flares Over How to Cut Greenhouse Gases

By TOM FOWLER
Jan. 17, 2009, 2:37AM

Amerex Brokers trader Francisco Padua speaks to a client at company headquarters in Sugar Land. He wonders if a carbon tax can be passed by Congress. - Carlos Javier Sanchez Chronicle

Attacking climate change through a complex greenhouse gas trading system is a centerpiece of the incoming Obama administration's energy policy.

But economists and energy analysts of all ideological stripes are saying a better approach to getting a cleaner atmosphere might involve a political dirty word - tax.

A cap-and-trade system for carbon dioxide, already operating in Europe and contained in some proposed U.S. energy legislation, would aim to reduce greenhouse gases by setting a cap on carbon dioxide emissions, issuing emissions permits and allowing companies to trade them in an open market. Over time, the number of permits would drop, forcing companies to lower emissions.

A tax, on the other hand, would simply impose a fee for every ton of CO2 produced by users of fossil fuels, like power plants and refineries. Over time the tax would increase, again encouraging companies to find alternatives. Both options give companies incentives to lower emissions, and both would result in higher energy prices for consumers.

But proponents of a tax on CO2 emissions say it would be less complicated and less expensive to administer and monitor. And the cost would be more predictable to businesses and consumers than a trading system, in which prices can fluctuate greatly.

Gregory Mankiw, the former head of the Bush administration's Council of Economic Advisers, and the Congressional Budget Office, among others, have touted a CO2 tax as a better path. Energy industry executives have too, including former Duke Energy Chief Executive Paul Anderson, Dynegy CEO Bruce Williamson and Exxon Mobil Corp. CEO Rex Tillerson, who said this month that a tax would be "a more direct and transparent approach."

"There seems to be a pretty good consensus among economists in support of a tax, which is surprising given the admiration most have for the strength of markets," said Amy Myers Jaffe, an energy fellow at Rice University's Baker Institute for Public Policy.

But getting a new tax passed could be a long shot, despite growing public support for climate change legislation and a Democratic administration and Congress that are more inclined to support taxes on industry than Republican predecessors.

"So even if a tax is better, can a tax actually get passed by Congress?" asked Francisco Padua, a trader at Amerex Brokers in Sugar Land, which is active in existing emissions markets. "Why even talk about it?"

Momentum builds

The momentum for a cap-and-trade program continued to build last week, as a coalition of business and environmental groups ranging from ConocoPhillips and General Electric Co. to the Natural Resources Defense Council provided a detailed plan to Congress.

No matter how CO2 is regulated in the U.S., it will have a large effect on Texas, and Houston in particular.

Harris County ranks No. 1 in the country for tons of CO2 emitted per year at 18.6 million tons, according to a Purdue University study released last spring. That's because of the concentration of refineries in the area, combined with more than 3 million cars and trucks. CO2 legislation likely would raise costs for local industry.

But a cap-and-trade system also could also create a business opportunity. CO2 trading could top $3.1 trillion by 2020, double the size of the current global commodities derivatives market, according to Point Carbon, an emissions market advisory firm. A U.S. market would be the largest, worth about $2.3 trillion.

Houston is home to many large commodity trading operations, so it would be a natural place to locate CO2 traders.

Cap-and-trade programs enjoy strong support for many reasons.

Such a program has been used for more than a decade to cut acid rain in the U.S. by reducing the amount of sulfur dioxide power plants produce. The program assigned a cap on emissions from coal-fired power plants and then created a trading system for allowances that lets companies decide whether it's more cost effective to reduce emissions or buy allowances to pollute.

Over time, the number of available allowances was lowered. This made it more expensive to buy emission allowances than to install cleaner technologies at the power plants - so plants installed more equipment to clean emissions.

The acid rain program cut sulfur dioxide emissions more than 30 percent below 1990 levels, according to the Environmental Protection Agency, in a way that was predictable and cost-effective to businesses. A similar program aimed at reducing nitrogen oxides, a key component of smog, helped cut those emissions 74 percent below 1990 levels in 20 Eastern states.

Much more complex

How much CO2 might decline under a U.S. cap-and-trade program would depend upon how it was structured, what caps were set and other factors.

But success with sulfur dioxide and nitrogen oxides trading won't necessarily translate to CO2.

Those trading schemes were applied only to a segment of one industry - certain coal-fired power plants. CO2 trading would apply to all power plants and many other industries, so it would be more complex and require more oversight.

Power plants also have several relatively easy options for sulfur dioxide and nitrogen oxides reductions, such as switching the type of fuels burned or adding smokestack scrubbers. For CO2, there are currently few easy options, highlighting a need for new methods.

And the early results for Europe's CO2 cap-and-trade system - which is many times larger than the U.S. sulfur dioxide and nitrogen oxides programs - are seen by some as less than stellar.

The first round of emission credits were free, allowing some emitters to sell permits at big profits without actually lowering their CO2 output.

And too many credits were issued, leading to a steep crash in carbon credit prices in 2006.

Another component of the system that has raised questions is a United Nations-run market that issues tradable carbon credits from projects that trap or destroy carbon emissions, such as restoring carbon dioxide absorbing forests. Stanford University researchers found some Chinese chemical companies actually increased their output of a refrigerant because destroying a byproduct of the process creates a carbon credit they could then sell.

Brice Lalonde, France's special ambassador in charge of climate change, defends the European Union's trading scheme, saying early problems will resolve themselves as the market develops.

"I don't see that many missteps," Lalonde said. "We had an experimental phase to start with, and we are trying to learn by doing. The main outcome is that the cap-and-trade system works."

Special interests

The Baker Institute's Jaffe has misgivings because a cap-and-trade system creates a large commodity market designed by the U.S. Congress under the influence of competing special interests.

"The lobbying over the design will be intense, and there are a lot of aberrations that can be created when you design a market through the political process," she said.

And just like any large commodity market, CO2 prices could be highly volatile, said Craig Pirrong, a finance professor at the University of Houston who is co-teaching a graduate-level carbon trading class this semester.

"Banks like the volatility and complexity, because the more volatile and complex, the more money they could make," Pirrong said. "But volatility may make companies put off investing in cleaner technology because they can't get an accurate estimate on the costs."

Some resistance to cap and trade also stems from the current economic downturn, triggered in part by failures on the part of market participants and regulators.

"I think cap-and-trade is unpoliceable," said S. David Freeman, a former executive with several large utilities around the country, including Texas' Lower Colorado River Authority. He now spends much of his time crusading against nuclear power.

"You could plant a bunch of trees for a credit, but someone has to make sure you don't cut them down five years later," Freeman said. "There seems like a lot of chances to manipulate."

Still, some leading environmental groups prefer cap-and-trade. The Environmental Defense Fund has favored trading, in part because it sets limits on carbon emissions and a tax sets only a price.

And many are skeptical that the government would make good use of tax proceeds. Various proposals call for the money to go directly back to consumers or to pay for research in low-carbon energy technology, but some worry that the money could just be used for other, un-related projects.

"The private sector would do a better job using that value," Amerex's Padua said.