Chairman Charles Rangel presided over an impressively substantive Ways & Means Committee hearing on economic policy to combat global warming this week. The seven witnesses at the March 26 hearing spanned a fairly broad spectrum of interest, representing the Congressional Budget Office, national environmental organizations, academia, think tanks and the corporate Right.
Among the takeaways: even stalwart supporters of cap-and-trade acknowledged the need to manage price volatility; two panelists suggested eliminating the market in carbon altogether and setting an explicit price based on scientific and economic principles.
Three witnesses displayed graphs showing that price volatility in the European Union’s carbon emissions trading system has risen with accelerating trading volume. They noted that such volatility along with collapsing prices discourages investment in energy conservation and alternatives but enriches speculators.
Michelle Chan, author of Friends of the Earth’s new “Subprime Carbon” report cautioned that a bubble in carbon-based derivatives is an almost certain consequence of a cap-and-trade system with unverifiable offsets, free allowances and unregulated secondary markets in carbon allowances. With Congress starting from scratch to design a carbon pricing system, Chan urged lawmakers to avoid the sub-prime carbon syndrome at the outset. Her warning seemed especially trenchant: across the Capitol, the Senate Banking Committee simultaneously heard testimony on how to untangle the wreckage from the collapse of the sub-prime mortgage bubble whose shock waves continue to rock financial markets and the world economy, throwing millions out of homes and jobs.
Reflecting the panel’s consensus, Douglas Elmendorf, director of the Congressional Budget Office said putting a price on carbon through either a carbon tax or cap-and-trade is the most cost-effective way to spur reductions in greenhouse gas emissions. He explained that flexibility about where, when and how to make emissions reductions is essential to capture all of the potential benefits from carbon pricing. Ideally, he said, carbon prices should not fluctuate in response to temporary factors such as weather or economic activity, but should reflect permanent factors that affect compliance costs over a period of years, such as new technologies. Elmendorf outlined the tools available to manage price volatility: banking, borrowing, a reserve pool, a price floor and ceiling, or a managed price approach.
Dan Lashof of NRDC (a member of the USCAP cap-and-trade coalition) said Earth’s atmosphere is “too big to fail” and argued that “a cap is the most effective way to re-power America.” He conceded that allowances will trade on a secondary market that could be volatile, regardless of whether they are auctioned or given away. Lashof insisted, however, that price fluctuations could have beneficial effects such as countercyclically providing price relief during a recession as is now occurring in the EU trading system. He listed six ways to manage volatility: 1) banking allowances, 2) market regulation, 3) access to high quality offsets, 4) complementary measures to promote energy efficiency, cleaner transportation and transformation of energy supply technology, 5) an allowance floor price established through a reserve price in the primary allowance auction and 6) a strategic offset and allowance reserve made available at a trigger price set to avoid undue economic harm.
Dallas Burtraw of Resources for the Future recommended a “symmetric safety valve” or “price collar” to set a floor and ceiling for allowance prices and limit market manipulation. Burtraw calculated that the acid rain (SO2) cap-and-trade program left roughly a billion dollars a year of environmental and public health benefits on the table because it lacks a price floor.
William Whitesell of the Center for Clean Air Policy agreed that a carbon tax would eliminate price volatility but expressed concern that even an adjustable carbon tax such as proposed earlier this month by Rep. John Larson might not reduce emissions enough to meet climate objectives. At the other extreme, he said, a pure cap-and-trade program lacks an effective mechanism to limit volatility. Whitesell called price volatility not only a market problem but a potential risk factor that would discourage investment in low-carbon energy supply and efficiency. He recommended Rep. Cooper and Doggett’s “Safe Markets” approach: an independent board would establish price targets to meet emissions reductions goals. The board would manage the supply of allowances to meet those price targets similar to the way the Federal Reserve manages interest rates.
Chan of Friends of the Earth predicted that carbon markets would experience boom-bust cycles. She noted that speculators now do the majority of carbon trading in the EU and predicted that they would continue to dominate as carbon markets grow. She suggested that speculation would drive prices higher, spurring development of sub-prime assets and creating the kind of bubble that precipitated the mortgage crisis.
Sub-prime carbon assets, Chan testified, would come from “shoddy” carbon offsets that would trade alongside emission allowances. She noted that in some proposals (e.g., USCAP’s January Blueprint for Legislative Action), offsets represent as much as 30% of carbon traded. Contending that regulatory agencies are often captured by well-heeled financial interests, Chan said FoE wants all offsets banned to preclude sub-prime carbon. She endorsed the structure of Rep. McDermott’s bill which eliminates the basic incentive for speculation by making prices predictable with quarterly sales that limit arbitrage opportunities.
Tufts University economist Gilbert Metcalf agreed with CBO’s Elmendorf that short-term price fluctuation is harmful and can obscure the longer-term price trends needed to set incentives. Metcalf testified that the trade-off between price certainty and emissions certainty can be managed under either a carbon tax or a cap-and-trade approach, but he cited these advantages of a carbon tax: first, it can be quickly implemented using existing structures; second, it avoids price spikes that can erode political support, such as the price spike that led to a relaxation of the cap in the Southern California smog emissions trading program, “RECLAIM.”
Metcalf recommended a “Responsive Emissions Autonomous Carbon Tax” (REACT) that would set an initial carbon tax with a specified growth rate, adjusted periodically to meet cumulative emissions goals, the structure that Rep. Larson’s bill employs. Metcalf suggested that in addition to straightforward implementation, and avoidance of price volatility, a carbon tax could be more easily made both revenue-neutral and regionally-neutral to reflect differing regional energy use patterns.
Alone among the panelists, Margo Thorning of the American Council for Capital Formation testified that all climate proposals would raise prices, hobble the economy, drastically raise unemployment and would not benefit the environment, because U.S. actions would not have any substantial effect on global emissions. She did, however, agree that a carbon tax would cause less volatility in energy prices than a cap and trade system.
Ways & Means Committee members questioned the panel extensively. Chairman Rangel (D-NY) asked whether revenue return would be easier with a carbon tax (as Metcalf had testified). Rangel said, “we want the most efficient system” and asked Elmendorf whether CBO had concluded that a carbon tax would work better. With the caveat that “CBO doesn’t advocate,” Elmendorf replied, “yes, cap-and-trade is less efficient than a carbon tax.”
Rep. McDermott (D-WA) asked why derivatives traders should be trusted to set carbon prices instead of EPA and Treasury. Lashof said we need market regulations. McDermott followed up: “Where have you seen a well-regulated derivatives market?” Metcalf and Chan nodded in agreement with his point.
Metcalf noted that the U.S. isn’t acting alone or first — the EU has led. He suggested that border tax adjustments provide a “GATT-legal” way to create economic incentives for other nations to follow and noted that such adjustments are easier with a carbon tax. Metcalf also noted that the EU had high unemployment long before its climate program started.
Rep. Doggett (D-TX) mentioned that last year’s Inslee-Doyle (“carbon leakage prevention”) bill included incentives for U.S. trading partners to enact their own carbon reduction systems. Doggett touted his “safe markets” approach — “training wheels” to limit volatility in the early years of the program.
Rep. Camp (R- MI) asked whether a carbon “cap and tax” would increase unemployment. Elmendorf replied that unemployment might temporarily rise in the transition to low-carbon energy, but because low-carbon energy production is likely to employ more workers, he expects the policy to reduce long-run unemployment.
Lashof disputed that climate policy would harm the economy. Even using Thorning’s estimate of a 1% relative reduction in GDP, Lashof calculated that the delay in the expected 50% growth to 2020 would amount to only several months. Lashof concluded that climate policy flexible enough to allow various compliance options should help build a more robust economy.
Links to written testimony:
- Douglas Elmendorf, Congressional Budget Office
- Daniel Lashof, Natural Resources Defense Council
- Dallas Burtraw, Resources for the Future
- William Whitesell, Center for Clean Air Policy
- Michelle Chan, Green Investments, Friends of the Earth
- Gilbert Metcalf, Tufts University
- Margo Thorning, American Council for Capital Formation
Graph: Point Carbon EUA OTC assessment