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The Politics of Carbon

The 2008 elections portend federal regulation of greenhouse gases by 2010.

Fortnightly Magazine - June 2008

U.S. power companies face increasing uncertainty because of possible government regulation of carbon dioxide and other greenhouse-gas (GHG) emissions. The most obvious sign of this uncertainty has been the postponement of investments in new power generation facilities as power companies and investors wait for regulators to act.

The federal government’s recent denial of California’s and other states’ petitions to regulate GHG emissions from automobiles, and several bills regulating GHGs pending before Congress, suggest any such regulation will come from Washington, D.C. The type of regulation enacted will affect the profitability of new power generation investments, shareholder returns, and how the economic costs of compliance are distributed between industry and consumers.

Comprehensive GHG regulation likely will emerge before 2010 because of growing public support for emissions reductions and probable Democratic and independent gains in the U.S. Senate in 2008. If GHG regulation occurs, it likely will originate in the U.S. Congress—and not the executive branch—and almost surely will take the form of a cap-and-trade system. However, the costs to carbon producers probably will be modest initially because compromise legislation will result in small and partially-binding targeted emissions reductions and the grandfathering of permits.

Carbon Penalties

Economists argue the best way to encourage investments in cleaner energy is to establish a price for emissions. There are two market-based means of controlling GHG emissions under discussion at the federal level. The first is a tax per metric ton of CO 2 or CO 2 equivalent (CO 2e) emitted. 1 An appropriate tax would bring the private cost of GHG emissions closer to the social costs and would create incentives for producers to reduce their emissions by adopting pollution controls.

An optimal tax would cover as many GHG producing activities as possible and be harmonized across industries (and ideally between countries). Using a dynamic integrated economic and climatic model, Yale University Economist William Nordhaus estimated the optimal carbon tax, the one maximizing world social welfare, at $7.4 per ton of CO 2 in 2005 (in 2005 prices) and increasing by 2 to 3 percent per year in real terms over the next fifty years. 2 The U.N.-sponsored Intergovernmental Panel on Climate Change estimated that a tax of $20 to $50 per ton of CO 2 between 2020 and 2030 would be sufficient to stabilize global carbon dioxide concentrations at safe levels by the end of the century. 3 In the United States, a tax of $50 would result in modest increases in gas prices (about 15 percent) but significant increases in the price of electricity (about 35 percent). 4

The second type of control is a tradable permits or cap-and-trade system. Under this system, the federal government would establish an annual maximum allowance of GHG emissions for covered industries and then distribute

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