Upset Over Offsets

When the President proposed his budget, he tried a gambit aimed atfoisting a new energy tax on the American people without serious debatein Congress. It would have come in the form of a “cap and trade” schemewhereby companies that emit greenhouse gases would have to pay thegovernment for permits to do so. Conservative estimates suggest thatthis disguised tax would have raised energy costs by $3000 perhousehold as companies passed on the costs. The gambit failed, so nowCongressional leaders like Henry Waxman and Edward Markey are proposinga cap-and-trade scheme which has been designed in part by the energycompanies it will affect. Already, however, there are signs that thethieves are falling out.

It might surprise people to learnthat companies are colluding with government in this endeavor. Afterall, Al Gore and others have spent a decade claiming that energycompanies oppose any action aimed at lowering greenhouse gas emissions.What Al and his friends in Congress miss, however, is that companieslove income streams guaranteed by government (it is so much easier thanhaving to go through the difficult business of persuading people to buyyour product). The biggest companies have discovered that cap and tradeprovides just that sort of guarantee, which is why they are circlingCongress like bees round a honey pot.

Here’s how it works.In a simple cap and trade scheme, government announces a cap onemissions and allocates permits to companies proportionately based ontheir historic emissions. If the company emits less greenhouse gasesthan it has permits for, it can sell the excess to other companies whoneed to emit more (perhaps because they have been successful and areemploying more Americans, for instance). Companies who have emittedless make money from the trades, while those who have had to buy morepermits pass on the costs to their customers. The cap reduces eachyear, meaning fewer permits. Theoretically, this system encouragescompanies to emit less.

As the cap reduces, the permits goup in value. They therefore become an important source of income tocompanies that can make simple emissions reductions. On the other hand,they become a burden on companies that find it more difficult.Significant wealth transfers accrue to the “carbon cartel” fromhouseholds and companies outside the cartel. This is what has happenedin Europe, where big utilities have enjoyed windfall profits as aresult of their cap and trade scheme. Household energy bills haveskyrocketed and small companies that emit greenhouse gases, includinghospitals, have seen their bills increase too.

That, however, is just the start. Industry lobbyists, such as their umbrella group the US Climate Action Partnership (USCAP, which includes BP America,Ford, Shell and environmental groups like the Natural Resources DefenseCouncil and Environmental Defense Fund) have also been pushing hard forthe inclusion of “offsets” in the Waxman/Markey bill. These offsetswork just like the sort of offsets Hollywood stars use to justifyjetting around the world to complain about greenhouse gases – they paysomeone else to reduce emissions for them. It has already beendemonstrated that these offsets are open to fraud and abuse – aninvestigation by the Financial Times suggested that companies in thedeveloping world were being paid millions of dollars for emissionsimprovements that cost a few thousand, while some companies were beingformed just so they could be shut down to claim the offsets.

TheWaxman/Markey bill, to its credit, recognizes this problem and proposesa scientific review board to assure the quality of offsets allowedunder its program. USCAP is annoyed by this.Its spokesman, from the environmental group the Pew Center on GlobalClimate Change, told the Carbon TradeEx expo in Washington, “The factthat the science advisory board would have to be involved would reallyslow things down.” It should also be noted that the bill allows for 2billion tons of offsets each year, which is greater than the amount ofemissions reductions required each year under the act. So the fact isthat the so-called cap on emissions might not result in any reductionin US emissions at all. Indeed, the offset allowance is so generousthat US emissions might increase.

What the Waxman/Markeybill does is to create a new set of financial derivatives to be tradedaround the world. It is approved of by big business because they seeways to game the system to their advantage. The burden of the systemwill fall on the households that the businesses pass their costs on toand smaller businesses that get caught up in the net of the bill andare unable to game the system to their advantage. Yet it also acts as aserious distortion on the energy market. Companies may decide that thetrading of these derivatives is a better source of income than theircore business. In fact, that is precisely what Enron had in mind whenit was lobbying for the Kyoto Treaty a decade ago. We may well end upswapping subprime housing instruments for subprime carbon instruments.Neither the economy nor the environment is likely to benefit from that.

IainMurray is Senior Fellow in Energy, Science and Technology at theCompetitive Enterprise Institute in Washington DC and blogs at