The End of the Cap-and-Trade Masquerade Opens New Doors For Investors

Despite Controversies, Climate Remains an Issue

Admittedly, it’s been a rough stretch for the cap-and-trade crowd.

The revelation last October that many of the scientists involved in climate-change research had tweaked the data to improve their case was not surprising. The climate-change industry has over the last two decades been rewarded with huge government grants and massive media sympathy. And since some scientists, like anybody else, can be fallible human beings, it wasn’t a surprise that some had papered over flaws in their arguments. Needless to say, it was therefore a relief when the Copenhagen Conference on Climate Change last December failed to produce a meaningful agreement based on that data.

Nevertheless, the fact that many scientists involved in climate change fudged their statistics, and that the Intergovernmental Panel on Climate Change’s Fourth Report in 2007 contained unfounded claims, such as the likely disappearance of the Himalayan glaciers in 2035, does not mean that climate change is entirely a myth.

There is a certain amount of well-attested evidence for climate change, and the suggested mechanism by which excess carbon dioxide might produce global warming is a plausible one. Further work needs to be – and should be – done.

Nevertheless, one can discount the more apocalyptic predictions about future climate and say that, while there may well be some warming in global climate, it is very unlikely to exceed 2 degrees Celsius by 2100. That would imply a rise in ocean levels of no more than a foot or two and only moderate agricultural disruption.

That has important policy implications. And here’s why. Schemes whereby the environmentalists get to rearrange the world economy to suit their own preferences – leading to trillions of dollars a year in lost or wasted output – can be rejected immediately.

The modest improvement in carbon emissions from some of the more-ambitious and complex carbon-capture-and-storage schemes completely fails to balance their enormous cost.

On close inspection, that’s what’s wrong with “cap and trade,” under which the government would announce a yearly cap on carbon emissions and then issue permits to power companies and others producing emissions. The government is not capable of assessing the cost and benefit of different possible levels for the emissions cap. Thus, its ability to issue permits merely produces a huge rent-seeking industry by which it can give favors to campaign contributors.

Last year’s House of Representatives “cap-and-trade” bill was an appalling example of this. It gave out so many favors to those with political “pull” that it ended by producing only an infinitesimal reduction in carbon emissions, and at an enormous cost.

The “cap-and-trade” concept, invented by BP PLC (NYSE ADR: BP) and Enron Corp. in the 1990s as a way to profit through setting up emissions permit trading operations (and through politically favored but uneconomic “biofuels” operations)  may not be entirely dead, even in the United States. Sen. Reid could revive it during the “lame duck” session of Congress after the upcoming mid-term elections, when many legislators will have nothing to lose. However, the balance of probability must be against it, unless the Democrats do unexpectedly well in November.

Hope Not Lost for Those Battling Global Warming

For those whose primary goal is to combat global warming – and not to increase government control over the economy – all hope isn’t lost. Take, for instance, a simple carbon tax, initially imposed at a moderate rate without politically favored exemptions. Such an arrangement:

• Would be much less economically destructive than a cap-and-trade system,
• Would provide few opportunities for rent-seeking by the Enrons of this world.
• And would be at least as effective as a “cap-and-trade” arrangement in combating carbon emissions.

In fact, by increasing the price of emissions, this carbon tax would favor technologies such as natural-gas power stations that reduce those emissions, while at the same time permitting the continued existence of high-emissions operations in areas where their closure would be impossibly expensive.

There’s an additional advantage: This tax would generate revenue for the U.S. Treasury, helping to cut the excessive U.S. budget deficit.

The Likely Path of Climate Reform

No matter which party does better in November, Congress will next year wish to start trimming the deficit, and tax increases are likely to be part of that push. A tax increase that does not fall directly on most consumers – and that can be sold as a “green” initiative – will be very attractive.

Even at a low rate of $15 per metric ton of carbon, such a tax would yield around $100 billion per year, while William D. Nordhaus‘ “optimal” carbon tax of $60 per metric ton would yield close to $400 billion per annum. If imposed without exemptions – and without offsetting wasteful expenditures on boondoggles – a carbon tax could go a long way to reducing the U.S. budget deficit.

Action to Take: For investors, the apparent killing of “cap and trade” is good news; we must hope that it stays dead. On the other hand, a modest carbon tax within the next year or two is quite likely, if only for budgetary reasons. Hence, investors should look carefully at those energy sources such as natural gas and nuclear power, which are low-carbon and cost-effective without additional subsidies.

News and Related Story Links:

• The Financial Times:
  Action on Carbon is Down the Drain
• The Telegraph:
  UN climate change panel based claims on student dissertation and magazine article
• Examiner.com:
  Dr. Michael Mann cleared of tweaking climate change data; second inquiry on the way
• Guardian.UK:
  IPCC officials admit mistake over melting Himalayan glaciers
• Wikipedia:
  Carbon Capture and Storage
• Money Morning News Archive:
  Cap and Trade
• Wikipedia:
  Enron Corp
• Money Morning News Archive:
  Midterm Elections
• Wikipedia:
  Carbon Tax
• William D. Nordhaus:
  Official Website