Energy Policy 101

Congress has started work on The American Clean Energy and Security Act, which, if enacted, will introduce a cap-and-trade system for curbing green house gas emissions. This officially fuels a much awaited debate on climate policy in the US. In the weeks and months to come, we will hear a lot about cap-and-trade and carbon tax, their effectiveness in fighting climate change, their price and their impact on consumers, workers and investors.

This is the first of a series of posts, through which I hope to communicate what I think you should know about energy policy to make sense of the information that is thrown at you.

1. Why?
If you'd like to challenge the need for regulation in this area, you may read my previous post.

2. What?
Carbon Tax - Carbon tax is a form of pollution tax. It levies a fee on the production, distribution or use of fossil fuels based on how much carbon their combustion emits. The price of commodities that cause higher emissions will increase as a result of the tax, thereby discouraging the use of such commodities and products. The intended benefit is that users of fossil fuels will seek alternative sources, thereby spurring innovations, and the tax revenue can also be used to fund such projects. This option is praised for its simplicity and impartiality.

Cap-and-Trade - The cap is a limit on pollution in terms of emissions. An emitter would have to hold permits/allowances [1 allowance to emit 1 ton of CO2] to emit carbon. If the emitter is able to contain emissions and ends up having an allowance-surplus, they may sell/trade those emissions to another emitter, who needs additional allowances to compensate for the excessive emissions they may have produced. In effect, this option would set a limit on pollution and set a market-driven price for emissions. This approach is lauded for its certainty with respect to pollution control.

3. Why Cap-and-Trade?
It is joked that Cap-and-Trade is the politically correct option, as it doesn't have the word "tax". Jokes apart, the underlying theory behind both approaches is to somehow make the stakeholders "feel the pain", so that they take action to wean themselves off of unsustainable ways of life. In other words, there are costs associated with both approaches that consumers, workers and investors/businesses will have to shoulder in varying degrees. Given that we will have to pay for reducing emissions any way, we might as well go with the option that has a better shot at getting the job done. The implementation of either approach will have to deal with challenges such as effective redistribution of revenue, alleviation of the impact of a regressive taxation framework and most importantly promotion of innovation. While the challenges are common, what gives Cap-and-Trade its edge is that it is the plan that has a clearly stated objective -- tangible limit on emissions. Isn't it funny that something so basic is obfuscated so much?!

4. Why-How?
Before we dive into the details of the Cap-and-Trade system, and which factors determine its success, it is important to recognize that the key to success lies in the design of a system that allows for effective incentives & penalties. The design of a market is no child's play, and this is especially true, when companies are to buy and sell the "right to emit CO2". As strange as that may sound, there is an invaluable opportunity to learn from research done in this area and through experiences from the cap-and-trade systems implemented in the US for SO2 in the 90s, and in Europe for C02.

5. How?
I appreciate your commitment, if you've gotten this far... I know... all you did was skim through and look at the last paragraph! Will cover the "How?" in a separate post.

I am Pat, and You need a Nudge?

Happy St. Patrick's Day, but this post has little to do with that!

Human Impact (I) on the environment equals the product of population (P), affluence (A: consumption per capita) and technology (T: environmental impact per unit of consumption).

With growing global population, rise of the middle-class in India, China and in other emerging economies, and the use of unsustainable technology, the human impact on the environment is set to grow on an ongoing basis. Thomas Friedman illustrates the exponential growth of this impact with interesting examples, in his recent book "Hot, Flat and Crowded". One scenario that caught my attention was the impact of giving a light bulb to each of the billion people who will be born between now and 2020 -- 20 new 500-megawatt coal-burning power plants.

We need to change the ways [technology] in which we produce, consume and recycle products that we choose not to consume, in order to minimize the impact that we have on the environment. While incremental improvements in technology can be helpful, you can imagine that it may not be sufficient to reverse the impact growing population and affluence will have on the environment. So, what we need is a series of breakthrough innovations in several industries that will promote a more sustainable product life cycle.

Businesses are driven by profit, and they tend to resist creative destruction, as breakthrough innovations often come with risks. To promote sustainability, governments across the world have come up with regulations for several decades and have learnt that the best mechanism is to provide a market based "nudge" to businesses. Carbon Tax and Cap and Trade are popular nudges that have been debated extensively. Operative word -- extensive. Will dive deep into that debate in my next post. Signing off for now, Pat.