Disputing David Sokol's Article on Cap and Trade

Today's Washington Post printed an op-ed by David Sokol, Chairman of the Board of Iowa-based MidAmerican Energy Holdings Co., a subsidiary of Berkshire Hathaway (article here).

His basic premise is that he believes cap and trade will cost an enormous amount and will attract schemers from the financial markets--and we know what they've done lately. In fact, he says we will pay twice: once to purchase allowances and once to build out the low carbon energy system. He may be right that the costs will be high, and most certainly there will be entrepreneurs of all types working to make money as our energy economy changes over from high carbon to low carbon. Some of them are likely to be "greedy," no less. I have trouble following his argument about paying twice, though. Under cap and trade, a regulated entity either buys emissions credits OR reduces its emissions through investments--not both. In the early years, the cap will be very close to existing emission levels, so the only utilities that may have to pay are the ones that rely heavily on fossil fuels, which is how it should be. In order to reduce the use of fossil fuels, we need to increase the costs of using it. The market will then decide if they want to pay the cost or find another way of making the electricity.

Most bizarre, though is his solution. I quote directly from the article:
"The solution? Keep the cap and remove trading from the equation: Mandate that the industry, over the same 40-year period, simply limit its emissions to the same levels proposed in the Waxman-Markey bill. This can be accomplished with a clear plan that gives states an option: Either they participate in a cap-and-trade program or they elect an alternative compliance mechanism to reach the same greenhouse gas emission goals by working with their utilities to develop a 40-year program of shutting down aging coal plants, retrofitting plants to capture carbon dioxide if the technology comes available, and /or building zero-carbon energy plants."

Huh? I thought he just said no cap-and-trade, and then he goes on to say that is one of the options.
Hypothetical: So I'm a state that has to make this choice. Well, why would I not participate in cap and trade? Either it's going to cost me more to get there through retrofits--in which case I'd rather trade for those allowances--or it's going to cost me less, in which case I would want to participate in order to sell my additional reductions and make money. Also, the trading part is entirely voluntary. If I, as a utility, want to just reduce my emissions to exactly my cap without trading either way, well then I can do that. So his second option is already available to anyone who wants to follow that path.

For me, I cannot see how a cap without trading will not cost more than the same cap with trading. Trading allows for the lower cost emission reduction strategies to be more effectively used, because they can occur anywhere and then credited in places where costs are higher. Without trading, each entity has to reduce its emissions regardless of costs, and those with lower costs have no incentive to go beyond its requirements.

Thus, without trading, no entity has any incentive to go beyond the minimum requirement and it costs more. With trading, clever entrepreneurs, technologists and others have a big incentive to go beyond the minimum requirements, thereby unleashing the creative forces that will propel us forward faster, and it costs less. Will some people get rich in the process? I hope so, because that will then attract more entrepreneurs into the field trying to make money, too--all of which helps us meet our goals better and faster.

The whole idea of cap and trade is that it does not dictate a pathway. The private sector is unleashed to figure out the most cost-effective ways to reduce emissions to the desired level (or below). For SO2 (the acid rain precursor), cap and trade has been a remarkable success, resulting in greater reductions at a small fraction of the expected initial cost for this very reason: the private sector figured out much cheaper ways to reduce emissions than were anticipated by anyone. Yet Sokol suggests that the state governments are going to be better and wiser about determining the pathway to lower emissions? State governments? Really?!?

Then we have the whole problem of state-by-state emissions. Washington state is low carbon due to its preponderance of hydroelectric plants. Virginia is high due to lots of coal. Who decides how that gets divvied up? Oh, maybe he's suggesting a nationwide average that can then be, well, capped and traded? How else? Any other option gets totally politicized with states arguing among themselves that their cap ought to be higher than yours, and on and on.

There is a simpler option, a simple carbon tax imposed way back at wellhead, coalmouth or wherever it is easiest to count and collect. That appears to be politically impossible right now, so the next best way to engage the creativity of the market is to provide incentives for them to take action: cap and trade.

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