Thursday, February 21, 2008

Will Enron kill climate change legislation?

Is it possible that Enron and the late Ken Lay (that's him in cuffs) will come from beyond the grave to doom a relatively tough climate change law?

The environmental lobby cried foul this week over attempts by Senate staffers who want to add a friendly sounding "safety valve" to the climate change law that is most likely to be brought up for a vote. Some are saying they'd rather have no bill at all.

Promoters of agricultural carbon offsets also screamed, fearing their investments will be dead on arrival.

The Lieberman-Warner bill establishes a cap-and-trade system to control greenhouse gas emissions, and is considered the most aggressive bill in the current Congress. But a recent report from the Congressional Budget Office made a case for the safety valve which sparked the green lobby outcry.

The bill aims to cut carbon-related emissions by more 70 percent by 2050 by requiring polluters to purchase allowances to pollute, which are capped in number. Over time, the number of allowances will drop, forcing businesses to cut carbon emissions or buy permits to pollute from a business that has some to spare. Obviously, the price of those permits could soar if it becomes more difficult to meet reduction targets.

Enter the CBO report's safety valve.

This feature would set a price cap on permits. Environmentalists hate it because it removes an incentive to cut carbon pollution. Business claims it will promote long-term investment by creating certainty in future prices.

But what exactly did the CBO report say?

It looked at current cap-and-trade markets, and praises the one launched in the 1990s in the United States that cut sulfur dioxide emissions:

The Acid Rain Program is run by the Environmental Protection Agency (EPA) and is widely viewed as being very successful, bringing about large reductions in SO2 emissions for lower-than-expected costs.

So far, so good.

Later in the report it cites the need for a safety valve to avoid a repeat of the volatility in the sulfur dioxide market -- that's the successful market it praised earlier in the report. It even included a graph from an academic paper (free registration required) on the subject by William D. Nordhaus.

But it did so selectively..

Nordhaus's graph included more information than the reprint in the CBO report, and Nordhaus's showed that sulphur dioxide permits were less volatile than crude oil futures..

Nordhaus doesn't say it, but one can imagine a scenario in which pollution permits trade inversely to fossil fuel prices (as it happening in Europe). So while they may be volatile, overall energy costs including the allowances will be far less so, undermining some of the argument for the safety valve.

The CBO report cites another piece of selective evidence in support of a safety valve: the volatility of California's nitrous oxide market in 2000 and 2001.

And here's the Ken Lay connection.

As California experienced rolling power blackouts, moth-balled power plants that lacked nitrous oxide controls were brought back online, and their owners scrambled for nitrous emission permits for those plants and paid up to 10-fold increases for allowances.

What the CBO fails to make clear is the context for that market volatility.

We now know that Enron was gaming California's power market to drive power prices sky high and in turn prices for emissions permits.

Without mentioning this, is CBO providing support for a safety valve by pretending the havoc brought about by the work of Ken Lay and his Enron cronies is a normally functioning market.

Not really, but their selective use of data is a little odd.

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