Global Warming Bills Hold Unpleasant Secrets

Published January 18, 2010

There are a few things the supporters of the House and Senate climate bills apparently do not want you to know. Consider the following.

Property Rights Denied

Section 721 of both bills denies property right status to tradable allowances and offset credits. In addition, it does not alter the authority of the Federal Energy Regulatory Commission (FERC) to deny just and reasonable status of the prices of allowances and offset credits.

These two provisions allow the government to change or eliminate the trading system without compensating the emission sources for losses, which would otherwise be required by the Fifth Amendment to the U.S. Constitution.

The chances of this authority being invoked are high. In fact, it already happened in California during the energy crisis of 2000-2001. The nitrogen oxide trading system under the Regional Clean Air Incentives Market (RECLAIM) was suspended, and huge losses were imposed on the emission sources that over-reduced their NOx releases to earn extra credits to sell.

At the same time the FERC retracted the just and reasonable status of the spot market electricity prices and ordered refunds to California’s electric utilities. Again, the counterparties incurred huge losses.

Utilities Trump Consumers

Under both of these government actions the prime beneficiaries were the electric utilities that escaped their contractual obligations. This same preference will most likely exist under the federal cap-and-trade system for carbon dioxide. Indeed, unlike other emission sources, electric utilities are not required to buy allowance endowments at auction.

The tragedy in California for consumers was that both the RECLAIM trading credits and the spot electricity prices could have been hedged by the electric utilities using natural gas futures and options contracts. Since natural gas is the fuel at the margin for generating electricity, its prices were closely correlated with both the RECLAIM trading credits and the electricity prices.

Natural Gas and Carbon Credit Prices

Since carbon dioxide emission sources are aware that they risk huge losses if they depend upon the government to keep its word, their reduction agenda will be altered. Instead of over-reducing emissions in order to earn extra allowances to sell to other emission sources, many will actually reduce emissions and not trade. The trading that takes place will be to hedge energy shocks rather than to reduce costs.

Moreover, a more attractive hedge will be natural gas contracts (see accompanying figure), which have property rights and are therefore protected against government takings by the Constitution’s Fifth Amendment. Thus the cap-and-trade scheme will achieve very little savings, if any.

Earning by Doing Nothing

Offsets are an important source of tradable allowances. These involve forestry options both domestically and internationally. Other agricultural sources do not receive the same emphasis.

Avoiding deforestation is one option for earning allowances, and it allows them to be earned by doing nothing. Farmers have learned how to do this from past agricultural programs.

Reforestation is another offset in both bills. Emphasis both domestically and for developing countries abroad is on replanting native species. Food and fiber projects need not apply.

Sequestration and carbon capture are allowed, but only under detailed regulation and supervision by the government. Like the allowances, offsets are denied property right status. The government can change its mind at any time, and there is no recourse under the Fifth Amendment’s protection against takings without compensation.

When Abraham Lincoln went to Washington as president, he was besieged by office seekers and lobbyists. He observed, in his folksy way, that Washington had more pigs than tits. Judging by the two climate bills, conditions there have not changed very much.

Jim Johnston ([email protected]) is an economic advisor to The Heartland Institute.