Nicely said:

Imagine that carbon permits are World Series tickets. If the government gives all World Series tickets to Exxon for free, will Exxon give them to us for nothing, or sell them for what the market will bear?

What, give something away for nothing? That’s not the Exxon I know.

istock gavelThis analogy, borrowed from Peter Barnes of the Tomales Bay Institute, is the simplest explanation I’ve seen of why grandfathering carbon permits is a bad idea.

Among climate policy geeks, it used to be the conventional wisdom that grandfathering—that is, handing out the right to emit carbon based on previous years’ emissions—was a smart way to go. Some of this support was political in nature. Big emitters, the theory went, might be less likely to kill a bill if their “right” to emit carbon was fairly secure.

But the times are a’ changing. Now, most people are coming to recognize that grandfathering is a dud. Instead, carbon auctions are the rage.

Here’s why.

  • Under the “grandfathering is good” mindset, people thought that handing out permits for free would protect consumers from sharp price increases.  Companies that don’t pay anything for their carbon permits, the reasoning went, wouldn’t have any costs to pass through to their consumers. 

    The World Series analogy helps show why this is bunk.  In a carbon-constrained economy—that is, a economy in which emissions are strictly limited—a permit to emit carbon is has a value in the marketplace, much as an World Series game with a limited number of seats has a market value.

    And when something has a market value, a rational business will want to sell it to the highest bidder, rather than just giving it away.

    So, regardless of how Exxon acquires those permits, and regardless of who buys them, the company won’t give carbon permits away for free.  Exxon will either sell a little less oil, allowing them to sell unused permits to the highest bidder; or they’ll use all the permits to sell as much oil as possible, but also raise prices.  In the former case, they make a profit from selling unused permits (which they paid nothing for).  In the latter case, they essentially require their customers to compensate them for the profits they could have made by selling permits instead of oil.

    Either way, grandfathering lets Exxon reap a profit from something that it paid nothing for—and it gets that profit even if it never reduces its emissions one whit!

    This isn’t to say that this would be unscrupulous behavior.  From where Exxon’s sitting, they’ll have no choice but to charge their customers more.  Corporations by law are required to follow the profit motive, and if they started giving away carbon permits at no cost, their stockholders would sue.

    The thing to remember here is that, in a carbon constrained world, carbon permits are as good as cash.  So if the government hands out permits for free, it’s the same thing as handing out money for nothing.  Exxon and its kin will profit; everyone else will pay.

    And that’s where auctioning comes in.  If Exxon has to pay the going market rate for their permits, they’ll still pass as much of their permit costs on to consumers as they can.  Energy prices will still rise.  But the difference is that the government—i.e., all of us—collect the permit revenue!  And we can use that revenue for all sorts of good ends, from cushioning consumers from the impacts of higher energy prices, to accelerating the adoption of clean energy technologies, to cutting taxes in other areas, to providing revenue for other priorities.  Peter Barnes (who started all this discussion) is partial to the idea of a “SkyTrust”—which means returning all of the auction revenue as a per-capita payment straight into our bank accounts.

    In the end, limits on CO2 emissions will force up energy prices, no matter how the right to emit carbon is doled out.  The only question is, where does the money go?  With grandfathering, companies keep the higher energy costs as windfall profits for themselves.  With auctions, the public gets the benefit.

    Which makes the choice between grandfathering and auctioning pretty clear, no?