Understanding the “Cap-and-Trade” Bill

Friday, August 07, 2009

The following is a detailed status report concerning the American Clean Energy and Security Act (ACES). I thank our friends at the American Manufacturing Trade Action Coalition (AMTAC) for this analysis.

This legislation would institute a cap-and-trade policy for the specific purpose of reducing greenhouse gas pollution by the United States. The Obama administration has made a it a top priority to change current U.S. energy policy with the aim of lowering carbon emissions, funding more renewable and cleaner energy source research, and reducing U.S. dependency on foreign energy. Bolstered by wide Democrat majorities, the U.S. House of Representatives recently passed a cap-and-trade bill and the U.S. Senate is considering similar legislation. Our comprehensive review of the House cap-and-trade legislation indicates that it will result in sizable production cost increases for U.S. manufacturers while enhancing the already significant advantages enjoyed by offshore competitors.

On June 26, 2009 the U.S. House of Representatives passed H.R. 2454, the ACES bill, by a vote of 219 to 212.

H.R. 2454 uses a cap-and-trade system to reduce carbon emissions. Cap and trade functions by establishing a limit, or cap, on the total amount of carbon emissions (CO2, CFC’s, etc.) from all sectors of production in a given year. If a company produces more carbon emissions than its designated allotment, it can trade for more allowances with another company or buy them at auction from the government. Such caps could have a significant impact on domestic textile producers and other manufacturers.

Allowances will be taken from the cap and provided to companies that produce above a given threshold, which the bill establishes at 25,000 tons of greenhouse gasses per year. Of the total number of allowances available, roughly 85 percent will be distributed at no cost while the remaining allowances will be sold at auction. The free allowances will gradually decrease from their base year in 2012 and are to be completely phased out by 2025. After 2025, the auction process will distribute all allowances. Included at the end of this report is a detailed chart showing the industry-by-industry breakdown of the free allowance distribution laid out by H.R. 2454.

The free allowances distributed under the bill are for the purpose of mitigating the increased costs of the program. Approximately 15 percent of the total free allowances have been allotted for use by the industrial sector. The amount an individual manufacturer receives will vary by industry classification. Allowances have been specifically allocated for certain industries including iron, steel, and phosphate. Other sectors, such as the textile industry, will have to meet certain criteria, which primarily involve greenhouse gas, energy, and trade intensity, in order to be awarded free allowances. In fact, industries that are broken up into multiple sectors like textiles (Textile Mills, Textile Product Mills, and Apparel) for data reporting under the North American Industry Classification System may be precluded from receiving any free allowances because the industry sector is deemed too small by the U.S. government.

To partially offset the increase in energy prices, the legislation allots 30 percent of the free allowances to utility companies. For example, because Duke Energy and Georgia Power are among the companies controlled by utility commissions and they will receive some of the allowances to offset increased costs.

These allowances are given primarily to help keep electricity prices for households from spiking. Various reports analyzing the effects of a cap-and-trade system give wide ranging estimates in relation to increases in energy costs faced by households. Of course many of these reports and projections must be taken with a grain of salt because groups that are either strong supporters or opponents of the bill have sponsored them. Less biased sources tend to project household energy cost increases in a range between $175 and $1000 per year. The increased cost range is so wide because each region of the country uses a different mix of energy sources. Areas that receive most of their power from coal power plants will be the hardest hit while areas that already use processes with less greenhouse gas emissions such as hydro-electric and nuclear facilities will not be affected as much.

The National Commission on Energy Policy has produced a report entitled Climate Policy and Energy-Intensive Manufacturing. This report was published with the intent of educating industries on the impact that ACES can have on factors that affect production like energy prices. The report states that energy intensive manufacturing companies will face significantly increased production costs and that these costs will vary heavily by industry.

The iron and steel industries will face the largest increases according to the report, close to 4 percent in 2012 and rising to 11 percent in 2030.

Another critical issue is whether a cap-and-trade system will place U.S. manufacturers at further disadvantage in relation to offshore competitors. If a cap-and-trade emissions policy is to have any realistic effect on the global climate, and avoid moving U.S. jobs and capital offshore, other countries, specifically India and China, must adopt similar restrictions. Both India and China, however, have stated that they have no interest in adopting any form of climate change legislation. President Obama attended the recent G8 summit in Rome in an effort to persuade other nations to be involved in a worldwide effort to help reduce greenhouse gas emissions, but was unsuccessful in his attempt. This exacerbates concerns that passage of cap-and-trade legislation will hasten the exodus of U.S. jobs. Obama’s own EPA administrator, Lisa Jackson, said that ACES “would NOT materially effect global carbon concentrations in the atmosphere” without similar movements from other nations.

The ACES bill makes a feeble attempt to keep foreign importers from gaining a competitive advantage over U.S. manufacturers by levying trade penalties on imports that come from countries that fail to place limits on greenhouse gas emissions. These duties, however, will not be implemented until the year 2020.

With a spike in the cost of production in the United States, many companies likely will be incentivized to move overseas to locations that do not have any greenhouse emissions restrictions. The companies that move, as well as existing offshore producers, will have a major advantage over U.S. based competitors. This trend will be especially prevalent in the interim period before the aforementioned tariffs go into effect in 2020.

After surviving a close vote in the House, it is the general belief that the Senate will attempt to move its version of cap-and-trade legislation this fall. Senator Boxer (D-CA) is expected to serve as the key sponsor of this legislation in the Senate and it is possible that Senate committees will begin drafting their version of the bill the last week of July. Nevertheless, this issue has clearly taken a back seat to healthcare reform. If healthcare legislation continues to preoccupy Congress through the better part of the fall, cap and trade could be pushed into next year.

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