Guest Column: Behind the Cap-and-Trade "Safety Valve"

This post reprints in its entirety a column today by veteran Washington reporter Darren Samuelsohn of ClimateWire, a new on-line news service published by E&E News. Samuelsohn’s column focuses on the controversial “safety valve” mechanism that would release additional CO2 permits whenever the price of carbon emissions overshot some set limit. The column, while lengthy, is essential reading for anyone seeking to understand the “devilish details” in carbon cap-and-trade proposals. Note that links to documents in the article are available only to ClimateWire subscribers. — CTC

Behind ‘safety valve’ debate resides 30+ years of history
Tuesday, March 11, 2008

By Darren Samuelsohn, ClimateWire senior reporter

Congress’ effort to pass passing global warming legislation faces many sticking points, but few are as sticky — or as wonky — as the battle over whether a cap-and-trade system for greenhouse gas emissions should include what is called a “safety valve.”

What started as an obscure, almost monastic dispute among economists three decades ago has now emerged as a potential make-or-break point for the proposed legislation. Tracking its tangled history may now be essential to outsiders who want to understand this issue — and the huge economic stakes involved — as champions on both sides of the political arena saddle up to do battle over it.

In recent years, New Mexico Democratic Sen. Jeff Bingaman has become the lawmaker most linked to this cause. His version of the safety valve emerged in 2005 in a legislative proposal that created a price cap on carbon. It would guarantee that American companies pay no more than $12 for every ton of carbon dioxide they release into the atmosphere. This rate would go up five percent annually beyond inflation.

Rallying against him are environmental groups and commodity traders who are concerned his plan would stifle investment in new low- and zero- carbon energy technologies. Meanwhile industry and labor unions are forming up their ranks behind Bingaman.

Finding a compromise to settle this feud won’t be easy. It has been brewing since 1974 when Martin Weitzman, then an economist at Massachusetts Institute of Technology, lit the fuse for the first salvo. An expert on how socialist governments distributed goods, Weitzman published “Prices vs. Quantities.” In it, he examined the best way to set a government policy where there is considerable uncertainty over a potential regulation’s costs and benefits.

Weitzman’s work didn’t have global warming specifically in mind. In fact, it touched only tangentially on environmental issues. But as many other academics have since noted, his findings helped to trigger the debate over how to minimize costs while reducing heat-trapping emissions.

Essentially, Weitzman found that government is best positioned to regulate by stepping in to manipulate prices when there is uncertainty about the net environmental benefits of taking action. But when the chances for an environmental catastrophe are high, Weitzman said, it’s better to tackle a problem with a quantity-based target.

“It’s without a doubt one of the most heavily cited papers in environmental economics,” said Joseph Aldy, a former White House economist now working as a fellow at the Washington-based Resources for the Future think tank. “And one of the most widely cited in economics.”

Engaging President Clinton

Building off Weitzman’s work, Mark Roberts and Michael Spence, who would go on to win a Nobel prize in 2001 for his work on information flows and market development, came up in 1976 with a “hybrid” system for reducing pollution. The Harvard economists premised their paper on the concept that a government could set up a cap-and-trade program to control pollution in the most cost-effective manner.

But because of uncertainty over those costs, Roberts and Spence suggested regulators could withhold some of the credits in this system and only release them if compliance prices exceeded a fixed trigger point.

Several more economists followed with their own complex formulas, but it wasn’t until the 1990s that the safety valve idea blossomed in government policy circles. In this case, it was the Clinton administration preparing for the 1997 United Nations climate negotiations in Kyoto, Japan.

Australian economist Warwick McKibbin and Peter Wilcoxen, then based at the University of Texas-Austin, published a paper in 1997 suggesting a ceiling price on carbon dioxide emissions permits.

Their work was followed by Billy Pizer, Raymond Kopp and Richard Morgenstern of RFF. The trio argued a few months later that climate change can’t be regulated with any specificity to prevent damage to the environment. Building off Weitzman’s work, they suggested a “safety valve” that provides a price guarantee for industry.

Among some members of the Clinton administration, the RFF paper sounded like a perfect fit. Clinton was still bruised from Congress’ rejection of his proposed energy tax on the carbon content of fossil fuels. Officials from the Treasury Department and Clinton’s own Council on Economic Advisers pushed for the cost containment measure. They said it was the best method for dealing with climate change absent an outright tax on carbon emissions.

Others in the administration urged Clinton not to meddle with future carbon prices. They insisted there would be an “announcement effect”: once the government revealed its climate plans, companies would undertake new technological innovations.

This debate entered the public arena two months before the Kyoto negotiations, when Vice President Al Gore asked about the price ceilings during a daylong forum that Clinton hosted at Georgetown University.

Alarmed by Gore’s question, environmental groups quickly pounced. Seventeen nonprofit groups, led by Environmental Defense Fund and the Sierra Club, sent Clinton a letter warning him against using what they dubbed a “relief mechanism.”

“This proposal would weaken, if not eliminate, any incentive for private sector innovation and investment in clean technologies that … is the key to successfully addressing the global warming problem,” they wrote.

Clinton decided to leave the safety valve out of the U.S. position going into Kyoto.

“The ED letter had a big effect,” recalled Rafe Pomerance, a top State Department official at the time. “It was basically dropped.”

Joseph Romm, a safety valve opponent who ran the Energy Department’s renewable lab office during the Clinton administration, said Aldy, then working for the White House, handed him a note after one high-level meeting following Clinton’s decision. It read: “Economists 0, Romm 1.”

But neither side could claim victory. John “Skip” Laitner, a top U.S. EPA economist from 1996-2006, explained: “They didn’t take the safety valve, but we didn’t win either. Because to win meant we had to come in with some really good domestic policies that would allow the market to be given a clear signal about the slow transition needed and to give the market greater capacity to respond.” Laitner is now director of economic analysis at the American Council for an Energy-Efficient Economy.

Courting Bush, McCain, Bingaman

Proponents of the safety valve pushed on. As President Bush arrived in Washington, Pizer shifted to the White House Council of Economic Advisers, where he served as a fellow under Chairman Glenn Hubbard. “He had a significant insider role,” said Pomerance.

There, Pizer recommended Bush use a safety valve as he advanced a campaign pledge to regulate carbon dioxide emissions from power plants. Bush, however, soon backed away from his pledge.

Attention turned next to Sens. John McCain (R-Ariz.) and Joe Lieberman (I-Conn.), who emerged in the fall of 2001 as lead authors of an economy-wide bill to cap U.S. greenhouse gas emissions.

After he left the Bush administration for a job on the Columbia University faculty, Hubbard sent McCain a letter urging him to consider the safety valve in his climate legislation. He was joined by fellow Columbia colleague Joseph Stiglitz, a top Clinton administration economist who had also won the Nobel Prize with Spence.

“Our support for the safety valve stems from the underlying science and economics surrounding the problem of global climate change, and is something that virtually all economists — even two with as politically diverse views as ourselves — can agree upon,” they wrote in their 2003 letter. “The climate change problem is a marathon, not a sprint, and there is little environmental justification for heroic efforts to meet a short-term target.”

McCain, no fan of Hubbard, threw the brief in his waste basket.

But ideas are hard to kill. The safety valve idea emerged again in a widely publicized 2004 report from the bipartisan National Commission on Energy Policy. The commission, a collection of industry officials, politicians and environmentalists, was asked to offer solutions that could help end the stalemate over U.S. energy and environmental policy. Their study recommended Congress pass legislation with a cap-and-trade system and a safety valve that didn’t allow CO2 prices in the first year to go beyond $7 per ton.

Such a price “reflects a judgment about the political feasibility of establishing a federal framework for reducing greenhouse gas emissions in the near term,” the NCEP report said.

A year later, Bingaman, then the ranking member of the Senate Energy and Natural Resources Committee, floated draft legislation with the safety valve as a centerpiece. Last summer, Bingaman introduced a formal version of his bill with a trio of high-profile Republican cosponsors: Pennsylvania Sen. Arlen Specter and Alaska Sens. Ted Stevens and Lisa Murkowski.

The legislation captured attention because he had won over three GOP senators who previously had not supported mandatory limits on greenhouse gas emissions. Major labor groups and the chairmen and CEOs of PNM Resources, Exelon, American Electric Power and Duke Energy Corp. also appeared at Bingaman’s press conference when he introduced the bill.

‘The worst case is X’

Safety valve advocates base their argument on one of Weitzman’s principal theories: that a price mechanism is best when there’s uncertainty over environmental benefits. Global warming is a byproduct of greenhouse gas concentrations built up over decades and centuries, and any one year’s emissions won’t push the climate over the tipping point.

Also, they claim a price limit will guarantee the new U.S. climate program won’t lead to a volatile market in the short-term. They also like being able to tell cost-conscious senators and congressmen exactly what the bottom line is.

“Ph.D.s, all of them, can make very reasoned-sounding presentations that reach shockingly different conclusions,” said Jason Grumet, executive director of the National Commission on Energy Policy. “Legislators don’t have the ability to differentiate among those.”

If he’s asked the worst-case scenario for energy or coal prices, Grumet said he can turn to the safety valve for a simple answer. “We didn’t have to start our response with, ‘Well, we think’ or ‘Our models project.’ We could simply say, ‘The worst case is X.'”

Labor groups, including the AFL-CIO, see the safety valve as a must have, though they’ve recently signalled a willingness to negotiate. So too do many industries.

“The way [Bingaman’s] come at it is the only way you can do this,” said Fred Palmer, senior vice president for governmental affairs at Peabody Coal. “There’s a big group in Congress who thinks we’re paying enough for energy now.”

“If you think that cap-and-trade is the best way to go, then the safety valve is your insurance policy,” said Aldy. “The reason you buy insurance is because the future is uncertain. We want to protect against the things we can’t currently imagine. This is a way to do it.”

Weitzman, who moved to Harvard in 1990, said he would prefer Congress impose a carbon tax of $50 per ton on the fossil-fuel content of energy sources.

But he also acknowledged that the political reality suggests lawmakers will go with cap-and-trade legislation. He’s open to that too, but said it must include a safety valve. “A very strong safety valve is equal to a tax,” he said. “If you don’t allow the price to vary very much, it’s the equivalent to taxing it.”

Counterattacks

Opponents say a safety valve would undermine the very nature of a cap-and-trade program. “Those who have taken global warming seriously have never supported something like a safety valve,” said Romm, now a senior fellow at the liberal Center for American Progress.

Indeed, the safety valve’s critics have lined up a number of political players to reject the idea, including Clinton, Gore, 2004 Democratic presidential nominee Sen. John Kerry and Sen. Barbara Boxer (D-Calif.), the chairwoman of the Senate Environment and Public Works Committee.

“There are a number of no-gos and poison pills, and safety valve would be among those,” explains Brent Blackwelder, president of Friends of the Earth. He added that any effort to add a safety valve would lead sponsors of the Lieberman-Warner bill to pull it off the floor.

Jonathan Pershing, director of the Climate, Energy and Pollution Program at the World Resources Institute, cautioned that none of the major U.S. environmental trading programs — for nitrogen oxides and sulfur dioxide — include a safety valve. The European system for greenhouse gases also avoided it.

Pershing said the safety valve doesn’t fit with the growing scientific warnings associated with global warming that call for near-term actions.

Europeans are weighing in too. “You can also pretty much forget about a global carbon market,” said Damien Meadows, a top climate official from the European Commission. “If Europe linked to America, and the price cap was reached, and we were just sending money across to the U.S. Treasury, that would be a major issue just as if American companies were paying Europe to do nothing because you reached our price cap.”

Meadows added, “Nobody has actually explained to me how that is overcome. And when people tend to think about, they tend to go ‘Oh yeah, I see.'”

Several proponents of the safety valve envision Europe adopting a cost ceiling to match up with the United States. “A cap sends the message that you really are prepared to wimp out of this,” counters Romm. “It sends the message to all the businesses that if they just whine enough that you can stop whatever it is you’re doing.”

A ‘Fed’ compromise?

A bill from Lieberman and Sen. John Warner headed for the Senate floor doesn’t include Bingaman’s safety valve. But it has several provisions designed to dampen the costs to the economy. One piece supported by environmental groups would allow companies to bank away extra emission credits they haven’t used. Another lets them borrow against future years, with interest.

Duke University’s Nicholas School for Environmental Policy Solutions also came up with a program added to the Lieberman-Warner bill that establishes a Carbon Market Efficiency Board. It would monitor the new U.S. climate market and release carbon credits when the cost gets too high, much as the Federal Reserve uses its powers to influence interest rates.

Under the Lieberman-Warner bill, the president appoints the board’s seven members to 14-year terms. Tim Profeta, a former Lieberman aide and the Duke school’s director, acknowledged that the concept falls distinctly on one end of Weitzman’s equation. “I think the Fed itself is a middle ground,” he said.

Harvard economist Robert Stavins disputes any correlation between this plan and the Federal Reserve, which, he notes, carries “a tradition of political independence,” a research board staffed by 200 Ph.D.s in Washington and reserve banks across the country.

Sponsors of the Lieberman-Warner bill are now on the hunt for additional compromises — and House members are only beginning to grasp this slippery subject. To find a middle ground will require movement from all sides. Grumet thinks that’s not impossible. “I’ve never seen a number in Congress that’s non-negotiable,” he said.

Photo: Monceau / Flickr.