California's Progressive, Divisive Cap and Trade Plan

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By Andrew Topf for Oilprice.com

California is claiming the environmental high ground by preparing to take the next step in its carbon reduction plan, but the result may leave drivers fuming.

Starting on January 1, 2015, a cap and trade system will go into effect for all transportation fuels in California, including, of course, gasoline. Oil companies are predicting it will mean an immediate increase of at least 12 cents a gallon at the pump.

Utilities and heavy manufacturers in the Golden State already have to pay to emit carbon through the Global Warming Solutions Act, passed in 2006 by then-Governor Arnold Schwarzenegger. The act aims to reduce California's greenhouse gas emissions to 1990 levels by 2020 -- a reduction of 28 percent from where they would be if no action were taken.

The state is also seeking to reduce the carbon intensity of its transportation fuels by the same year.

When California's cap and trade plan goes fully into effect, it will be the world's most comprehensive carbon-pricing regime, covering electric power and large factories with big carbon footprints, as well as greenhouse-gas emitting products including gas, diesel, natural gas and methane.

Under a cap and trade system, governments impose a limit, or cap, on emissions from heavy polluters like power plants and refiners. It then issues permits, also known as carbon allowances, that polluters are required to buy. Companies purchase the permits from the government or a carbon trading exchange, with prices set by supply and demand. The theory is that the government will gradually reduce the cap, and the number of permits issued, thereby driving up the value of the permits and making it more expensive to pollute.

The problem with carbon pricing, though, is that it can be extremely unpredictable, as shown by Europe’s experience. In 2005, the European Union set up a market for carbon permits, but failed to scrutinize emissions data, leaving it up to companies to report their emissions. The companies exaggerated the levels, which caused the price of the permits to rise; they then suddenly crashed when carbon traders realized the actual emissions were lower. After the 2008-09 recession, EU governments kept issuing more permits even though the recession had lowered industrial output -- ergo, emissions, and prices, fell again. Cheap carbon permits are no way to curb greenhouse gas emissions.

Fortunately, the situation in California is different. Sightline Daily, a sustainability blog based in the U.S. Pacific Northwest, reports that California's emissions rose from 1996 to 2007, and then dropped during the recession and have since plateaued. The state has also taken measures to avoid the wild permit price gyrations seen in Europe, including setting floor and ceiling prices. Permits trade in California for between $11 and $14 a ton of carbon dioxide, compared to just over $7 a ton in Europe, according to The New York Times.

While that would appear to motivate Californians to go to the next phase, the carbon reduction plan has, naturally, caused some opposition, especially from fuel distributors who will have to either eat the costs of the permits or pass them on to consumers. The Western States Petroleum Association predicts the cost of cap and trade allowances will add $2 billion to the cost of gas and diesel, or about 12 cents a gallon, CBS/AP reported.

The group of oil companies is instead proposing a carbon tax on fuels starting in 2015. The idea has the backing of Darrell Steinberg, the leader of the Democratic majority in the California State Senate, who proposes a 15-cent-per-gallon carbon tax. Steinberg argues that a carbon tax would keep fuel prices more stable than a cap and trade system, due to the continually changing price of carbon permits issued by the state.

However, Mary Nichols, chairwoman of the Air Resources Board, California's powerful environmental agency, believes that a carbon tax would not force polluters to curb their emissions.

As California debates the pros and cons of cap and trade versus a carbon tax, they would be wise to look north, to one jurisdiction that implemented the latter. Six years ago, British Columbia passed a tax on fuels and carbon emissions, and the evidence shows it is working. According to The Globe and Mail, the tax, currently about 7 cents a liter, has led to a 16 percent drop in fuel use, compared to a rise of 3 percent in the rest of Canada.

Moreover, the tax is revenue neutral -- meaning revenues raised by the tax require equivalent cuts to other taxes. Since 2008, the province has cut $760 million more in taxes than it needed to offset carbon tax revenue, effectively giving B.C. the lowest personal income tax in Canada and one of the lowest corporate tax rates in North America.

This article was originally published on Oilprice.com.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Commodities , Taxes , Travel and Lifestyle

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