Are you carbon beta rated? Here's a look at the likely winners and losers in the carbon rationing age

Chief Executive, The, July-August, 2008 by Ronald Bailey

American business executives are increasingly resigned to the fact that carbon controls are coming. Some 17 bills for cap-and-trade schemes to limit greenhouse gas emissions from fossil fuel energy sources are floating through the halls of Congress. Both Republican and Democratic Party presidential candidates favor limits on greenhouse gas emissions.

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Limiting carbon dioxide will have far-reaching effects on every business in America, ranging from energy production, transportation, food and beverages to retail. Right now, Congressional committees are meeting to pick which industries and companies will be winners and which losers in the great carbon rationing brawl. Executives who know this are likely to be winners; those who are oblivious or think it doesn't concern them are going to be losers.

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The idea behind cap-and-trade schemes is to progressively lower carbon dioxide and other greenhouse gas emissions cost-effectively throughout the economy. Why? In order to prevent greenhouse gases--like carbon dioxide emitted from burning fossil fuels--from accumulating in the atmosphere where they tend to heat up the planet. Under a cap-and-trade scheme, the government sets limits on how much in greenhouse gases companies may emit. Emitters must have allowances for every ton of greenhouse gas (chiefly carbon dioxide) they emit. Some companies will find it easier and cheaper to cut their own emissions, leaving them with excess allowances that they can sell to other emitters who cannot cut as easily or as cheaply.

Carbon rationing will hike the price of fossil fuel energy, which will push companies and consumers to conserve energy and seek energy supplies that do not emit greenhouse gases. Advocates of carbon rationing argue that higher prices for fossil fuels will encourage inventors and innovative companies to develop new low-carbon and no-carbon energy supplies, such as wind, solar, biomass and nuclear power. This energy can be sold without having to be offset with government-issued emissions allowances.

The leading cap-and-trade bill in Congress is the Lieberman-Warner America's Climate Security Act, introduced by Sen. Joe Lieberman (I-Conn.) and Sen. John Warner (R-Va.) last fall. The Climate Security Act aims to cut U.S. greenhouse gas emissions 70 percent by 2050, below what was emitted in 2005. The cap applies to U.S. electric power, transportation, manufacturing and natural gas sources that account for 87 percent of U.S. greenhouse emissions. The cap starts at 4 percent below the 2005 emission level in 2012 and then falls every year at a constant gradual rate. By 2020, emissions will be 20 percent below 2005 levels, reaching 70 percent by 2050.

In order to achieve this goal, the Environmental Protection Agency (EPA) will issue 5.7 billion emission allowances, each one equivalent to 1 metric ton of carbon dioxide. The number of these allowances will decline by 106 million each year (1.8 percent annually) ratcheting down the cap to 1.7 billion allowances in 2050. Initially, in 2012,77.5 percent of the allowances will be given away free to emitters and states, while 22.5 percent will be auctioned by the federal government. The number of allowances given away free declines until 70.5 percent of them are auctioned off in 2031.

This cap-and-trade scheme allows companies and anyone else to trade, save and borrow emission allowances. If a regulated company emits less than the allowances it holds, it may sell those allowances to other companies emitting more than the allowance they hold. In addition, companies can generate new allowances by investing in projects that cut emissions in businesses, forestry projects and farms that are not covered by the Act.

The EPA estimates that emission allowances would cost $22 to $35 per ton in 2015 and $28 to $46 in 2030. Using those estimates, that means the total value of the permits would be $125 billion to $200 billion in 2015 and $100 billion to $177 billion in 2030. The total value of permits in 2030 will be lower, despite the fact that the prices are higher, because only 3.8 billion emission allowances will be issued that year. But are these estimates realistic?

A real-world example suggests caution. In 2005, the European Union created its Emissions Trading Scheme (ETS) that covers about 45 percent of the continent's greenhouse gas emissions. Compared to the ambitious goals set by the Climate Security Act, the ETS cap is a relatively modest 8 percent cut in emissions below what was emitted in 1990. The ETS has had its ups and downs--the price of carbon dioxide allowances collapsed to near zero in 2006 when it was discovered that European governments had handed out far more free emissions permits than there were actual emissions. No scarcity, no price. However, EU governments promised to tighten up, and the ETS market recovered. Recently allowances were selling for nearly $40 per ton. What has been achieved so far? In 2007, EU emissions were up by 1.1 percent. So the simple truth is that nobody knows what the actual prices of emissions allowances will be. (See sidebar, p. 31.)