After the failure of the Copenhagen meeting, the Italian Senate passed a motion calling for a re-assessment of European Union climate policies as well as a review of the IPCC process. The motion, presented by Sen. Antonio D’Alì (chairman of the Environment Committee) and Sen. Guido Possa (chairman of the Education Committee) as well as many other Senators, is a powerful sign of wide and growing dissent in many EU member states.

The EU is the largest economy to have ratified the Kyoto Protocol, under which it is committed to cut its greenhouse gas (GHG) emissions to 8% below 1990 levels in 2008-12. The EU has subsequently adopted a package of directives, the so-called “20-20-20,” that mandates a 20% reduction of GHG emissions below 1990 levels by 2020 and that 20% of total energy consumption will be provided by renewable sources, with a non-mandatory target of a 20% increase in energy efficiency.

In order to achieve such ambitious goals, Europe has created a large cap and trade program, called the Emissions Trading Scheme (ETS), under which over 12,000 industrial installations are required to surrender an amount of emission allowances high enough to cover their own annual emissions. Extra allowances can be bought and sold on the market. Theoretically, such a mechanism is supposed to create incentives for businesses to invest in clean technologies, reducing emissions through an economically efficient process.

Despite the political success of cap and trade – easily sold to voters as a means to force “big business” to pay for the pollution that they supposedly cause – cap and trade is often criticized, even by mainstream economists, as inefficient and ineffective.  The costs, it is argued, outweigh the benefits.

Act Locally, Warm Globally

Assuming that cap and trade (and, more specifically, the ETS) is actually working, the cost of energy and of energy intensive production should rise. As a result, all else being equal, fewer energy-intensive goods and services will be produced. Fossil-fuel production will drop as as alternative energy sources come on line and as energy consumption falls due to conservation measures.

And as energy supplies fall and prices rise, energy-intensive production will relocate from Europe to countries in which production costs are lower, such as in Asia’s emerging economies. Ironically, since the level of technology is lower in these countries than in Europe, the amount of emissions per unit of production may actually increase. In other words, one consequence of a working cap-and-trade scheme is that emissions may fall where the scheme is enforced, and simultaneously rise in other parts of the world.

Suppose, for example, that an Italian paper producer moves a plant to China. For a unit of production worth, say, US $1,000 of value added, the Chinese plant would emit 2.120 instead of 0.250 tons of CO₂ equivalent. EU emissions would decrease by 0.250 tons, but Chinese emissions would increase 2.120 tons, with a net increase in global emissions of 1.870 tons, or 748% above the counter-factual scenario. Since global warming is, well, global, EU policies are likely to result in more, not less, warming (assuming that anthropogenic emissions are a substantial cause of climate change).

This is obviously an extreme case, and there are also examples of genuine reductions achieved thanks to the ETS, but the net balance of reductions and increases is, at least, ambiguous. Even under the most favorable scenario, actual emissions reductions are significantly lower than expected. This phenomenon, known as “carbon leakage,” impacts more than the economics of the ETS; it also has a political impact. 

A World Bank survey has found that “dirty” economic sectors tend to be more energy-intensive than “clean” sectors, and about as, or slightly less, labor-intensive. In the short to medium run, higher carbon prices would translate into higher energy prices, with the risk of substantial delocalization. Being held responsible for job destruction, or for seriously harming important sectors of the economy, is not a nice business card for a policy. Not by chance, the European Union claims that its policies will, somehow, create new jobs and more growth, but there is no evidence for that (the evidence is, in fact, to the contrary).

But the point is, regardless to what they say, the EU bureaucrats know very well what they do, and understand its consequences. In order to prevent negative impacts on energy-intensive industries, they are designing a number of “corrections” to the policies currently employed, including (but by no means limited to) exemptions from ETS and the distribution of free emission allowances to all industries exposed to international competition.

Punishing the Innocent

What is the consequence of ETS? As some energy- and carbon-intensive sectors of the economy are partly or totally protected from the need to cut emissions, the burden is shifted onto less carbon-intensive production, or onto carbon-intensive production that has little or no exposure to international competition (most notably the electricity sector). This is unfair and inefficient. It is unfair because businesses that emit relatively less are required to pay for businesses that emit more. It is inefficient because, even intuitively, the marginal abatement cost for less carbon-intensive production is higher. It is also ineffective, because there are limits to the ability of businesses to adjust their processes and investments in the short run. This is a perfect recipe for the ETS to work neither properly nor efficiently.

The result is that ETS doesn’t provide a real incentive for carbon-intensive businesses to change their behavior, and most of the price is paid by non-carbon-intensive businesses. At the end of the day, the ETS is equivalent to an inefficient environmental tax, with the emphasis on “tax” rather than “environmental.”

While these problems are being willingly inserted into the ETS in Europe, the ETS has worked poorly so far for other, more serious reasons. In the first phase of ETS (2005-7) emissions actually rose as a consequence of an over-allocation of quotas in the most politically powerful countries, which drove the price of emission allowances close to zero. In the (current, 2008-12) second phase, however, emissions are falling dramatically in the ETS sectors as well as, the EU believes, in non-ETS sectors. The drop may be enough so that, contrary to forecasts of just a couple of years ago, the EU could meet, or only slightly miss, its Kyoto targets.

Figure 1. EU27 GHG emissions trends and projections to 2020. Source: European Environment Agency 2009.

Fewer Emissions = Less Energy = More Poverty

What is becoming clear, though, is that climate policies are not the primary reason for the reductions in GHG emissions. Instead, it was largely the economic crisis that drove the 16% drop in ETS sector emissions during 2008-2009. While data are too poor to draw significant correlation – ETS Phase 2 has been in force since 2007 – it is intuitively clear that economic growth, or lack thereof, drives emissions reductions in the short run, as the next figure shows.

Figure 2. Emissions (2007=100) and economic growth rate in the EU27 and Italy in 2007-2009.

This probably works both ways. That is, emission reductions may drive the economy down. There is a very strong link, in the short run, between emissions, energy consumption, and wealth creation. The more wealth is created, the more energy is demanded, and the more emissions are produced. Any policy aimed at cutting emissions will, in the short run, endanger economic growth. In the long run, a policy might be neutral with respect to growth only if alternative, cleaner technologies are available at the same, or lower, cost than carbon-intensive technologies. In that case, though, climate policies would have little impact, because businesses would shift to cleaner technologies anyway, not for the sake of cutting emissions, but to save money.

All of this helps to understand the rationale behind the Italian Senate’s motion. On the one hand, as the figure above shows, Italy’s GDP fell more in 2008 and 2009 than did that of the EU27, and its emissions fell accordingly as well. Policy makers and the public at large realize that the two things go together.

On the other hand, the country had perhaps a more lively debate on climate issues than many other EU member states. That created favorable political conditions for such a strong position to be taken as did a number of courageous senators such as Mr D’Alì and Mr Possa. The motion is likely to have no practical effect, though, because the government is showing no sign that it is willing to follow the Senate’s lead.

Moreover, even if the government, and particularly the environment minister, Stefania Prestigiacomo (who, so far, has not been able to develop a credible position on climate), were willing, under the EU treaty, there may be no way in which to achieve a re-negotiation of the energy- and climate-related package of directives.

Yet, politics is not just about decisions: it is also about feelings and signals. The Italian Senate’s motion is perhaps the strongest indication of discontent since the vocal opposition from Czech Republic President, Vaclav Klaus, was heard and since the attempts by Poland and other Eastern countries to mitigate the scope of the “20-20-20” policy. In the long run, sound ideas may make a difference. The Italian Senate should be praised for its willingness to show that the debate is not over.

“This agreement will be good for Enron stock!!”

- John Palmisano, “Implications of the Climate Change Agreement in Kyoto & What Transpired” (1997)

The 219–212 passage of HR 2454 inspires another look at Enron’s infamous “Kyoto memo,” written almost 13 years ago by company lobbyist John Palmisano. Indeed, an Enron memo upon House passage of the Waxman-Markey climate bill would have been similar! Change the dates and some other specifics and the bottom line would be the same–potential gains for Enron’s profit centers in wind, solar, CO2-emissions trading, energy outsourcing, and natural gas.

One can imagine a quotation like this from Enron’s fabled public relations department, hyperbolizing a half-victory into something bigger in the attempt to create a bandwagon effect:

“This historic vote was heard ’round the world,” stated Kenneth L. Lay, chairman of Enron Corp. “Although much work remains before we have new law, HR 2454 signals a new commitment toward clean, green energy, of which Enron is the acknowledged world leader. All of us look forward to working with lawmakers and citizens in this new era of global climate protection.”

Perhaps Al Gore himself would have placed a call to Ken Lay to congratulate the company that did to much so spark the CO2 reduction debate within the industry in the 1980s and 1990s. Indeed, the U.S. Climate Action Partnership (US CAP), a bootleggers-and-Baptists coalition that had much to do with the opening draft of Waxman-Markey, probably had more to do with Ken Lay protégé James Rogers  (now chairman of Duke Energy) than any other single person.

Reprinted below, verbatim, is the infamous Enron Kyoto Memo, the original copy of which is posted here.

To: Terry Thorn, Joe Hillings, Cynthia Sandherr, Jeff Keeler, Fiona Grant, Hap Boyd, Bill Shoff, Dan Badger, Tom Kearney, Lynda Clemmons, Bruce Stram, Mike Terraso, Rob Bradley, Jim O’Neill, John Hardy

From: John Palmisano

Date: December 12, 1997

Subject: Implications of the Climate Change Agreement in Kyoto & What Transpired

This memo summarizes the implications of the agreement reached in Kyoto and also describes what I was doing and provides some observations.

Implications

If implemented, this agreement will do more to promote Enron’s business than will almost any other regulatory initiative outside of restructuring of the energy and natural gas industries in Europe and the United States. The potential to add incremental gas sales, and additional demand for renewable technology is enormous. In addition, a carbon emissions trading system will be developed. While the trading system will be implemented by 2008, I am sure that reductions will begin to trade with 1-2 years. Finally, Enron has immediate business opportunities which derive directly from this agreement.

On the policy-front: There will be a great number of country-specific and international meetings related to every aspect of this agreement. I do not think it is possible to overestimate the importance of this year in shaping every aspect of the agreement. Three issues of specific importance to Enron are: (1)the rules governing emissions trading, (2) the rules governing joint implementation within Annex-1, and (3) the rules governing the proposed clean energy fund (which promises to dwarf the GEF as a fund for wind, solar, and power plant conversions.)

On the business front: During the next year there will be intense positioning of organizations to capture an early lead in a variety of carbon trading businesses.

The endorsement of joint implementation within Annex-1 is exactly what I have been lobbying for and it seems like we won.

The clean development will be a mechanism for funding renewable projects. Again, we won. (We need to push for natural gas firing to be included among the technologies that get preferential treatment from the fund.)

The endorsement of emissions trading was another victory for us.

Highlights of the Agreement

38 developed countries are required to reduce greenhouse gas emissions to or below 1990 levels by 2012.

The U.S. reduction objective is 7%, the European Union is 8%, and Japan is 6%; therefore, it is not possible (or at least credible) that Congress can say the United States is at a comparative disadvantage vis-à-vis its main trading partners or competitors since the EU and Japan have higher control targets and are more “carbon-lean” than are we.

Six gases are included (CO2, CH4, N2O, HFCs, PFCs, and SF6).

Emissions trading is included. Details of an international system are to be worked out in 1998.

A “clean development fund” is included. The fund would allow for emission offsets from projects in developing countries.

Joint implementation for Annex-1, developed countries and the transitional economies, is included. This means that Enron projects in Russia, Bulgaria, Romania or other eastern countries can be monetized, in part, by capturing carbon reductions for sale back in the US or other Western countries.

While I do not have the final version of the agreement, I do have the first and second versions. The latest version is not on the world-wide web.

What I Was Involved In

I gave three speeches and received an award on behalf of Enron. The speeches dealt with emissions trading, energy efficiency/renewable, and the role of business in promoting clean energy outcomes. The award came from the Climate Institute and was for Ken Lay and Enron for our work promoting clean-energy solutions to climate change. The other recipients were Sven Auken, MP and Minister for Energy and Environment in Denmark, and MP and former Environment Minister for the UK, John Gummer. I have met Gummer and Auken several times before and it was nice for them to hear Enron praised so much. (I gave a speech with Gummer last Saturday and it was the third time we have been on the podium together. He is someone who still retains considerable influence in the UK and Europe and someone Enron might want to cultivate.)

I was also involved in a press conference.

Observations

I believe that it will be impossible to separate electricity restructuring from climate change as a domestic political issue. The administration has signaled its view that the two issues are intertwined. At yesterday’s White House press conference, this connection was underlined by the comments from Tom Kasten, President of Trigen Corporation who spoke in favor of the climate change agreement and its linkage to restructuring. His remarks had to be cleared by the White House. These remarks are entirely consistent with every other signal from the Administration’s climate change team.

Through our involvement with the climate change initiatives, Enron now has excellent credentials with many “green” interests including Greenpeace, WWF, NRDC, GermanWatch, the US Climate Action Network, the European Climate Action Network, Ozone Action, WRI, and Worldwatch. This position should be increasingly cultivated and capitalized on (monetized). (Parenthetically, I heard many times people refer to Enron in glowing terms. Such praise went like this: “Other companies should be like Enron, seeking out 21^st century business opportunities” or “Progressive companies like Enron are….” Or “Proof of the viability of market-based energy and environmental programs is Enron’s success in power and SO2 trading.”)

Developing countries have acquired substantial negotiating power. The shift in negotiating power to India, Brazil, China, and the G-77 has been gradual and pronounced.

The EU negotiated as a group. Until two years ago, they negotiated as individual countries. While there are still individual country interests, the EU retains substantial power when working together. It was this cohesiveness that lead to a more stringent agreement.

EU delegates asked for my input into the agreement to oppose some of the positions espoused by some US delegates. In particular, the US was advocating no rules governing the trading of carbon emissions because rules would “inhibit trading.” My position is that rules defining who owns what reductions, how reductions are traded, how they are tracked, and liability rules will help promote trading since rules give both buyers and sellers more confidence in the commodity.

While some companies and trade associations continue to criticize developing countries for not doing more, no company wants to be specific on this issue. To the extent any company does, they will hide under the shield of a trade association. I think that shield will soon be pierced. I believe that some companies will soon break from the line that developing countries should do more. It is a weak position in terms of equity and suicidal in terms of their commercial interests in these countries.

An increasingly ugly trend has become evident to the environmental NGO community and the delegates from developing countries. They see the argument about developing country participation as a thinly disguised recycling of the early twentieth century fear-mongering characterized by the so-called “yellow-peril” or invasion of the US by Asian peoples. The developing country delegates see the argument of the carbon lobby that the US will lose markets to developing countries as empty and racist—they see energy-intensive imports to the US coming from Japan and Germany in terms of automobiles (and these are high cost energy areas) while economic growth in developing countries is fueled by local growth or Western industries requiring low cost of labor, low cost for land, or permitting flexibility for new plants. Enron should not participate in any argument like this because it hurts our credibility with developing countries, NGOs, and developed country governments.

I should have a copy of the agreement today.

The next year will be very intensive because the structure of the agreement exists, business opportunities are being defined, the rules governing emissions trading will be developed, and identifying, financing, and managing JI projects will be important.

One final point, Terry, if you remember, I predicted an agreement that would yield a 5% reduction by 2010; we got 7% by 2012. I now predict ratification within 3 years. I predict business opportunities within 18 months. I predict this agreement will have very significant influences on the energy sector within OECD and transitional economies and will accelerate renewable markets in developing countries. This agreement will be good for Enron stock!!

Who was/is John Palmisano?

After leaving Enron, Palmisano was named Managing Director of Evolution Markets, LLC on January 31, 2001 (Enron would collapse later that year). He is now Senior Vice President for Strategy and Sustainable Energy at China Horizon Management LLCSVP.

Palmisano’s career in environmental issues (up to 2001) was described as follows:

John Palmisano’s career spans the entire spectrum of the emissions reduction field, from his start as a US EPA regulator to both international and domestic commercial activity. Mr. Palmisano founded the first US emissions trading firm – AER*X, in 1984, and over the past 24 years has advised governments, international organizations such as World Bank, and trade associations on how to promote cost-effective environmental and energy policies. He recently founded John Palmisano & Associates LLC and was assisting both industry and governments to develop emissions trading strategies. Until May of 2000, he was Senior Director for Environmental Policy and Compliance at Enron Corp., managing Enron’s greenhouse gas policy and commercial activities. He is an acknowledged leader in the field of emissions trading, having written many papers, participated in millions of dollars in related policy and commercial studies, and given over 200 presentations on these subjects around the world. He currently serves on the Board of the Emissions Marketing Association and the European Business Council for a Sustainable Energy Future (e5).

As was widely predicted, Waxman-Markey has degenerated into little more than a special-interest pork-fest, where the political system is getting ready to give away at least 85% of the valuable emission permits to favored energy constituencies such as electrical utilities, university researchers, low-income households, renewable manufacturers, anti-deforestation programs, and so on. The Obama administration’s pledge to auction off 100% of the emission permits was a joke on the face of it: virtually all emission trading programs feature extensive “grandfathering” of polluters and favored constituencies.

Principled environmentalists have turned their guns on what has emerged. Michael Shellenberger of the Breakthrough Institute, in particular, has explained that it’s not only the trade elements of Waxman-Markey that are bogus, it’s the cap as well. It turns out that under Waxman-Markey’s byzantine provisions, “carbon emissions in regulated sectors of the U.S. economy [are] to rise at business as usual (BAU) rates through 2030.”

Here is his explanation and challenge to we’ll-take-anything environmentalist groups behind Waxman-Markey:

But whether or not you believe the legislation would result in lower emissions, there appears to be universal acknowledgement that various provisions in Waxman-Markey — including but not limited to off-sets and the strategic reserve pool— prevent the “cap” from being binding. Given this, Waxman-Markey cannot be accurately referred to as establishing a “cap” on U.S. emissions, much less a “binding cap.” Probably the most accurate term is “non-binding cap.”  

Waxman-Markey advocates have offered reasons why they believe the high levels of allowable emissions in Waxman-Markey should not be a concern: a) a 17% reduction in emissions targeted in the bill will be easy and inexpensive to meet, thereby obviating the need for firms to purchase offsets in lieu of reducing their own emissions; b) there aren’t enough legitimate offsets available to replace mandated emissions reductions; c) there are other provisions in the legislation, such as renewable energy standards and efficiency standards, that will ensure that targeted reductions are achieved even if the “cap” allows emissions to increase.

While these assertions are debatable, none refute the fact that the “cap” in Waxman-Markey would not legally mandate emissions reductions in regulated sectors of the economy for at least two decades. Instead of capping emissions the legislation sets a “target” of 17 percent reductions by 2020. But a “target” is not a “cap” and the two terms are not interchangeable.

It would also be inaccurate to say that the legislation “would mandate emissions reductions” since firms would be able to increase emissions if they purchased off-sets. And it would be inaccurate to say that the legislation “would reduce emissions” since the reduction of the emissions is by no means guaranteed or even mandated. A more accurate way of describing the legislation as a whole (though not the “cap and trade” provision) might be that it “aims to reduce emissions” or something like that.

Most analysts agree that Waxman-Markey will establish some price on carbon, albeit one that will be highly constrained by free allowances, offsetting allowed above the cap, and the strategic reserve auctions, which explicitly limit how high the carbon price can rise. There is disagreement, however, as to a) what the carbon price would be, and b) how many emissions reductions, if any, these carbon prices would achieve. Whatever your view, these are projections based on various assumptions — the behavior of firms, the future price of low-carbon energy, the potential for efficiency and conservation, the availability of off-sets, etc. They are not guarantees of reductions.

Whatever emissions reductions result from Waxman-Markey will be determined by the various cost-containment mechanisms described above, and the non-cap provisions in the bill, not the “caps” and targets that have dominated most of the debate and press coverage of the bill since it was marked up last month.

I assume that this is something that everyone committed to an accurate description of Waxman Markey would agree with. But in case I’m missing something, I’ve cc’d NRDC and EDF staff, the lead advocates of Waxman-Markey, in case they think there is a more accurate way of describing what we are reading as a non-binding cap that would aim to reduce emissions.

Waxman-Markey  shows one thing clearly: Congress is capable of crafting a bill that is far worse than even the most pessimistic policy analyst could ever envision. There is not only “market failure” but “political failure” in the policy response, requiring the public policy community to balance the two in any policy prescription lest “analytical failure” join the other two.

“Since 1976, Enron [and predecessor company] employees have been at the forefront of developing air credit trading policies for governments and businesses…. Enron today is the largest and most sophisticated air emissions credit and allowance trading organization in the United States. Since 1990, Enron has participated in over 80 SOx allowance transactions and has also been active in establishing policies for trading NOx in the United States and carbon [dioxide] world-wide.”

- “Enron Corp.’s Participation in Air Trading,” Enron Capital & Trade Resources, November 4, 1996 (copy in files).

“If implemented, [the Kyoto Protocol] will do more to promote Enron’s business than will almost any other regulatory initiative…. The endorsement of [CO₂] emissions trading was another victory for us…. This agreement will be good for Enron stock!”

- John Palmisano (December 12, 1997) from Kyoto, Japan. Quoted in Bradley, Capitalism at Work, p. 307

“If anyone has environmental credit needs, that’s what we do. We want to be to be the clearing house to monetize available credits or to manage risk.”

- Kevin McGowan, director of coal and emissions trading, Enron Corp., (Enron Biz, November 29, 2000, copy in files)

“We are a green company, but the green stands for money.”

- Jeff Skilling, CEO, Enron Corp., quoted in Capitalism at Work, p. 310.

Enron is Exhibit A against Waxman/Markey’s cap-and-trade proposal. Enron was poised to make money coming and going by being the nation’s and the world’s largest market-maker in CO₂ permits, and the “smartest guys in the room” were ready to game and game for incremental dollars (remember California?). Enron’s business model, in retrospect, had to do with regulatory complexity, as I note in the introduction to my book Capitalism at Work. Enron gamed the highly prescriptive accounting rules (GAAP), tax system (the corporate tax division was actually a profit center as told in an exposé in the Washington Post.

And so, happy-be-it that, in the words of a Ken Lay (with Roger Sant) editorial, “Controlling Climate Change: It Is Not a Sprint, It Is a Marathon” (Energy Daily: September 1, 1998). Such a “marathon” (and although not mentioned, complexity) is what Enron wanted and needed—to make money month after month, year after year in a political-market setting.

Enron, remember, was a green ( “we want cap-and-trade”) company, but the green stood for money, as Jeff Skilling deadpanned to a perplexed coal executive who encountered a “green” Enron memo on his first day on the job. (Enron quietly got into coal in its last years.)

All this confirms the fears and disdain of uber-vocal NASA scientist James Hansen, who complains in his recent commentary,  Worshipping the Temple of Doom:

“Governments are retreating to feckless ‘cap-and-trade’, a minor tweak to business-as-usual….

“Why is this cap-and-trade temple of doom worshipped?  The 648-page cap-and-trade monstrosity that is being foisted on the U.S. Congress provides the answer.  Not a single Congressperson has read it.  They don’t need to – they just need to add more paragraphs to support their own special interests.  By the way, the Congress people do not write most of those paragraphs—they are ‘ suggested’ by people in alligator shoes.”

Enron Lives! in Waxman-Markey. The sooner the public, media, and intelligentsia realize this, the faster cap-and-trade can be put in the dustbin of bad ideas.

The current debate has proven one thing very clearly. The U.S. climate debate is not about saving the climate.* It is about regulation for its own sake in the name of “saving the climate.” This fact should give pause to everyone who really cares about human welfare. Cap-and-trade is at odds with the economic wealth needed to adapt to a future that cannot be centrally planned by politicos.

* With Waxman-Markey’s aspirational goal of an 83% reduction of U.S. emissions of greenhouse gas emissions by 2050 reversing out only about 3 percent of the human influence on climate (according to IPCC model projections), equating to about 0.09°F, this is an insurance policy with virtually no redemption value.