U.S. cap and trade plans risk European mistakes

LONDON/BRUSSELS Fri May 15, 2009 3:54pm EDT

The chimneys of Belchatow Power Station near Belchatow, the Europe's largest thermal power plant emit fumes May 7, 2009. REUTERS/Peter Andrews

The chimneys of Belchatow Power Station near Belchatow, the Europe's largest thermal power plant emit fumes May 7, 2009.

Credit: Reuters/Peter Andrews

LONDON/BRUSSELS (Reuters) - Plans by the United States to tackle climate change through a cap and trade scheme must learn from the mistakes of Europe if they are to avoid giving away multi-billion-dollar windfalls to industry.

American lawmakers are at the first stage of drafting a cap and trade scheme, in a larger climate bill which could transform how the United States produces its energy and boost the chances of agreeing a new ambitious global pact to fight climate change.

Fierce lobbying by industries and some legislators to dilute the impact on fuel bills, especially during a recession, could undermine carbon cuts, European analysts say.

"The U.S. debate is really U.S.-centered. There is so much focus on buying the 60 (Senate) votes needed, and each senator's vote that is bought comes with something attached, some type of concession for a sector or for trade unions," said Susanne Droge of the German Institute for International and Security Affairs.

The European Union scheme, launched in 2005, has struggled to shake off two early mistakes: handing out too many permits which removed the requirement to buy them, and giving them to power plants for free.

Analysts say utilities pass on the price of carbon permits to consumers regardless, making billions of euros (dollars) in windfall profits across the sector as a result.

And because there were initially too many permits the EU carbon price crashed to zero two years ago, relegating the first trading phase of the scheme from 2005-07 to an experiment.

As well as paying higher power prices under the EU scheme, industries such as metal makers, chemical plants and paper mills have their own carbon quotas, implying a double cost.

DRAFT

U.S. details are far from finalized in a process which needs approval of both houses of congress and is now only at committee stage.

The chairman of the Energy and Commerce Committee, Representative Henry Waxman, said on Thursday his panel would debate and pass the bill by the end of next week.

That would clear it for other panels to consider before a debate by the full House, probably by August.

The legislation faces more uncertainty in the Senate.

European academics implore lawmakers to resist the pressure of industry lobbyists, for example for free handouts.

So far the U.S. plans appear aware of the risks -- allocating free permits for example to the steel sector according to average emissions -- meaning if you pollute less you'll still get the same number of permits, and a surplus to sell as a reward for being clean.

The ruling Democrat plans would also avoid some of the risks of EU-style windfall profits, because in the electricity sector the permits would go to local distribution companies regulated by states which could limit how far utilities pass on costs.

"The difference between this and the EU is that they go to regulated entities that have to pass the value directly to consumers," said Tony Kreindler, spokesman for Environmental Defense Fund.

But not passing carbon costs to consumers could limit the incentive for them to trim electricity use and therefore emissions.

U.S. President Barack Obama had wanted all of the permits to be sold, but has indicated flexibility. Under the latest proposals, utilities would get free permits amounting to about 90 percent of their emissions initially.

Trade-vulnerable industries such as steel, cement and glass would also get a certain portion of free allowances.

"The whole point really is to try and set a carbon price which makes companies think carbon's going to be more costly, and the more free allowances you hand out the more diluted that signal is," said Michael Grubb, chief economist at the UK-funded Carbon Trust and chair of the Climate Strategies research group.

Another advantage of selling permits is that this raises cash for the public purse, relieving the need for carbon taxes.

But the U.S. plans may avoid a repeat of an EU-style price crash by allowing companies to "bank" surplus allowances for use through 2050, avoiding a glut in any one year, a U.S. analyst said.

(Additional reporting by Timothy Gardner in New York; writing by Gerard Wynn; editing by James Jukwey)