I've often said that carbon credits only apply to the marginal.  Those systems clearly cost effective do not have certain additionality.  Most cost prohibitive systems are still cost prohibitive with carbon credits.  The margin is thin and uninspiring.

If Duke reduces coal power demand with residential hot water collectors, clotheslines, swirl light bulbs, attached greenhouses with Trombe walls, cogeneration displacing carbon fuels, and public promotion to not use electricity then how do output-based GHG carrots and sticks play a role?  Where does Roger's fiduciary responsibilities lie with regards to these low hanging fruits?  Carbon tax (by any other name) does not need to be complicated.

but I think I follow you.

My research background with market solutions is with water quality - so I've been extrapolating most of my knowledge of those systems to try and join the debate on carbon policies.  In water quality cases, we want a mass cap, so at first I didn't understand why that doesn't work as well for carbon dioxide.

I wasn't convinced the first time I read through this, but now it's starting to make sense to me.  I think I agree, but I'm going to have to give it more thought before I can add anything useful.

I'll comment later. But what you are essentially talking about is regulatory additionality. While we have disagreements, this is an important point. Regulatory additionality is much easier to monitor and enforce than additionality compared to what-if scenarios. I will add that you are also talking about giving away 100% of permits, which has a number of problems. Yes the people they are given to will sell any they don't use. But what you have is an initial giveaway and allocation. As much as I hate to agree with Adam, it has nothing to do with offsets.

One thing I'm really curious about. What do you mean by "output" once you leave the electricity generation field. You are allocating initial permissible emissions in ratio to some output. In electricity it is per kWh. OK - whatever disagreements I might have that is certainly clear. If we agree or disagree it is obvious what we are discussing.

But how do you decide the allocations for a cement plant? For a computer chip factory? Both have substantial emissions. Are you allocating per dollar of output? So emissions allowance would rise if prices did? Or are you talking emissions per thermal unit generated for use in industrial processes? Cause that is really input, not output. Or what? Note that this a question, not a debating point. I really don't see how you do this.

You're right about 3, but this issue is innate to any carbon scheme, in the sense that you have to come up with some fair way to quantify the carbon impacts of biomass.  (And not just corn-based biofuels, but also closed vs. open loop considerations, landfill gas, MSW incineration, etc.)  Whether a tax, cap & trade or output-system, some regulatory entity has to figure out how to address those issues.

Do note though that in a market-wide system, the carbon impacts of the fertilizer would be factored into the fertilizer cost and don't need to be re-ascribed to the fuels.  (As I propose above, this would comprise thermal use, and be paid by the fertilizer mfr.)  Soil carbon and sustainable harvest would still need to be addressed, but no more than in other models.

I don't think I'm talking about giving away any permits.  I'm simply suggesting that we set acceptable level of tons per unit of output and then  mandate financial settlements on either side.  Those who over-emit must buy down to the level and those who under-emit get paid.  

I suppose one could make the case that the person who is emitting >0, but less than the ton/unit level got an allocation, but I'm not sure that matters in this case, because the net impact is to drive investment towards stuff that is cleaner than average, thereby driving down the average and thereby driving down total atmospheric GHGs.  (As compared to an allowance in a more traditional cap & trade model, which creates a cash windfall to anyone with the good fortune to be grandfathered and gives them an artificial advantage relative to new cleaner - but not carbon-free - power.)

Great question - and the one I slipperily dodged with respect to thermal.  Here's the short version:

With electric, as you note, it's easy to measure output, since there is a spinning meter registering kWh.  

With thermal, by contrast, you have very good metering on the input side (your fuel bill), but little on the output side (Btus to serve some purpose.)  Ironically, if all we did was encourage metering, we'd induce massive efficiency - as we've found in all the industrial energy projects we've done.  (Aside: energy managers are typically responsible for operating industrial energy assets, and perhaps for buying fuel, but do not then "bill" the other side of the operation for useful Btu production.  One of the ways that third-party outsourcing of energy assets creates value is simply by slapping on meters, which suddenly make it obvious where plants need to be tightened up.  We have found instances where industrials were quite literally throwing away millions of dollars worth of natural gas a year due to bad metering.  Buttoning those up is perhaps the fastest payback GHG reduction out there - in many cases, instant.)

So here's the general thought on how to address: the vast majority of fuel combustion devices that are used to generate thermal energy (furnaces, boilers, heaters, etc.) operate within a fairly narrow band of efficiencies - the best can approach 90% conversion efficiency and the worst are in the range of 65%, with the majority clustering around 75%.  This means that for every 100 Btus of fuel burned, the typical industrial gets 75 Btus of useful energy.

So here's the idea: you simply stipulate the low end of the range - for the sake of argument, let's say 70%, and calculate thermal based on fuel purchase and a 70% efficiency.  Then add a trap door that says that if a thermal user can provide an independent technical analysis indicating that they are operating above this level, they can - subject to regulatory review - use that # for their conversion efficiency.  By picking a low number, you give everyone an incentive to start metering (which, for the reasons described above, is a good idea in and of itself).  And if people decide they don't want to go through the effort of metering, you've at least ensured that you're on the conservative end of things.

(And as a practical matter, one could fairly easily envision a gov't review of existing equipment populations to verify the 70% number as the starting point.)

One last note: key to this (and lost in most GHG inventories) is that all fuel that is burned for reasons other than transportation or electricity generation is burned for thermal uses.  It might be to heat bldgs, boil water, sterlize autoclaves, fuse metals or induce chemical reactions - but it's all thermal.  Note also that in most of those processes, you can install metering.  But in others (for example, the coke you add to iron to make steel), you have to either rely on theoretical calculations of efficiency or else use my stipulated method.  In all cases though, the key is to get to output.

Good question on negawatts.  The idea behind the output based standard though is that you regulate the carbon at the point where it is released.  So long as the regulatory model covers the electric, thermal and transportation sectors, you have 100% coverage.  The fact that someone downstream then installs a more efficient lightbulb is then separable, and can lie outside of the GHG regulatory structure.  

Note though that per this model, carbon intensive energy becomes more expensive, giving greater incentives to chase negawatts precisely in those areas where a negawatt has the maximum carbon-reduction.

That said, there are benefits from energy efficiency that are greater than GHG impacts, and I certainly wouldn't argue that one shouldn't install CFLs just because your electricity comes from a solar panel.  But in the interests of keeping the regulation as focused as possible, I'd suggest that those non-carbon issues are best encouraged through non-carbon policies, rather than trying to trap all good things in a GHG bill.

Just to be clear - on thermal end: the allocation is emissions per BTU for thermal uses? You get so many emissions free for each BTU you generate? If your emissions per BTU are lower than that you have permits to sell? If your emissions per BTU are higher than that you have to buy permits from someone?

Fair restatement? Still not understanding you properly?

Yes, the calculation is per delivered Btu for thermal uses.  

Let me guesstimate some numbers to show an example.  Natural gas when burned emits something like 130 lbs of CO2 per MMBtu.  Coal emits something on the order of 200.  Oil in between.  So I will presume we do an audit of all the fuel used for thermal purposes (easy to do, but I haven't done it) and we determine that the average thermal fuel used as a carbon signature of 150 lbs/MMBtu of fuel burned.  Which means that at our 70% stipulated efficiency, we have a output standard with the midpoint (allowance, if you will) of 150 / 0.7 = 214 lbs/MMBtu of delivered, useful energy.

Now let's say that you have a coal boiler at your factory, consuming 350,000 MMBtus/yr (about the coal demand for a midsize college steam plant).            This means that you are allowed to emit:

350,000 x 0.7 x 214 = 23,782 metric tons of CO2 per year.  (I'm leaving out the lbs to metric tons conversion, but hopefully you're following me.)

Your actual emissions are:

350,000 x 200 = 31,752 metric tons/yr

And therefore you must buy the excess from someone else with credits to sell - from folks who are on the other side of that metric.

To get to a point where you have credits to sell, you have to pursue either low/zero carbon fuels and/or greater energy efficiency.  (Note also that if you cogenerate, you immediately get more "denominator" from a single fuel source, thus rewarding that particular flavor of efficiency.)

Hopefully I did my math right... Make sense?

I think you miss my point.  There are a near infinite number of approaches one could take to meet our shared goals of reducing CO2 emissions - such is the nature of human ingenuity.  Legislation that rewards anything other than the ultimate goal - e.g., people who reduce CO2 by any means necessary - is, by definition finite, and therefore stands in opposition to maximally reducing GHGs as fast as possible.

A silly example: if you want people to jump up and down, pay them a buck every time they jump.  This will encourage a lot of up and downing.  If, on the other hand, we seek to encourage jumping up and down by paying anyone who jumps up and down on a pogo stick, we may encourage jumping - but we've also driven capital dollars towards pogo sticks and away from trampolines, bouncy castles and plain old sneakers.  

I don't mean to be flippant, but hope my point is illustrative.  The goal is not to deploy geothermal, solar and wind: it is to lower carbon. Selectively encouraging an incomplete subset of technologies towards that goal is what I meant when I referred to winner-picking - our challenge is too great not to make sure that we have every possible horse in the race.

OK Sean, so two (maybe last) questions.

1) I assume allocations are based on initial delivered BTUs, and don't change as they do.

Suppose I have a factory making tomato paste. A certain number of delivered BTUs are needed for this purpose. Now suppose instead of delivering these BTUs  more efficiently or supplying them from a solar source I switch to a filtering system that uses many, many fewer BTUS. Because the few remaining BTUs I need are low temperature ones, deliverd by a boiler designed to produce high temperatures, those deliverable BTUs may even be produced less effficiently. But the new system uses so much less heat that I still reduce my emissions by 90%. In other words, I am not producing BTUs more efficiently, but I am producing tomato paste more efficiently. Presumably I still have allowances based on my old usage, so now have emission credits to sell. My allowance did  not get lowered when I reduced the number of BTUs I needed. True?

2)On the other hand if my factory uses a filtering rather than heating to reduce tomatoes to tomato paste to begin with, my allowances are based on the actual number of BTUs I use. So if Fred down the road makes tomato paste by the more old fashioned means, and uses more BTUs, he gets more initial allowances than I do, because he uses lots of BTUs , and I use only a few. That is true even though the end product is the same - tomato paste. Allowances are allocated based on delivered BTUs, not on products those BTUs help create. True?

I think I may have confused things.  

The calculation that determines whether you are a buyer or seller is a function of your useful energy production, not your input energy.  The reason why my math included input energy was simply because - at present - very few boilers calculate output energy.  Fuel meters are ubiquitous, but steam meters aren't.  This can be fixed - but not overnight.  Thus my idea to stipulate a low efficiency that gives folks an incentive to prove that they are more efficient and install meters... but the operative structure throughout is delivered Btus of useful energy, just as on the electric side where the operative structure is output kWh.

Now back to your question.  If I change my process such that I need fewer Btus, then I realize a benefit by virtue of the fact that I'm buying less fuel, independent of carbon pricing.  If I had an inefficient/high carbon boiler, I would realize an additive savings from the fact that I now don't have to buy as many carbon credits either.  If I had an efficient/low carbon boiler, then maybe I don't get to sell as many credits back, but I don't think that's worth losing too much sleep over.  (Even without GHG pricing, someone with an 80% efficient boiler has less economic incentive to keep their plant insulated than one with a 60% efficient boiler, but that's a purely academic issue, and certainly wouldn't argue for providing added incentives to the efficient guy.)

On your last point about "initial allowances", I think I may have misled you.  This structure has no "starting gate" allowance such as in a cap & trade w/allowance model.  It simply sets a national (global?) standard for tons/MWh and tons/Btu, compels all who combust fuel to provide annual metering and evidence that they have bought/sold as appropriate to get to the output-based standard and then lets the market take care of the rest.  And, per the structure outlined above with annual corrections for total GHG emissions (necessary to impose a cap within this structure) and/or annual re-averaging to slowly ratchet down the tons/output metric, I would expect the tons/output value to be re-set each year.  

Now let's look at your example with Tomato Gar and Tomato Fred.  If, in year 1, Gar is below the standard and Fred is above, then Gar gets to sell carbon reductions and Fred must buy.  Now suppose in year 2 that Gar installs a filtering device so he doesn't have to run his boiler as hard.  On his annual meter, he shows that his Btu production fell and his carbon emissions fell as well.  If Gar's tons/Btu is still below the standard, Gar still gets to sell, but doesn't have quite as many to sell.  (On the other hand, you're saving $ on fuel.)  Fred, meanwhile, still has to buy the same amount, unless he has done something to change his process - or, to the degree that the standard was recalibrated in that year, a slightly different amount, but there is no economic gift given to Fred by virtue of his initial condition.  All emitters must meet the same standard in any given year, either by lowering their emissions or paying someone else to lower their's.  If you start with a high carbon intensity, you have more to pay.  Start low and you have more to sell.  This is key to the whole structure, that all tons are priced equivalently, and everyone has the same incentive to lower their emissions.  No gifts.

Clear as mud?

Where did you get your US GHG data from? Because you've completed excluded one of the biggest emitters of all: agriculture. All those cows and pigs and chickens at CAFOs produce a lot of methane, through enteric fermentation and then the subsequent anaerobic decay of their manure.

Your output-based standard seems reasonable for certain sectors where data is easily trackable and available (a point that you acknowledge). I like the idea.

The beauty of the Kyoto carbon offset market is this: it transfers money, skills, technology and ideas to the developing world in a novel, win-win format. Most of these CDM projects would have never occurred without carbon credits, and CDM does a great job of introducing new technologies to countries that would otherwise suffer without them (due to prohibitive costs and skills-barriers). Project developers in the industrialized world like the revenues and entryways into developing countries that offsets provide; the public, and most project owners at large likes the sexiness of carbon offsets.

Developing countries don't have caps or regulations on their industrial and agricultural gas emissions. Maybe they might in the future (and that, too, might be limited to India and China and no other developing country), but for your output-standard idea to work, it'll still require huge capital costs that offsets help to meet. You won't see as much technology-transfer and skills-transfers to the developing world through your output-based system, because it will be just as expensive (if not more, due to trade laws, importation of western technology, taxes, customs issues, etc.) to develop an output project in Mexico as it would in Belgium or any other developed country. There has to be some kind of market for offsets to encourage clean development in countries that don't have access to capital or have difficult, restrictive importation laws.

OK so the process is dynamic. Everybody gets an annual emission allocation based on useful BTUs delivered. So Tomato paste Gar who with a filtering system that uses very few BTUs, who produces those few BTUs inefficiently has to buy permits. Tomato Paste Fred who uses a lot of BTUs, but produces them very efficiently has permits to sell.

What's the problem?  With or without a carbon price, you have an incentive to be Tomato Paste Gar because of the resulting fuel savings, and it would take some pretty implausible numbers to get to a point where the carbon pricing paid under this scenario comes anywhere close to the benefits of burning less fuel.

I think some math is in order.   A northern CA tomato canner has a peak steam need during canning season of something like 100,000 lbs/hr, which is about 100 MMBtu/hr.  They run full bore for about 4 months of the year, and then essentially shut down, giving them an annual delivered Btu demand of 100 x 24 x 30 x 4 = 288,000 MMBtu/yr.  And if we assume that they currently have an 80% efficient steam boiler, that's 288,000 / 0.8 = 360,000 MMBtu of fuel per year.  At 130 lbs/MMBtu (assuming natural gas - this is CA, after all), that means that this facility is emitting 21,228 metric tons of CO2 per year.

Now let's look at how the model would apply to them.  Per my illustrative math above, the output based standard is set at 214 lbs/MMBtu of delivered energy.  The actual emissions of this facility is:

[21,288 x 2205 lbs/tonne] / 288,000 = 163 lbs/MMBtu.  So they are a net seller, by virtue of the fact that their emissions are lower than the national average and our system incentivizes people to steadily lower the average emissions.  Their total credit is:

(214 - 163) x 288,000 = 6,661 tonnes/year.

For the sake of argument, let's assume current gas prices of $10/MMBtu and presume that they can find a GHG buyer at $15/tonne.  Their annual energy cost for this plant is therefore:

$10/MMBtu x 360,000 MMBtu/yr = $3.6 million
minus $15/tonne x 6,661 t/y = $99,918
equals $3.5 million per year in net energy costs.

Now let's look at Tomato Gar.  He has found a way to use only half as much steam per tomato, but his facility is otherwise identical, so he needs 144,000 MMBtu/yr.  But he's got a lousy boiler - call it 50% efficient.  A total dog.  That means he needs to buy:

144,000 / 50% = 288,000 MMBtu/yr of fuel

which emits:

288,000 x 130 = 16,982 metric tonnes/year

or, 260 lbs/MMBtu of useful energy.  He is thus required to buy offsets, to the tune of:

(260 - 214) x 144,000 = 3,004 tonnes/yr

At the same gas and carbon pricing, this gives us net energy costs of:

288,000 MMBtu/yr x $10 = $2.88 million
plus 3,004 tonnes/yr x $15 = $45,069.
equals $2.92 million in net energy costs.

Thus, your process has an operating cost advantage against Fred's, for the simple reason that benefits from avoiding fuel costs are well in excess of the differential cost for your inefficiency.   (And this is with really extreme numbers.  I've seen horrendous boilers in my life, but I'm not sure I've ever seen one under 65%.)  Note also that if you were to install a boiler as efficient as Fred's, you'd save both carbon and fuel, giving you an added (carbon) incentive to do the right thing.  Meanwhile, Fred has gotten a little bit of a gain from the fact that he put in an efficient boiler, but he's still sucking wind economically against your plant, so he's got an incentive to follow your lead and cut total Btu use.

I think these incentives are precisely aligned, for the simple reason that it prices the carbon when it is used.  What happens after that point is subject to separate economic considerations.

I'm taking all this as a yes. This is exactly what happens. Fred & Gar both produce the same amount of tomato paste. Fred uses many times more BTUs than Gar to produce that same amount of Tomato paste. But because he produces those BTUs more efficiently Fred has extra permits to sell, Gar has to buy permits. this is true even though Gar produces many fewer emissions then Fred. I will post on a number of issues you have raised, including this later.

Sean, correct me if I'm wrong, but for all practical purposes I'm pretty sure that this idea is- to take your electricity sector example- the equivalent of 1)capping CO2 economy wide at 2,393 million metric tons; 2)allocating .6 permits to every generator per MWh.  The solar plants would be able to just sell all their credits, and coal plants would have to buy credits enough to balance out the extent to which their actual production is over the .6 average.  It works out just like you described.

I see a minor difference - that credit allocation would have to be by MWh produced last year, or capacity times capacity factor currently or something, obviously you can't allocate a priori based on FY2009 production in 2008.  But this is a very minor difference - the real fundamental of trading rights to get to that .6 (or w/e you set the average to) is completely the same.

So question 1 is do you see a major difference that I'm missing here?  If you don't, then I would take issue with the idea that the best thing to do with those credits is allocate them to industry, even on an output basis (which admittedly if you must do it is the way to do it).  Also, if you acknowledge that its fundamentally the same as cap with allocation by output, then I think the straightforward cap is better because you can bring industrial heating and transportation under the same cap, making it more inter-sector neutral in finding the lowest cost reductions.  

If 80% of the reductions under an economy wide cap would come from the electric power sector (which most models say they would), then why mandate equal reductions for electric power and industrial heating?  You're mandating more expensive reductions.  Or if you are going to have to set different levels for different sectors, you're opening up a real can of worms politically with making that fair.

But I'll stop here and first let you answer whether or not you see a substantial difference here.  Maybe I'm missing something.  

Let me try to take these in order:

...that credit allocation would have to be by MWh produced last year, or capacity times capacity factor currently or something, obviously you can't allocate a priori based on FY2009 production in 2008.

That's right.  And as a practical matter, you do an algebraic true up each year, not on MWh, but on actual CO2 emissions in the given year.  Otherwise, you lose the integrity of the cap.  

I would take issue with the idea that the best thing to do with those credits is allocate them to industry

I'm not sure I understand your point, but the critical point here isn't that industry is deemed worthy, but rather that the optimal point of regulation is at the point of emissions release.  It's a point that is as obvious as it is rare in the CO2 trading space.  At the point where fuel is burned to release CO2, the emitter has a choice to change fuels, invest in different capital or any of a suite of other options, both good and bad.  In other words, it's the point where behavior can be shifted.  Too much GHG policy is instead focused on penalizing upstream sources (LNG imports, petroleum refining, etc.) who really have no other options than the status quo.  An owner of a gas boiler can switch to biogas - but an LNG importer cannot retrofit her capital to accomodate biogas input.  Too much GHG policy is also focused on rewarding activities downstream of the emissions release (lightbulbs, etc.) which are certainly positive in their own right, but one step removed from carbon issues.  A GHG policy ultimately must transparently regulate GHG release  such that all tons are equivalently priced - and if it includes mandates for end use efficiency, it confuses that, as there is no easy way to differentially incent end-use efficiency downstream of a coal plant relative to the same technology downstream of a gas plant.

So at core, it's not about placing incentives and/or penalties on industrials; it's about placing incentives and penalties on the point of CO2 release.  Which is predominantly in power plants and industrial boilers, but we ought not confuse cause and effect.

Also, if you acknowledge that its fundamentally the same as cap with allocation by output, then I think the straightforward cap is better because you can bring industrial heating and transportation under the same cap, making it more inter-sector neutral in finding the lowest cost reductions

I don't quite understand what you're suggesting well enough to say whether I agree or disagree.  But the problem with residential (not industrial) heating and transportation is ubiquitous to all GHG plans: namely, that (a) the combustion devices are poorly metered, and so numerous as to be problematic to regulate and (b) they all have very low annual capacity factors, making their annual capital costs dominated by capital recovery rather than fuel costs.  In my mind, this latter issue is the most important, as it means that any price on carbon set in other markets will be too low to drive behavior in those sectors.  This probably means that the optimum regulatory approach is on the equipment side, whether through mandates (e.g., "all air conditioners must have a COP of X or better") or incentives.  This gets disconnected from carbon, but is probably a better tool to incent behavior - and is equally true in any GHG regulatory scheme.  Even if you choose to stick a carbon tax on the fuel, you're still stuck with that basic economic calculus.

If 80% of the reductions under an economy wide cap would come from the electric power sector (which most models say they would), then why mandate equal reductions for electric power and industrial heating

That's not what an output-based standard does.  It doesn't do any sectoral mandates - it simply forces us to acknowledge that a ton reduced in one sector has the same value as a ton reduced in another.  The reason to make sure this is done is because there are so many massive opportunities to drive up overall efficiency with combined heat and power - but if tons of CO2 associated with thermal generation are not given an equivalent value to those associated with electric generation, you will end up artificially biasing capital deployment.  (Note that this is precisely the problem that is currently bedeviling the folks in CA, who have crafted AB32 in a way that provides differential incentives in thermal & electric.)

Sean, instead of responding to all your points, I want to back up a bit because I don't think either of us really seems to understand the other right now.  So I'd like to get back to the real thrust of my question:

For all practical purposes I'm pretty sure that this idea is- to take your electricity sector example- the equivalent of 1)capping CO2 economy wide at 2,393 million metric tons; 2)allocating .6 permits to every generator per MWh.  The solar plants would be able to just sell all their credits, and coal plants would have to buy credits enough to balance out the extent to which their actual production is over the .6 average.  It works out just like you described.

I'd first like to know if you'd agree that this is essentially what your plan does.  Then I'd be happy to continue the discussion on inter-sectoral neutrality, point of regulation (upstream vs downstream), etc.  But first I want to make sure we're talking about the same plan.  

Yes.  

Sean, in response to my saying I didn't think giving these permits to industry was the best use, you wrote:

"the critical point here isn't that industry is deemed worthy, but rather that the optimal point of regulation is at the point of emissions release.  ...At the point where fuel is burned to release CO2, the emitter has a choice to change fuels, invest in different capital or any of a suite of other options, both good and bad...  Too much GHG policy is instead focused on penalizing upstream sources (LNG imports, petroleum refining, etc.) who really have no other options than the status quo.

You're definitely right that the point is not who is deemed "worthy."  But pragmatically, requiring credits be submitted upstream (for some fuels, namely oil and nat gas - its not done for coal b/c coal is almost exclusively used in power plants, which have emissions monitoring equipment) is just far more convenient.  It's easier to get credits from 20 major importers than however many millions of cars or households, or even businesses.  And this requirement doesn't "penalize" the upstream sources.  Those costs get passed along.  No one doubts that the actual reductions happen downstream.  But those reductions are still incentivized with upstream regulation because the cost of that pollution gets internalized to everyone who buys from those who are regulated (e.g. everyone when upstream is regulated) by the cost premium passed along on emissions-intensive fuels.  This actually then makes it harder to game the system or slip through the cracks.

The other point is I think more important.  Prices would still rise.  The grid as a whole will still be overwhelmingly carbon intensive in the near term, steadily declining but still fairly so for a while.  This is inevitable unless you set a draconian cap. The wholesale price of electricity is then going to be set at the price where fossil fuels + cost premium = renewables - benefit from permit sale.  This is going to inevitably be above our current prices, which are basically set by fossil fuels without that cost premium.  

Cost increases for fossil fuels will be offset with cost decreases for renewables, but this is not to say price increases for fossil fuels will be offset by price decreases from renewables.  They'll sell at the clearing price as well and pocket the difference.  So I'm a bit wary of your creating such a cap with no consumer assistance for inevitable higher prices.  Though admittedly there are some very bad ways to design consumer assistance (like L-W) but there are some good ways as well.

Also, to the extent that your program gives an extra permit per extra MWh sold, I'm afraid its losing the neutrality we both prize because this puts end-use efficiency (home appliances, etc) at a disadvantage, by incentivizing build build build, sell sell sell.  This comes with associated costs of course of new transmission, load imbalance, reliability, etc - you know more about this than I do.

I think your program is a great way to get more capital in the hands of the firms that will need it to invest in the solutions we need.  That's important.  But its not the whole goal, and I'm afraid this as a standalone program thus fails to take account of other issues.  To the extent that some "transition assistance" or other cash/permits thrown to companies might be politically necessary, it would definitely be better to have it output based than fuel or historical pollution based.  But in striving for fuel neutrality I think you've deincentivized (at the risk of sounding like Amory Lovins, whom many gristers probably know I'm not such a fan of) negawatts.  And not included consumer assistance which will still be necessary.  Those are my two main issues.

On the upstream/downstream, perhaps monitoring per se isn't necessarily infeasible because of the 50,000 monitored point sources.  But I would still be suspicious of enforcement then, and trust a system that demands compliance (and so checking the books) of only a handful instead.  Maybe I'm wrong, but that's how I see it.  As a political point its also worth noting that since cap/trade is criticized as being complicated anyway, it definitely seems like an easier sale to do it upstream then downstream where so many more sources would have to do more to comply than just be more efficient with their fuel.  Lots of taxes go unpaid because the IRS can't audit everyone.  That's a waste of money, sure, but if you have carbon fuel being traded unaccounted for slipping through without permits, then that's a real problem, more than just lost revenue.  

On the extent to which those costs get passed through, I would first note that energy demand is way more inelastic than plane tickets.  Your point about the PUC's interfering with utilities is a good one, but I think represents a(nother) instance of needed regulatory reform, not an inherent problem with cap/trade.  States know that regardless of whether price increases represent deep underlying issues that don't represent current policy or not, they (as elected representatives) will be held accountable.  So there's definitely a conflict of interest in terms of their desire to artificially keep prices low, even if its inefficient.  

You say significantly high energy prices would be really bad for the economy and we have to pursue the most cost effective solution.  I think by now you know I completely agree with that.  I just disagree that your plan is the most cost-effective.  If you don't give away all the permits, you have more than enough revenue to offset the price increases on both consumers and firms (though not in certain 'affected industries,' but unfortunately a degree of attrition in some of these is necessary to achieve the reductions).  Your plan transfers all the permits, without completely containing prices, though admittedly it would some.  But you could get that degree of effective price mitigation other ways, and have funds left over for advanced energy research, which unlike deployment of current technology, a carbon policy shouldn't just rely on the private sector for.  

Finally I never suggested some sort of alternate way of incentivizing end-use efficiency.  My point was only that you relatively disincentivize it by using all the revenue to incentivize building new capacity.  You qualify my little new cost equation that it only has renewables.  Fine, I should have written "clean generation" instead, but the point still stands.  The prices still rise with no consumer relief, and limited to renewables or not (and we'd both agree not) you're strictly  incentivizing additional capacity.  That inherently is a relative disincentive for end use efficiency, because they're direct competitors.  Its the same point you make on how guaranteed capital recovery, accelerated depreciation scheduling, etc for certain new generation sources under current regulations relatively disincentivizes CHP.

A few responses:

I wouldn't underestimate the political complexity of changing utility regulation.  I completely agree with you that it needs to be changed, but it has 100 years of regulatory and judicial history.  I've been personally and quixotically trying to get that changed for the last decade!  And it's a mess of federal and state policies that require lots of jurisdictions to move concurrently and in mutually reinforcing ways.  I'm not saying it shouldn't be priority one of any energy policy - just that from a practical perspective, we ought to assume a fairly significant time constant on the reform, at least insofar as we are crafting GHG policies that are contingent thereon.  By all means, let's shoot to reform it quicker - let's just not depend on it.

We probably disagree about whether carbon funds should be used for things not directly related to carbon reduction.  Clearly, the government as a role to play in funding R&D.  But in order for a ton of increase to have the same price as a ton of decrease (but for the sign change), you need to link buyers and sellers.  If instead the proceeds are distributed out to various actors, including but not limited to those who would immediately act to reduce CO2 emissions, you effectively place a higher value on a ton of reduction in one venue than another.  (e.g., the existing coal plant that doesn't produce avoids a cost of /ton.  But the new solar plant that is relying on carbon payment to finance gets </ton, since some portion of the total number of receipts was paid out to other entities who are not directly engaged in the reduction of GHG emissions.)  This is the ultimate cost-effective test for a carbon policy: the cost of a ton.  Many other social, technical and energy programs warrant government support - but if we use proceeds of a carbon policy to provide that support, the carbon policy is no longer a low-cost way to lower carbon.  It is reminiscent of a conversation I had many years ago with the headmaster of a private school, who essentially said that as much as there is a certain moral discomfort that comes from being a part of a system that provides better education only to the wealthiest kids, the problem is the system.  As he put it, a private school has one agenda: getting kids prepared for college.  A public school by contrast has many competing agendas, including not just college but also busing, special ed., curricula mandates driven by school board politics, conforming to government nutritional guidelines, teachers union negotiations, etc.  All of which are independently noble, but which conspire to divert resources away from education. This, writ large is the problem with any carbon bill that seeks to do 15 things well.  The central  conceit of an output based standard is that it aims only to do one thing well: quickly and cheaply reduce GHG emissions.

Finally, re: compliance, you're certainly right about the audit trail.  But is it really any different than all the M&V that goes into certifying REC credits?  Or from the audit trail required for corporate financial filings?  Are these audit systems perfect?  Of course not.  But they are largely workable systems to assemble and independently verify data that is more voluminous and way more complicated than what we're talking about here: all an OPS needs is fuel records and good energy meters.  Compare that to the deep dive that accountants must do on accounts recievable, journal entries, capital depreciation schedules, etc. to sign off on the financial books of any given company and the challenge of audit compliance for a carbon policy is trivial.

I definitely hear you on hoping for the best but planning for the worst, at least for the foreseeable future, on utility regulations.  I have to admit I feel like most of the complications and jurisdictional overlaps, or gaps, in how we regulate electricity in this country are beyond me.  I really wish I knew more about it (and if you happen to know of good book on it that would be great).  I do assume though that FERC, or at least Congress, could preempt/prevent PUC's from mandating that permits allocated to electricity plants be used to artificially depress price increases (tho Lieberman Warner recommended they do exactly that, perversely).  The question though is would they.    

I think the real place we disagree is illustrated by your point that: "But in order for a ton of increase to have the same price as a ton of decrease (but for the sign change), you need to link buyers and sellers."

It sorta goes with your insistence that a price on carbon alone is a stick without a carrot.  I think this thinking in general misses the point.  Because demand for electricity is so inelastic, and most consumers are served by vertically integrated monopolies, you have these companies with a basically captive market.  People will be stuck paying whatever rates they get, which is why we regulate them so heavily (although obviously not always intelligently), and people will be stuck still needing (and consuming) the product (kwhs) more than most.  The issue then for any energy policy is relative economics.  To what extent does it rearrange investment appeal among the menu of options technically available to encourage the demand be met sustainably, factoring in carbon pollution.  To that extent a carrot and a stick are a distinction without a difference.

I'm afraid it might seem that I'm arguing back to where your point is - that a ton of carbon should cost the same whether its a + or a -.  But the thing is, I don't think your coverage then extends "full" coverage so much as its double coverage.  There is significant demand already for electricity in this country.  To the extent that any policy prices polluting sources out of the market for meeting that demand and recovering costs, that is guaranteed market share for clean sources.  It's like a free market feed in tariff.  And all the costs incurred by the fossil fuel generators, even the ones that do stay in business, serve to raise the wholesale price of electricity, which is a further benefit to the investment appeal for clean generation.

But what's inescapable in both our plans is that the nominal cost of electricity will raise.  This is why I prefer keeping a substantial portion of the money for consumer assistance, to lower the effective price increase.  Meaning price increases occur in both our plans, but consumers can better afford it in mine, meaning less economic disruption, which we both agree is important.  You're spending the money on doubling down an incentive that already exists without that extra spending.  So aside from the perversity of    inadvertently disincentivizing negawatts, its just not the best use of the money.

Technology research is one of my other programs, and I have very few.  Consumer assistance (lump sum, not graduated like a tax cut), corporate tax cuts to free up capital for firms to invest (which yours does by just giving them all the permits), and technology research.  And the research really is key for a few reasons.  First, you can't try and mess with the market to prevent price increases per unit of a good if you're not decreasing the carbon intensity of that good, or you can but it does more harm than good (like I wrote in the oped).  So research allows you to develop ways to fundamentally lower the carbon intensity of certain goods, which is the only way to lower the actual bills (along with conservation/efficiency).  

Second, the flood of capital in the private sector will quite naturally go to the low hanging fruit.  That's good and rational, but we need to start now to ensure that the price of additional reductions doesn't spike unreasonably once those are picked.  Like I've written before, the entire electricity sector is low hanging fruit, relatively speaking.  We need better batteries to bring the transportation sector under that roof to keep those national emissions reductions going without having to turn to a more complicated/expensive means of reductions, just to give one example.  The cap itself compels deployment of today's solutions, but it still underdeploys research for tomorrow's, because that creates benefits that no one company can capture.   That's why the public sector has to be involved.  

Your program seems really appealing at first, and I grant its better than L-W.  But when you realize how this really works out, that trading to get around that .6 average is really a cap with full allocation by production, you run into some unintended consequences that compel me at least to conclude we could use the permits better.

wow, so much for brevity.

Sean Caston wrote: the new solar plant that is relying on carbon payment to finance

A special carbon payment to a low-carbon plant would add up to a double-subsidy for that plant, if carbon emission is already taxed. A  tax on one's competition is also a latent subsidy for oneself. There is no intrinsic need to subsidize the low-carbon plants twice, Sean, by adding discrete subsidy to their existing latent subsidy. Either the latent-subsidy they receive is high-enough to allow them to compete, or the carbon-tax needs to be higher.

Hey Sean, on the subject of electricity regulation, there's something I don't understand that companies don't do on their own.  Everyone complains about the uniform rates during the day, despite different marginal costs of producing electricity (more expensive sources get fired up to meet peak load).  As I'm reading, I see that EPAct 2005 mandated that utilities craft a graduated rate schedule to be available to customers if they ask.  Why should customers have to ask?  Isn't it clearly in the utilities' interest as well to have their customers shift some of their consumption to when the utility can provide it for at less cost to themselves?  I don't understand why the free market didn't implement this long ago on its own.  And PUC's don't prevent them.  Or do they?

PS nucbuddy, its Sean Casten, not Caston.

I still think you're missing the implicit carrot.  You write:

"If we mandate a carbon price on those utilities and don't provide customers with the freedom to generate their own electricity and/or otherwise bypass the grid - e.g., we simply keep the status quo - then stipulating that the carbon price imposed on the utility will be fully reflected in the retail rate for power is implicitly stipulating that regulated utilities - who are, after all, the source of the carbon - should not be asked to bear any of the costs of carbon compliance.  Follow the math:  

   1. Pre GHG policy: Costs + profit = price
   2. Post GHG policy: Costs + G + profit = price + G (where G is the cost of GHG pollution).  "

What you're missing is a 3. Post GHG policy for clean generation (renewables, chp, w/e): Costs (w/o G) + profit = price + G

So adapting your equation actually lets me prove my point better, that even in the situation you argue doesn't have enough of a carrot - look, there is one.  Dirty generation still has to factor in adding the G to its costs, while clean energy doesn't.  So there's the full difference of G of the incentive of extra cash that the utility can keep, if it deploys clean generation to meet demand (and will still keep the +G price premium!) instead of dirty energy.  That full difference of G between clean and dirty production is the definition of internalizing the cost of carbon.

Finally, you write that cutting carbon doesn't have to result in price increases.  I agree with you to an extent, maybe entirely.  But I'm drawing a distinction between what cuts COSTS and what cuts PRICES.  They're not always equal.  And when you introduce these permits into the market, no permit will be retired to make a kwh unless the generator can recover (in higher prices) enough additional revenue to compensate it for forgoing the revenue it could have made by just selling the permit.  That's an inescapable fact, especially since the grid will continue to be carbon intensive to some degree for a while.  So we definitely want to promote clean generation and efficiency, but I see your full allocation as an unnecessary doubling of the price differential to sorta stronghand your way to what could way more efficiently be done by just changing regulation.  

Again I know, changing the regulation is easier said than done.  But I'm not quite ready to concede that the alternative must be to exaggerate the economics so much that they have no choice, perverse regulation be damned, but to take that cogen.

In fact, it might easily still not accomplish that because the utility would have such a windfall of capital from these permits it would very likely choose to invest it all in building its own clean generation, instead of contracting out.  And then it still falls prey to being strongly disincentivized against the CHP.  But even if you're right, remember this whole discussion started over how to not pick winners.  Now you're talking about doubling the price of carbon (which is essentially what you do - make a 2G difference instead of a G difference between clean and dirty), and still while the government takes in no revenue.  And all to (just maybe) strongarm the system enough to adopt CHP.  Which again I don't even necessarily concede.  Those utilities would rather take that money and build wind/solar and pocket the extra credits themselves.  It doesn't really address the underlying problem of differential treatment, unless you change the regulatory problems you have today.  Which unfortunately I get may be a long time coming.

Your point three implicitly assumes that there is a single clearing price for power which everyone pays and has access to, such that the utility increase in price by G naturally creates profit for us clean guys in the form of G.  That's the way ideal markets work.  It's not the way utility markets work.

First, let's take a simple case where you install a solar panel on your roof.  You don't export to the grid, but you reduce your power purchases.  To the extent that the utility commission decided that the financial rights of utility shareholders to their dividends trumped the rights of their consumers to cheaper energy (and to the extent that those costs are passed along equally to all customers - which is dubious), G is fully reflected in your cost, and your savings against retail rates theoretically increase by G and your math holds up.  But those are two big extents.  And in fact, it's even trickier, because your electric bill typically consists of three elements: a fixed, $/month charge, an energy $/kWh charge and a demand $/peak kW charge.  The G math only applies if the rate is restructured so as to apply to the energy charge.  If it falls onto the monthly demand charge, your solar panel hasn't had any impact on savings.  And if it goes onto the $/kW charge but the solar panel doesn't operate during the relevant coincident peak (which typically happens in mid-afternoon, after the solar peak), you're going to get <100% of G back.

Now let's look at a case where you are exporting to the grid - a "merchant" case in the jargon of the trade.  No retail rate displacement, just the sale of power onto a grid.  The price you can get on the grid is a function of all the diverse generators on the grid.  Which means that credit you get as a zero-carbon generator is diluted by whatever average stuff is on the grid (e.g., the hydro, the nuke, the gas and the coal) and the degree to which those resources can pass those prices along.  As a new generator, you need to get a price that is sufficient not only to recover your variable costs, but also to earn an acceptable level of capital recovery.  But that old dirty coal plant operating at the end of the line will run so long as they can recover their variable costs, giving them much more flexibility.  Again, your revenue realization is inevitably less than G.

Now let's take a hybrid case.  You put a cogen plant in your factory, displace all of your purchased power and export the rest to the grid.  Your displacement ends up being subject to the same limitations as in case 1.  But your export price is essentially set by the utility, who - given their monopoly franchise - can more or less pay you whatever they want.  If they really need you, they'll pay you a lot.  If they don't, they'll offer you a sufficiently low rate to penalize you for daring to take their customer away.  Again, your incremental revenue is <G, approaching 0.<p> It's precisely because of this that the system needs a carrot = G.  2G doesn't exist outside of theory.

Sean, I certainly buy that there's regulatory issues preventing the efficient pass through of variable costs (which would include permit costs, which are a function of production and fuel type) to encourage optimum consumption.  But I'm not sold that your plan really fixes this.  You do say that there will be ample opportunity for bilateral agreements between customers at the load for onsite generation and the utilities.  But there are now as well.  If I've learned anything from you in all my gristing its that.  

So when you break it down your program is giving away tons of capital to sources based on output, net assets for some and net liabilities for others (with the cap requirement).  But everyone at first has lots and lots of capital.  Like you have said, utilities get money by spending money, not by saving money, because of their fixed rate of return.  So what makes the utility suddenly want to contract with a customer for on site generation to reduce the utility's operating expenditures (permit requirement) which you point out they rarely have any incentive to do, when they could instead seek permission (and inevitably get it) to build a solar/wind farm or nuc plant, or install their own CHP on their coal plant, and get a fixed rate of return on it.  

In essence you're really just throwing a lot of capital into the system.  Which is important in enabling solutions, but I think you overestimate the extent to which it is incentivizing smarter ones.  Its tricky and people make this mistake all the time in understanding the incidence of where permit revenues really end up and what (if anything) they actually encourage.  The answer is not always, in fact rarely is, intuitive.

So I get the distinct impression that your last post is a problem for both of us.  And that we're both stuck trying to institute some sort of regulatory reform.  If its any encouragement though, right now its mostly an environmental problem of excess pollution from wasting dirty fuel.  If you price carbon, without smart solutions like regulatory reform for low hanging fruit, prices will go up.  A couple well timed washington post/nytimes articles to expose the nonsense will be a lot bigger news and generate a lot more political support and pressure behind it, once its an issue of preventing people from getting fleeced on this price hike, instead of a (largely) environmental issue.  The world is not all grist.  Wasting dollars is a much more captivating public outcry than wasteful emissions.

Thomas Edison's plant was 6% efficient.  But he also recovered thermal energy, driving his overall efficiency up to about 50% - although the metering of the thermal output was a heck of a lot spottier and less well documented than the electric side.  A situation that has only slightly improved in the ensuing 100 years, I might add...

With respect to your second point, you need to be careful not to confuse the first and second laws of thermodynamics - it is a point that many a trained engineer does (and many a CHP developer uses to earn profits at the expense of engineers who think they know better).  Many years ago, I had an engineer at Columbia University assure me that the project I was proposing to them - which would have achieved an 80% overall fuel-to-electric conversion efficiency - violated the laws of thermodynamics.  His exact line to me was "you're lying."  And in the heat of the moment - and my youth - I didn't have a good response to him.  But I did go on over the subsequent 5 years to put essentially the same project in at a number of Columbia's competitors.  So thbbpt.

Here's the crux of the math:

Let's start with a facility that needs A units of electricity and B units of heat.  They buy A off the grid and produce B in their boiler.  The grid averages something like 33% efficiency, and their boiler about 80%, so the total primary energy use associated with their demand is

A / 0.33 + B / 0.8

Now suppose they put in a thermally matched cogen plant, sized to produce 100% of their thermal load (always the best way to size a cogen plant for maximum overall efficiency).  We'll assume a gas turbine, with a nominal heat rate of 10,000 Btu/kWh.  (Recall that there are 3413 Btus in a kWh, so this implies a generator fuel-to-electric efficiency of 3413/10000, or 34.13%.)

Per the first law, all the energy that goes into the gas turbine comes out as heat in the exhaust (I'm ignoring the minor losses in bearings and generator windings, ads they only add up to a few percent, but you can adjust my math if you'd like to include).  That means that there is a total of (10,000 - 3,413 = 6,587) Btus of heat in the exhaust per kWh of power generated.  Heat transfer considerations mean that not all of that is recoverable, but you can generally get 70 - 80% of it back as steam.  Let's say 70% to be conservative.  So they now have a cogen plant that is consuming 10,000 Btus of fuel per delivered kWh and producing 1 kWh (or 3,413 Btus of electricity, if you prefer) and 70% x 6587 = 4,611 Btus of steam.

What's their efficiency?  The simple answer is to add the two up: [3413 + 4611] / 10,000 = 80.24% efficiency.  Not bad.  But not accurate either.  Because look at what's actually happening to the fuel consumption at this facility.  Those units of heat that are recovered as steam are displacing their need to buy fuel - and they need to buy 100 units of fuel for every 80 units of steam, per our boiler efficiency assumption above.  Thus, the net impact on fuel use at this facility is an increase in gas use (for the gas turbine) of 10,000 Btus/kWh minus an avoided fuel use in their boiler of 4,611 / 0.8 = 5,763 Btus per kWh of generation.  So the net impact of the cogen plant is to increase gas consumption at the facility by (10,000 - 5,763) = 4,237 Btus for every kWh they generate, for an actual net fuel-to-electric efficiency of 3413/4237 = 80.6%.

It sounds like all sorts of laws are being violated, but recall that Carnot only applies to work cycles - and much of our output here is as heat rather than work.  But from an economic perspective, this plant will run so long as their marginal electric rate is >1/.806 of their gas price, which is the same as if this actually was a 80.6% power only power plant.

And note also that the net global impact is that every 80.6% efficient kWh they generate displaces a 33% efficient kWh off the grid.  So to your question - no, there is no way that this leads to a reduction in overall efficiency.

I'll let Sean Casten answer more fully if he wants, but  

thermal efficiency means the percentage of heat that's successfully converted to electricity.  When Sean talks about efficiency he means the percentage of heat that's converted to dollars, which means either sold as electricity or heat.  So while plants used to be less thermally efficient (less electricity per heat) they sold some of the excess heat so they still got more dollars per heat.  We don't do that anymore so much.

Second, even if homes need less and less heat over time, theres always gonna be heavy industries running huge furnaces.  Glass, steel, w/e.  So there's pretty much always gonna be a market for that heat.  Plus I think it would generally be more economic to sell the heat to a couple large industrial buyers than to 100 houses anyway.  And the industrial buyers are more likely to be nearby than the houses because of land use ordinances.

Sean (and Max), is decoupling a sufficient regulatory reform to remove some of the barriers you guys are talking about? (I imagine the devil's in the details, of course.)

Because there does seem to be some nascent but growing political momentum behind decoupling. It finds a modest place in lots of the climate and energy bills flying around. Maybe it could be a wedge to open up a space for larger regulatory reform?

grist.org

Sort of.  In theory, decoupling takes the negative incentive away from a utility to conserve energy.  But it doesn't necessarily create any positive incentive, in the sense that it does not allow a utility to increase their profits if they conserve costs (such as is the case in any other business).  There are some interesting ideas of ways to address this, but they are in their infancy.  

Note also that decoupling simply changes the way that utility revenue requirements are converted into rates.  But it doesn't change the fact that utility revenue requirements are still set based on a commissioner's judgment about the prudency of utility capital investment.  The upshot is that in an ideal world, decoupling removes the incentive for a utility to block conservation during the period between rate cases.  But it does not take away their incentive to get expensive capital deployed - and deployed by their shareholders - in rate cases.  Because any MW of load served by someone other than a utility - no matter how efficient, and how decoupled they may be - is a capital investment that the utility is not allowed to recover through rate base, and therefore a potential dividend they won't be able to distribute to shareholders.

Bottom line: within the context of the current regulatory paradigm, it's an improvement.  But it doesn't address the fundamental problems with the paradigm.  To fix this, you really have to address the fundamental concept that utility returns are sacrosanct.  And, by extension, that socialism is a valid economic model.  Because when you strip everything away, modern utility regulation is about as anti-capitalist a model as there is.  5 smart dudes get together once every 5 years to review demand forecasts, set supply, allocate capital and set prices.  If it sounds like a perfect analogue of a Stalin-era economic model, it's because it is.  Decoupling simply adds another tool for the 5 smart dudes to play with, but doesn't question the innate fallibility of the 5 smart dudes, nor the power of markets - and the risk of bankruptcy - to more efficiently set supply and price.

I take your criticism about unintended consequences.  But note that the basic framing in which buyers and sellers come together to trade a ton of CO2 at a known price is no different from any other market - and I'm guessing none of which would be subject to this level of consternation.  If I want to buy a parcel of land, I pay someone who owns land a mutually acceptable price and I end up owning the land.  I now have P fewer dollars than I had before, and the previous owner has P more dollars than they had before.  So yeah, there's a 2P difference between us.  But now I've got land, which has value of P to me, and so we're net even.

There is no difference with carbon pricing, other than the fact that - prior to the mandated transaction - we have failed to monetize it's release.  But going forward, the coal plant wants CO2 credit and I have one to sell them.  We agree on a price and they get an asset (which I no longer have available to sell) and I get some money.  How I use that money and how they pass those costs along in their rates is secondary.  But the important thing is that we have created an incentive to deploy capital that lowers GHG emissions.  The rest is details.  

Note though that it's not about giving away tons of capital to anyone: it's simply about mandating a transaction that didn't used to exist.  It does create a wealth transfer from the dirty to the clean, but there is no net increase or decrease in public or private coffers.  (This is in contrast to carbon taxes and cap & trade which do indeed create net financial shifts that are purely an artifact of their structure.)

Your 2P example is not really relevant to my 2G number, I think you're mixing up transactions.  Under my system I could say a nat gas plant, which may have permits it bought or was allocated for any reason, increases its efficiency in some way.  So now it sells a permit, and it has P extra dollars and the coal plant that bought it has P less, and so the difference is 2P.  Note this is totally separate from any consideration of your output based system, so I don't think your example quite captures my criticism of the 2G thing, which was separate and was unique to your system.  But we might have to just agree to disagree on this, we've been rehashing this point for a while and I don't think either one of us seems to be budging.  Although it has been really interesting and certainly educational at parts for me.

Your second paragraph also is not specific to your plan as opposed to mine, so I definitely agree but don't think it really proves your point.    

On the third paragraph, I think you still miss a bit how this would play out when you distinguish it from a cap and trade.  This was why once upon a time I started this thread by asking if you'd agree it was fundamentally a cap and trade with full allocation by production, and the answer I got was yes.  I would just return to that here, when you say you're not allocating capital, you're just mandating transactions, even tho it ends up in a wealth transfer from the dirty to the clean.  Its more than that, because by imposing the liability that all must get to that .6 (which is the equivalent of a cap mandating you have a permit for every ton of emissions), you are making the "cleanliness" of the clean sources itself valuable capital.  Which is the point, but in doing so and allowing it to contract out that cleanliness, whether you want to call it offsets, allowances, or bilateral contracts, it is a cap and trade, with certain consequences for how you use the permits, and certain consequences (like higher prices) that are inevitable just by letting such permits on the market at all(via the opportunity cost thing I've mentioned a few times).  

I would just finish then with reiterating what was the main point of my last question, that I still don't think I saw an answer to.  How does your program actually incentivize utilities to behave more rationally and contract for new power at the load or cogen?  This is the main benefit you attribute to it, as I gather from our discussion.  But doing that would represent reducing operating/variable costs, which just get passed through anyway so they have no incentive to save.  But using the permits/capital/bilateral-cleanliness-contracting-rights to build its own major capital expenditure in clean generation would allow a utility to profit at its prescribed rate of return.  I don't see how your program fixes this fundamental problem.  It definitely offers an incentive to install clean power somewhere, but it doesn't avoid the fact that regulations make utilities prefer to make that big investment themselves rather than outsource it for efficient savings.  Like you said, utilities make money by spending money, not saving money.

Two last brief things - first, that Southern Company joke was great, I'm gonna have to borrow that.  Also, I actually stumbled across that article of yours you linked above a while ago.  As a prelaw student interested in energy policy, needless to say it was right up my alley and really fascinating.    

David, you mentioned that decoupling is gaining some support in climate bills.  The only bill I know really well is L-W (and B-L-W), and the way it encouraged decoupling was by having a pool of allowances that would be given to the states, according to certain criteria.  The criteria were to be developed by the EPA to rank states according to how well they lead on reducing emissions. Decoupling was specifically prescribed as an indicator to be used in appropriating out of this pot.  The allocation for the states changed a bit from L-W to B-L-W but this pretty much encapsulates how they both did it, I believe.  If not exactly like this (maybe decoupling wasn't an indicator for this pot) the bill definitely had the feds dangle credits to entice states to take regulatory action for decoupling that had to be taken on the state level (ie FERC couldn't do unilaterally, for reasons Sean can explain far better than I can).

So this is where I thank you, David, because this has given me my last ditch effort to try and entice Sean to the dark side.  

Sean, it seems we pretty much at least agree that the fundamental problem is on certain fairly ubiquitous PUC regs, that aren't worth going through again.  You maintain that your output based plan sidesteps them somewhat, which I'm not sure I buy, but I look forward to a clarification on that. Meanwhile, I now propose to set aside some portion of credits (we can haggle over the exact number later) for states to transition however they deem fit (helping affected workers, investing in new infrastructure/technology, w/e), but that states would only even be eligible for in the first place if they adopted certain specific utility regulatory reforms.    

Thanks for the link.  I definitely agree the devil is in the details, which is why I think the lack of details on decoupling is one of the rare things L-W got right.  As I understand our system of government, the way that section would be implemented (which just says states get a piece of a 2% pot of allowances if they adopt "decoupling" with almost no elaboration) would be: 1) the EPA would put out a notice of proposed rulemaking on exactly what constitutes decoupling.  2) Everyone would get to comment, the EPA would refine its decision, and through the magic of bureaucracy, 3) we have a detailed definition of what kinds of state regs qualify as adequate decoupling, written by people far more expert than Congressmen (or even their staff).  I don't think its as simple as since the law just says decoupling, anyone who does anything can make their case to the Court that that's enough.  But I could be wrong.

And yea, I definitely hear that decoupling is easier said than done.  I often hear people say 'we need to decouple,' and ask them what they mean.  "Well, y'know, change the regulations so the big energy companies don't make more money by selling more energy."  When you ask what kind of a business model would encourage that, without some sort of perverse unintended consequence (like your example of moving to a flat monthly rate, which encourages consumers to waste), well, the point is easier said than done.  

But some of the regulatory problems would be much easier fixes if there was the political will.  And having a pot of money to grab at can motivate some serious political will.  So what do you say Sean, cross over and I'll throw you a pot of 7% of the credits just for states that offer equivalent capital financing and cost recovery for any source of meeting demand, across fuels. And a tie-breaker qualitative preference for demand met at the load if projected costs come up equal between that project and a new centralized power plant.    

I think you're right that we seem to be talking around each other without reaching any clear resolution.  Either I'm not understanding your algebra or you're not understanding mine.  And since I'm of purest intent and mathematically infallible, the problem must be simply one of you understanding my math!

One more effort to try and clarify, because I do think you have some innate assumptions in your logic that may be creating the conflict:

You continue to believe that this transfer increases the price of energy, but that is not necessarily the case.  Company X's costs per MWh go up to accomodate the tons they need to buy.  Company Y's costs per MWh go down to reflect the tons they got to sell.  When you net that out on the system, the total cost per MWh as perceived by the customer (averaged across all MWh) doesn't necessarily change.  (There is admittedly a bit of unknowable algebra relating to the weighted average MWh sold and bought above the line, since one could have a lot of dollars going to very clean MWh thus increasing the $/MWh, or vice versa.  But I see no reason why this is more likely to be directionally up than down, especially given the massive amount of lower cost, low-carbon generation that is waiting for a more rational energy policy to be deployed.)

Your idea about leaving set asides for transition assistance is morally noble, but note that it has the effect of guaranteeing that the net impact of a carbon policy will be to raise the cost of energy, effectively reinforcing the problem it's trying to solve.  Let's take one extreme where all carbon sources are taxed and the proceeds are used to fund methadone clinics (just to pick something completely unrelated to GHG emissions).  This clearly raises the cost of energy.  Now let's take another extreme where all low/zero carbon generation is given a payment from the feds, funded out of income taxes (but the dirty guys get neither penalty nor reward).  This clearly lowers the price of energy.  Both extremes are economically irresponsible, in the sense that they are stealing from Peter to pay Paul, but the directional math should be obvious.  The only way you eliminate the Peter/Paul issues is to link buyers and sellers, such that all payments and reciepts are directly linked to actual tons of GHG.  Maybe that's not politically possible - but as soon as you start setting aside any fraction of the proceeds for uses other than the direct and quantifiable reduction in GHG emissions, you are leaning towards the first example above and increasing energy costs.

Your question about incentivizing utilities is orthogonal to the goal.  Whether or not we incentivize utilities to behave more responsibly is a tactic, but it doesn't trump the larger goal of reducing CO2 emissions.  This is a pretty critical point, and one that is lost on regulators as well.  If the universe of ways we have to lower electric-sector related CO2 emissions are bounded by the universe of what utilities can do under current law, we are shooting ourselves in the foot.  We didn't get overnight mail based on the innovations at the postal service.  We didn't expose the high costs innate to our hub & spoke airline system based on the innovations at TWA.  We didn't get cell phones based on the innovations at Ma Bell.  And we won't get the kind of innovation that our electric sector desperately needs within the conservative cultures of electric monopolies.  Thus, the question really needs to be reframed as "how does a GHG bill incentivize investments in low-carbon generation sources?"  Who builds the generation is irrelevant.  Whether or not utilities remain solvent is irrelevant.  (Does anyone give a damn that Pan Am went bankrupt?)  By giving industrials and developers a fiscal incentive to build clean energy plants, an output-based standard does that.  But go through Lieberman-Warner and try to find any way for those same industrials and developers to see a dime worth of revenue for the same project - you won't find it.  And you also won't find it in most of the other ideas being put forth, from carbon taxes to cap & dividend that all presume that if you just slap a penalty on the existing dirty folks, magical good things will happen.  

You give EPA (or any other federal bureaucracy) a hell of a lot more credit than I do to get the details right.  Policies that are contingent upon the review of comments from interested parties inevitably become driven by the loudest, most well funded voices - not some benign search for the truth.  More cynically, there's an old saying that regulators are only as smart as their lobbyists allow them to be - and the most well-funded lobbyists are by definition those who represent the status quo, since the new guys haven't yet had enough financial success to hire their own team.  (Which leads to another DC aphorism that "losers always cry louder than winners cheer".)  

Bottom line: you have to have the key details in the enabling legislation.  Not all of them, but make damn sure that the important ones are there to make sure that when the federal agencies get down to writing the enabling regulations, there is no confusion about the "will of the congress" on the important issues.

Superb material. I am really impressed with your thought processes. You need to somehow get this injected into the political process. I would send a copy of the entire thing to both the McCain and Obama campaigns. It's better thought out than anything I have read to date. Simple, concise, and I think correct on the key points.

Victory in Pattani

(I'll number my paragraphs in response to your numbers)

1)You write: "Company X's costs per MWh go up to accomodate the tons they need to buy.  Company Y's costs per MWh go down to reflect the tons they got to sell.  When you net that out on the system, the total cost per MWh as perceived by the customer (averaged across all MWh) doesn't necessarily change."

I keep trying to draw the distinction between costs and prices, although obviously I haven't done a very good job since you keep making this point.  But the economic literature is very clear that if you allocate allowances, though they keep DOWN COSTS, they result in windfall profits and so still HIGHER PRICES (sorry for the obnoxious caps, I'm new to the blogging thing and not html savvy).  

Take the example of the EU ETS.  Though they allocated allowances differently, the point translates.  Because they could have made the same point (and they did) that the costs of purchasing a credit would be more than offset by the allocations of the credits to cover those costs.  But this cost offset does not eliminate the price increase, it just lead to windfall profits.  The price increase is a fundamental result of having these credits on the market, no matter who you give them to or how (at least in the scope of our discussion), because of the opportunity cost thing that I won't go into detail again here, but its unavoidable.  I really urge you to talk to an environmental economist if you still disagree.  Ask him/her if full allocation based on production will eliminate price increases, and maybe they can explain it better.      

Your write that in your plan "all payments and reciepts are directly linked to actual tons of GHG."  That's just as true in mine.  Even with government auction there will be trading, and even if there wasn't you see a fundamental change where  there is none in whether that allowance is bought from the government or a wind farm or my grandma.  

You write "By giving industrials and developers a fiscal incentive to build clean energy plants, an output-based standard does that.  But go through Lieberman-Warner and try to find any way for those same industrials and developers to see a dime worth of revenue for the same project - you won't find it...presume that if you just slap a penalty on the existing dirty folks, magical good things will happen."  

Sean, this is how L-W does it (though imperfectly), and how I would do it (perfectly of course).  It 1) raises the price of electricity (which raises the investment appeal of clean generation) while 2) Imposing additional costs on dirty generation per unit of pollution, such that the dirtiest forms of generation today are disadvantaged in terms of investment appeal, even despite the higher energy prices.  Note this relative disadvantage for dirty energy provides more market share and more demand for clean energy.  3) Provides lots of funds directly to consumers to allow them to afford the higher costs (all analysis shows there is more than enough money to do this, with plenty left over if you don't give all the credits away like you do), which also prevents greater economic disruption. 4) Provides (less, but still significant) firms with funds (corporate tax cut, or potentially a very very scaled down version of your allocation by production) to provide firms with the capital to pursue the now very appealing investments in clean generation.  Also 5) for my plan (tho not L-W) I encourage the more equitable (and efficient) capital treatment by state PUC's with the 7% pot they're only eligible for if they take my (really your) advice on certain simple needed reforms, which state politicians will have no choice but to go for.
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Sean, wouldn't Coke's sales go up if Pepsi was priced out of the market?  This point holds even more true for the energy market with carbon pricing.

I think we're both being a little selective.  I'm saying lobbyists undermine Congressional language so better to leave it to EPA.  You're saying lobbyists undermine EPA rulemaking so better leave it to Congress.  Clearly we both agree that if you could get perfect language, even some key details right, in the bill or the CFR that would be great.  I'm just pointing out that its hard to get good points like that in a bill without the bill's managers being compelled to throw an expensive bone to some lobbyist (though you make the same valid point about the federal agency).  

But if you get it wrong in the bill, EPA's hands are tied and it has to be written wrong.  If you're vague, its all on EPA and I would be more confident in that venue for two because this would no longer be just an environmental issue.  In a Carbon constrained economy if you allow wasteful carbon emissions its a very real economic impact on everyone in the country.  This allows the forces crying for it to be more sensible get more mainstream support.  In general though, I'm sure you've been involved in far more political action than I have, so I'm not gonna press this point much at all if you still disagree.    

I'm not arguing about the impact of allowances in the EU ETS or any other system, but really talking about a totally different structure.  Follow a simple example:

Company A sells dirty 1000 MWh of dirty power for $30/MWh.

Company B sells 1000 MWh of clean power for $40/MWh.

We will stipulate that the total societal load for power is served by these two companies.  Ergo, society spends $70,000 for 2000 MWh of power at an average price of $35/MWh.

Now let's add an output based standard.  Company A is forced to buy credits from Company B.  Let's arbitrarily say those credits work out to $15/MWh.  Company A now has a $15/MWh higher cost which - if they can pass that cost along in ther price means that they will now sell 1000 MWh for $45/MWh.  Company B now has $15/MWh of additional revenue which - if they choose to pass that revenue along to their customers means that they can now sell 1000 units of power for $25/MWh.

We have created an investment these for clean power and induced more clean sources to enter the market.  But the net societal cost for power remains $70,000 for 2000 units, or $35/MWh.

I certainly take your point that Company B may choose not to pass along this revenue to their customers, instead keeping the profit margin for their shareholders.  (Hell, I would if I could too.)  If competitive pressures allow them to pocket the change, they will.  But the same pressures apply to Company A, wherein competitive pressures may or may not allow them to pass their increased costs along to their customers.  It's your point about allowances, but including the inverse to recognize that you have cash carrots and sticks instead of just having sticks as is the case in the EU ETS and L-W.

This isn't a point where I disagree with environmental economists - but one where the environmental economists haven't really looked at, because they tend to assume that all you ever need is a higher cost on the carbon sources that will magically lead to higher prices.  Which per, your point, isn't necessarily true.  That's the problem that the OPS is seeking to address.

Sean, wouldn't Coke's sales go up if Pepsi was priced out of the market?  This point holds even more true for the energy market with carbon pricing.

Of course, but I think you're contradicting your own logic.  We both agree that an increase in costs don't necessarily translate into an increase in price.  And in this example, Coke's sales don't increase because Pepsi's costs go up.  They increase because Pepsi's price goes up.

That's precisely the problem with L-W and carbon tax models.  We conflate costs and prices at our peril.  My ability to sell a clean-energy project to one of my customers is based on the perceived economic value that project will create relative to the alternative source of supply.  And if my competitor has absorbed some or all of their cost increase rather than pass them all along in a price increase, then I haven't seen any change in my value proposition, or at least not one that is proportional to the increase in carbon costs imposed on the dirty competition.  

You may just have to trust me on this one - we spent a lot of time looking at Lieberman-Warner for coldly financial reasons, trying to figure out if it would have any change in our ability to deploy capital.  (Recognize that our corporate mission is to profitably reduce GHG emissions - we won't do any project that doesn't meet both of those tests.  So in theory, any GHG bill ought to create additional value for our investors.)  And the answer is that L-W doesn't do a damned thing to change our investment thesis, at least in the near term.  Nor do carbon taxes, nor cap & dividends, nor any other structure that presumes that cost increases will magically translate into price increases.  

I'm not suggesting of course that society has any obligation to my shareholders.  But a GHG policy that fails to incent capital deployment in GHG reduction is - to be quite blunt - a piece of crap, not worth the paper it's written on, much less the time it took to write it.  Maybe, in the way off distant future, dirty-power shareholders get tired of bearing the costs of carbon compliance and convince managers to raise their rates.  But it's neither immediate nor guaranteed.  And we don't have the time to dawdle around waiting for costs to slowly translate into prices before we start investing serious capital to get the GHG concentrations down.

First, I guarantee you plenty of environmental economists have indeed thought about allocation by production - actual or capacity.  Sean you're a reputable guy, call up a Harvard or MIT environmental economist who works on carbon trading and ask if full output based allocation cap and trade will eliminate price increases.  I guarantee you'll get "no," and hopefully I guess better explained than I've been able to.  Its been a bit humbling for me, 'cause I could have sworn I've hit on the key points.

You say "We conflate costs and prices at our peril."  I agree.  The point I keep making is that you keep telling me how your plan prevents COST increases, but my point (and seemingly yours) is that that doesn't mean it will prevent PRICE increases.  While the ETS allocates allowances differently (more by politics than production) they made the very same point about not incurring additional costs, and yet still saw prices go up.  Your plan is not fundamentally different in that respect.  

Here's one reason I think L-W would have helped your business.  Emissions from a coal plant are basically a product of how much coal they burn.  Merchant coal plants may see no reason currently to invest in CHP or cogen because the penalty for wasting all that heat is just buying more coal.  And coal is cheap (maybe not the plant but the rock), so its not worth the capital expenditure to save some of that wasted coal.  A cap and trade will nominally would reduce the price of coal because of reduced demand, but a better way of thinking about it's effect on coal plants is that it raises the price of coal.  This is because burning a ton of coal comes with an automatic additional cost (that of retiring an allowance) that for practical reasons you can just consider as part of the "actual" price of coal. The EIA, in their model of L-W, found that coal will triple in price by 2020 (varies a bit between cases but this is pretty middle of the road, and I think their most reasonable case based on assumptions - HC) if you consider it this way.  So the increased effective variable/fuel cost of a coal plant from a cap/trade makes your cogen/chp look good, because it lets them get more heat/kwh/$ without spending more on "fuel" (fuel+allowances).  And again, that "fuel" cost isn't significant now but is under a cap/trade.      

I'll now work from your example.  The thing is its not just Company A and Company B.  Its very many Company A's (selling dirty power) and very few Company B's, though they will gradually increase.  But again, the point is the grid will remain overwhelmingly carbon intensive for near future.  This is important, because your plan demands everyone get to the average, (.6) not 0.  Which you couldn't get anyway.  So if the grid is going to still be very carbon intensive for the foreseeable future, the wholesale price is going to be set by the price they sell at.  And that price will include the market rate for a credit for every kwh they sell, because if they retire a credit to make electricity without raising the price, they are not serving their shareholders.  Because they could have not sold that kwh, lost MR but saved MC (which are equal at the margin of production), and instead also gained revenue from selling the credit.  

So the very many credits you're giving to fossil fuel generators lower their costs, but not their price increase.  And since its a carbon-intensive grid still, that sets the market rate for electricity.  You write:

"Company B now has $15/MWh of additional revenue which - if they choose to pass that revenue along to their customers means that they can now sell 1000 units of power for $25/MWh."

But Sean, if the price of electricity has gone up for all carbon-intensive (which is most) generators (even allowing for plenty to shut down), why would Company B possibly sell so low below the going market rate?  You're a businessman.  Is that "rational" in the economic sense?  If you did that are you serving your board?

I still think you thought of this all as transactions without realizing the market impacts of making these transactions binding under force of law (to get to that .6).  You've made the "cleanness" of clean energy a marketable commodity, which dirty generators also have, though to a lesser degree.  This is cap and trade with full allocation, albeit by production.  The price ramifications are unavoidable, as I've tried to explain.  You may lessen them a bit longterm by spurring so much investment in clean generation (because of the windfalls which dont help prices short term), but my plan does that without giving away all the credits from the cap by investing in research directly.

And since I'm afraid we're gonna end up going in a circle with your pointing out generators won't all act rationally because of regulations, I'd again repeat your plan suffers that consequence too.  Regulated utilities would rather spend a new massive capital investment to meet the cap (and earn their rate of return) than contract with your company B, lower operating expenditures and earn no rate of return.  But at least my plan can help fix this by enticing states to get their regulatory act together.

Your plan really is just a cap, and then throwing all the revenue into the market as capital.  CBO director Peter Orszag has said as much - "Allocation to industry is the same as auctioning all allowances, and then giving them the revenue from the sales."  But don't take my word for it (haha though I have been trying to get you to for two days now), give someone a call who has a bit more credibility than me.  And ask if cap/trade with full allocation by production (which you've admitted this is) would prevent price increases.  Otherwise I guess we'll just wait for the empirical evidence on who's right when you're king and do it by fiat.    

I don't dispute your long-term view of how carbon pricing eventually raises the cost of power from coal.  Unfortunately, "eventually" doesn't do much to incentivize investment.  I have to go first to a customer and then to a board to convince them that the value I will create from a zero-carbon power plant is in excess of the current retail power rate.  Neither of those conversations is very long, nor do either get to a point where it changes the investment thesis.  

Take the customer conversation, and let's assume for the sake of argument that I need $45/MWh to earn the level of returns necessary to justify a capital investment.  (This is hardly a big number - US average rates are approaching $90.  Typical industrial rates are around $60.  Typical industrial rates in the coal belt - the place we'd most like to change the generation mix - are on the order of $30 - 50.)  Most other zero-carbon power sources - solar, nuke, wind, etc. - are all going to require well over $100/MWh once you factor in capital recovery.

Customer: "I'm currently paying $40/MWh for power.  If you can sell me power for less, I might consider signing a long-term contract with you."

Me: "Yes, but your utility generates high-carbon power. Mine is low."

Customer: "Tell me why that matters"

Me: "Because eventually, they will have to pass that price along in higher rates."

Customer: "So what?  Today I'm paying $40.  Lots of things might happen tomorrow, but if you want to sign a contract with me, you've got to beat $40".

So I go back to my board and try to get them to commit to an investment at $40/MWh:

Board: "Does this project give us a competitive return?"

Me: "No, but it might someday."

Board: "When?"

Me: "I don't know. It depends on how long it takes for the carbon price being borne by the coal utility to translate into rates."

Board: "How much might your revenues increase if and when that happens?"

Me: "None if my customer wants a fixed long-term contract.  But maybe I can get them to give me some upside if power prices increase substantially."

Board: "Would you agree to that if you were them?"

Me: "Absolutely not.  It's a risk they can't control.  Why should I give away my upside?"

I'm being overly socratic, but you get the jist.  Environmental economic theories notwithstanding, you don't get an investment thesis out of the L-W approach.  That might be different if we had a fully transparent market for power with multiple buyers and sellers.  But we don't.  And we won't for some time.  So we're stuck having to compete with the utility rate and the innate lag time between higher utility costs and higher utility prices - during which time you don't have any change in the investment thesis for new technologies.  It is but one of the many places where the theory of economics is grossly at odds with the practice of capital allocation.

I certainly take your point that Company B may choose not to pass along this revenue to their customers, instead keeping the profit margin for their shareholders.  (Hell, I would if I could too.)  If competitive pressures allow them to pocket the change, they will.  But the same pressures apply to Company A, wherein competitive pressures may or may not allow them to pass their increased costs along to their customers.

Sean, do you really think that if a national cap and trade program passed and every company had to pay some price for their carbon, PUC's wouldn't adjust allowed rates?  That would, for a lot of coal plants, mandate they operate below even variable costs (because of the added carbon cost premium on the coal).  This to me seems unlikely.  But, even if you disagree, this is why I tried to preempt you with this:

"And since I'm afraid we're gonna end up going in a circle with your pointing out generators won't all act rationally because of regulations, I'd again repeat your plan suffers that consequence too.  Regulated utilities would rather spend a new massive capital investment on clean power (and earn their rate of return) than contract with your company B, lower operating expenditures and earn no rate of return.  But at least my plan can help fix this by enticing states to get their regulatory act together."

So it doesn't actually incentivize those wonderfully efficient transactions you keep attributing to it.  And in fact you compound the build build build mentality of utilities enshrined in our current regulatory model, because you incentivize new production by giving cash (credits are a marketable commodity, giving a $20 credit is just giving $20) for each new kwh sold.

I still haven't gotten an answer to that.

You wrote (and then repeated for me): "I certainly take your point that Company B may choose not to pass along this revenue to their customers, instead keeping the profit margin for their shareholders.  (Hell, I would if I could too.)  If competitive pressures allow them to pocket the change, they will.  But the same pressures apply to Company A, wherein competitive pressures may or may not allow them to pass their increased costs along to their customers."

But this misses the point.  The opportunity cost of retiring an allocated permit WITHOUT raising prices is AGAINST the competitive forces of the market.  Competition forces companies to use all assets to maximize profit.  If they could profit more by selling the credit than making a kwh with it, they will sell it instead.  You may argue that regulations will get in the way of this, but not competition.  And like I keep saying, to the extent regulations get in the way of my plan, they do more with yours, because at least mine comes with a powerful incentive to all states to change this regulation.    

do you really think that if a national cap and trade program passed and every company had to pay some price for their carbon, PUC's wouldn't adjust allowed rates?

Not really.  There is precedent (albeit rare) for a PUC to stipulate that returns on equity fall. They don't need to fall below zero (such as is implied by a variable price < variable cost), but even if they were to mandate a fall of a couple percentage points, it could absorb much of the cost of GHG compliance such that utilities did not increase their rates to reflect those costs, or at least not significantly so.

Note also that there is a push for precisely this behavior from the environmental community, on the not unreasonable grounds the investors who built the coal plant in the first place must bear some of the financial pain of it's environmental consequences.

Regulated utilities would rather spend a new massive capital investment on clean power (and earn their rate of return) than contract with your company B, lower operating expenditures and earn no rate of return.

You're right in a narrowly mathematical point, but  wrong operationally.  We simplify this in terms of power, but the reality of really clean power projects is that they are (a) small, relative to central plants and (b) tightly integrated into local processes, both in terms of the connection to opportunity fuels and the use of waste heat.

Because of (a), clean power really doesn't fit their model, regulations notwithstanding.  We interviewed a guy from Cinergy a year ago who had been their before and after their merger into Duke, doing lots of interesting industrial efficiency projects (including CHP, interestingly enough) and he was leaving because he said that given the size of the organization, it was clear to him that the opportunity space was all well below the level that would ever get seniors mgmt to engage and buy off.  (e.g., in a many-billion dollar company that has to meet quarterly earnings forecasts, $50 million investments that pay $5 - 10 million annuities are too small to matter.)  This isn't a regulatory issue, but a size issue.  Jack Welch said famously that GE had "fat fingers", meaning that he couldn't get down to do really neat things at a small scale.  This happens in utilities as well - and as it turns out, the majority of low-carbon power investments are in the $1 - 30MM range.  

Because of (b), even if you solved the regulatory issues and set up some sort of "skunkworks" (as Welch did at GE), you're still stuck with the fact that they don't have the skills.  Doing a project at an industrial requires intimate knowledge of the industrial process, fuel availability, their commercial constraints, their heat needs, their permitting restrictions and the overall compeitive profile of their industry.  By contrast, doing a big central power station is freakin' easy.  You get your construction permit, you get your rate approval, you get your fuel lined up and you build.  This is why even the utilities that set up unregulated arms to get into this space have failed so dramatically.  Building a local, wholly integrated energy plant that happens to generate some power has as much in common with building a central power station as building a petroleum refinery has with building a biodiesel plant.  Are there a few skills that overlap?  Sure.  But would you expect someone with expertise in the latter to do a good job at building the former?  Not remotely.

So the crux is that the utilities really can't get into this space, for reasons that are regulatory, financial and technical.  The change will have to come from without.

I'm not disagreeing with you that it's against a business' interests to reduce their price just because their cost fell.  I'm simply saying that there are multiple variables that affect price, of which cost is only one.  Every entrepreneur that's ever had a great idea (myself included) was convinced that they say an opportunity to sell a product at lower cost than their competition and would keep the marginal gain as greater profits - to your point.  And the long history of markets is that those margins gradually get whittled down again in the face of competitive pressure.  Just because a car has 300 horsepower doesn't mean you get to charge a price equal to the cost savings associated with not owning and caring for a 300 horse stable (even though the first guy to sell a car probably used something like that to set his competitive price).

And note also that this works on both sides in an OPS.  Just as the recipient of carbon-reducing credits may not be able or willing to pass all that economic gain along in lower prices, so to will the payer of those credits may not be able or willing to pass along their added costs in the form of higher prices.  Models that only put the financial transaction on one side of the ledger are implicitly taking a bet that costs and prices are linked.  Models like the OPS that put the financial transaction across that divide hedge the bet.

I would go through and respond but I'm afraid that this thread will continue indefinitely without either of us swaying the other.  And I for one have to get back to work.  This has all been a bit on borrowed time for me over the past couple days.  I still think you continue to miss the implications of your plan being a cap with full allocation, albeit by production (which is a significant but not fundamental difference for the issues- like inevitable price increases- we've been debating).  So we're just going to have to agree to disagree I guess.  

There really are a lot of environmental economists that do just this though.  The idea of giving out credits by production is not new - it was even in L-W originally (section 3902 as passed out of EPW) though only for fossil fuel plants.  Which of course is different than across the board (like yours), but the point is the idea has been around.  The crucial aspects of why free allocation doesn't prevent price increases, and why a carbon constrained economy's private sector undersupplies advanced research, still apply.  I really would encourage you to talk to one then.  If for no other reason than to practice the sales pitch for when you're king and declare this.  But you really might be surprised if some of the things you hear sound awfully familiar...

You can take the last word/post, but, unless you say something about my mom, I'll just leave it at that.

: )

You know somehow I knew that was coming.  I would say great minds think alike, except that we just spent 2 days debating a point with no real resolution.  I guess now its just a race to who gets the Crown to implement their program first (or last?)