New study sponsored by the Institute for Energy Research (IER): more junk analysis from the well-heeled oil industry

The Institute for Energy Research (IER) just released a study claiming that the American Power Act (APA), comprehensive climate and clean energy legislation released last May by Senators John Kerry and Joe Lieberman, would provide a windfall profit to America’s wealthiest households (the top 20% of income earners), at the expense of everyone else. Worse, millions of jobs would be lost.

Before proceeding with a critique of the study, it’s worth noting a couple of simple points:

• The average net cost to households (which the authors don’t present), is only $163 by 2020, far smaller than the $1,042 gross estimate they provide in the abstract. You can calculate this average from Figure 14, which provides net costs to households by income brackets. Why is the net cost so much lower than the gross? Because it accounts for the market value of pollution allowances (i.e. they don’t disappear from the economy). This disappearance trick has been used before by other obstructionists, albeit much less honestly (click here and here).
• Next to their projected costs to households, one sees no estimate of projected growth in household income. This is not surprising, since all formal modeling of climate legislation projects increases in income that greatly exceed cost. For example, next to EPA’s estimated household costs of -$7 (yes, a net gain) and $169 in 2020 (it uses two models), one can estimate growth in median household income of more than $6,000 and $10,000, respectively (for details on this calculation, as well as estimates from other non-partisan studies,click here). Surprisingly, this result is even found in studies by the opposition, though the reader must do a little work to discover it. 
• The Institute for Energy Research (IER) has heavy ties to the oil industry. It has taken money from big oil, and its president, Thomas Pyle, is a former Koch and oil-industry lobbyist. Robert Bradley, a former Enron executive, is IER’s CEO and one of its founders. One of IER's directors, Steven Hayward of the American Enterprise Institute (an outfit that also takes money from big oil) was exposed in 2007 for attempting to pay IPCC scientists to criticize the IPCC's findings on climate science.

Hopefully the above is enough information for you to stop reading here. But if you have the time and curiosity, here’s more.

The authors:

1. Want you to believe that bottom 80% of households will suffer a loss under climate legislation, while the top 20% will receive a nice profit.
2. Want you to believe that millions of jobs will be lost.
3. Want you to believe that allowance prices will be very unstable due to the transportation sector not participating in the allowance auction market (instead the transportation sector must purchase emission allowances at the price determined in the auction).

All of these results contradict findings in more objective analyses not funded by industry.

Taking each point in turn:

1. Wealthy households will not benefit at the expense of everyone else. The result that poor and middle class households will lose at the expense of the top 20% of income earners contradicts four non-partisan studies, from the Congressional Budget Office (CBO), the Environmental Protection Agency (EPA), the Massachusetts Institute of Technology (MIT), and Resources for the Future (RFF). These studies all conclude that comprehensive climate and energy legislation like APA will yield a net benefit to poor households (click here, here, here and here for the studies), and overall will be largely progressive over the income distribution. IER’s spurious result is based upon the assumption that utilities receiving free allowances will pass on all of their value to shareholders, and then raise electricity prices anyway. The authors argue that, just like energy providers in the European Union did, utilities in the U.S. will raise prices despite getting the free allowances. The authors fail to note, however, that the EU did not impose any legal requirement on utilities to pass on the value of allowances to their customers. The EU government left everything up to the utilities. In contrast, regulated utilities in the U.S., by law, would have to pass on allowance value to their customers. Public utility commissions failing to enforce this provision can be legally challenged by ratepayers.
2. The methodology used to produce job losses is not valid. The authors take an estimate of the reduction in GDP growth from EPA’s modeling and attempt to translate that into job losses. The problem with this is three-fold. First, there is no set mathematical relationship between GDP changes and changes in employment. Decreases or increases in GDP could be associated with either in jobs. This is not intuitively obvious, but nevertheless true. EPA does not attempt to translate its results into employment changes because its models are not designed to do that. Second, the authors do not actually even model climate legislation. Nowhere will you find a discussion of changes in clean energy production versus carbon intensive energy, nor any complementary policies in climate legislation that promote clean energy and energy efficiency. This is critical, because both are more labor intensive than fossil-based energy. As one would expect, studies that do examine employment changes in the electricity sector find significant job growth under climate legislation. Here’s a table summarizing two studies that look at such changes (click here for a more extensive discussion, and here and here for the original studies).

**See end of original blog for discussion of model shortcomings.

3.    Requiring refiners to purchase allowances outside of   the primary auction market will not cause price volatility. While it is true that too few auction participants can result in volatility, research has found that the number of bidders needed to prevent such volatility is not very large. Even though refinery purchases of emission allowances are handled outside the auction, there will still be plenty of participants to provide effective price discovery. Economists also know a lot about designing effective auctions; there are many mechanisms to limit price volatility. Equally important, APA has several provisions to prevent large fluctuations in allowance prices. First, there is a minimum and maximum price for allowances (both of which grow every year at a set rate after adjusting for inflation). If the minimum is reached, the government will withhold allowances from the market. If the maximum is reached, the government will sell additional allowances from a reserve. Second, polluters can bank allowances for use in the future, or borrow them from the future for current use, to satisfy compliance requirements. If the current cost of mitigation is high, compliance can be met by borrowing (with some restrictions) future year allowances. If the cost of mitigation is expected to be high in the future, investors can bank allowances for future use. These mechanisms smooth prices over time. Finally, secondary markets (trading of allowances post-auction) will increase competition and price discovery, allowing investors who worry about future compliance costs to lock in prices through futures contracts. Thus, secondary markets also smooth prices over time.

Conclusion

This new study sponsored by IER misrepresents its own estimates of household costs, mistakenly claims that rich households will benefit at the expense of other households, relies upon a methodology to estimate job impacts that is invalid, and ignores many market forces and regulatory design mechanisms that will greatly limit price volatility in carbon markets.