I believe that phasing in the auction of allowances will help the United States reach our environmental goals at the lowest possible cost to the economy and consumers. That’s a very important concept during these difficult economic times – and one that needs close attention.

Shell supports prompt federal action on climate change issues. We believe a cap-and-trade program can deliver the best environmental result at the lowest cost. But it’s important to recognize that there will be a cost. Let’s be clear – the cost to the economy and consumers will be higher with a full, immediate auction.

President Obama anticipates that a full auction will raise $645 billion in seven years. That’s nearly $100 billion a year. That money will come from the pockets of manufacturers, utilities, car companies and oil and gas companies. When people talk about “polluters” in the context of greenhouse gas emissions, it’s important to recognize that we are talking about companies that manufacture iron, steel, paper, cement, glass, rubber, chemicals and aluminum – many of our everyday items. These manufacturers will have to pass their costs on to their customers. That’s what businesses do. Utilities that use coal and energy-intensive industries (like cement and chemical companies) will be hit particularly hard. That means their customers may be hit particularly hard.

A phased-in auction buffers U.S. energy-intensive industry exposed to international competition – a full auction doesn’t. This could have significant impact on American jobs. I am concerned that with a full, immediate auction, U.S. businesses will be put at a competitive disadvantage in the global marketplace. I worry that this could prompt some companies to move their operations offshore, taking needed American jobs with them. And that could increase our already high unemployment.

I am concerned that this economic reality is getting lost in the discussion. I believe free allowances in the early years, based on a company’s current emissions, will soften the transition to a low-carbon economy for industry, business and consumers. We would still achieve the same benefit for the environment. Whether the allowances are free or auctioned doesn’t change the GHG reduction targets. President Obama has proposed some steep environmental targets with a full, immediate auction. Shell is a member of the United States Climate Action Partnership (USCAP), which has set environmental targets almost identical to the President’s. But USCAP strongly advocates the free allocation of allowances in the early years. Either approach delivers the same benefit for the environment.

A phased-in auction also encourages the deployment of key technologies critical to meeting our environmental goals. The various targets proposed by President Obama, USCAP and key leaders in Congress share a common characteristic – they are relatively shallow in the early years and become very steep in later years. USCAP’s proposal requires an 80 percent reduction in emissions by 2050, while President Obama aspires for an 83 percent reduction. To achieve those goals, we need a host of climate technologies that don’t exist today, ones that depend on aggressive investment in research and development by government and private industry. Free allowances in the early years encourage such investment. Once Congress enacts a cap-and trade-program and sets a price on carbon, American industry has a strong incentive to funnel its capital into research and development of clean energy technologies.

Finally, I believe that free allowances must be based on an accurate reporting of a company’s emissions. That was the mistake in the early years of the European Union Emission Trading Scheme. The European Union didn’t have the accurate emission data we are accumulating here in the United States and issued too many allowances resulting in a carbon price that was lower than it should have been. Shell applauds the EPA’s rule that will create a mandatory, national GHG emissions registry. Shell joined the California Climate Action Registry three years ago and The Climate Registry last year. As a result, we are required to report and third-party verify our emissions. We have done this in California for the past two years – and are doing so for all Shell U.S. emissions this year.

In sum, I think full and accurate reporting of emissions, followed by a workable cap-and-trade program and the phasing in of a full auction, is the surest path to achieving our environmental goals with the least impact on consumers and the economy.

Initiating a large-scale auction of allowances in the initial stages of a carbon cap-and-trade program violates a fundamental principle of public policy -- "Do No Direct Harm."

Even proponents recognize the auction proposal violates this policy. This is evidenced by their efforts to present elaborate ways to "undo" the direct harm that the auction would cause through poorly targeted tax rebates or other measures. However, to date, they’ve failed to provide any convincing or equitable solutions.

For example, President Obama’s budget proposal correctly points out that consumers will be harmed by increased costs. His “solution” is to recycle a portion of the auction revenue back to consumers.

This mechanism is flawed in its approach primarily because it severely penalizes consumers in the 25 states that depend on coal for more than 50 percent of their electricity. Those people will have to pay much more to purchase allowances for their utilities than consumers in states that rely on other forms of energy generation. Yet when it comes time to recycle funds back to consumers, this is done without regard to how much was paid in, such that those who gave more will not receive more in return. To put it another way, consumers in the Midwest and Southeast will be subsidizing the energy costs of those on the coasts.

Industries in general also will feel the negative effects of this proposal. This is an issue not covered by the president or in any proposed legislation. An auction will have several interrelated financial impacts on industry that will effectively deprive them of capital and limit their ability to raise more at a time when new capital is needed to fund carbon reduction projects. For example, an auction could effectively devalue some industry assets to the point where companies might find it more prudent to shut down those assets rather than pay higher operational costs.

In addition, industry will have to "front" the cost of allowance purchases to cover emissions, and then hope to recover those costs through sales over the course of the year. In reality, that money will never be recovered because it will have to be used to purchase allowances for the following year.

Simply put, the cost of industry allowances (in excess of $50 billion a year) will be effectively locked up in an allowance purchase cycle, and removed from the capital that could otherwise be invested in carbon reduction projects.

The financial impacts of an auction on industry -- and specifically the impacts on industry's ability to raise capital for carbon reduction efforts -- is a harm that has not been well-explored or resolved.

To summarize: The harm that a large-scale auction of allowances will cause is well-documented – everyone agrees there will be a considerable price to pay. It is equally clear that the price will be disproportionately borne by states that depend on coal-fired generation. And legislative gyrations to mitigate consumer impacts and other complications are incomplete, inadequate and, frankly, unnecessary. While cap and trade has laudable goals, the auction portion is a discretionary act that would do nothing to reduce carbon emissions. A carbon cap will work regardless of how allowances are allocated or auctioned.

As we move forward with a cap-and-trade program, let’s move cautiously and conservatively, focus on free allocations to power companies in regulated jurisdictions, and to generators and LSEs in deregulated jurisdictions, to ensure there is no harm to consumers or to industry.

President Obama is right to auction off 100% of the carbon credits and he is also right to refund that revenue to American taxpayers—this is the key piece of the puzzle that will promote broad based support for climate change policy.

Giving away these permits would, in the words of Peter Orszag, President Obama’s budget director, amount to "the largest corporate welfare program that has ever been enacted in the history of the United States."

Once there is a cap on emissions and a price on carbon, the credits become a valuable commodity. This commodity will be a necessary input into the production process for energy producers that use fossil-fuels, and in competitive markets, the price of this commodity will be passed on to consumers whether they are initially distributed for free or not. The exception is in regulated energy markets, where utilities are subject to price controls. In these markets, consumers would have to rely on local regulators to protect their interests.

The result of the give-away (as evidenced by the EU’s implementation) is windfall profits for companies that do not protect many working families from rate increases. It’s a backwards policy and a regressive transfer of wealth.

By asking the polluters to pay and refunding the revenue to taxpayers, President Obama buffers American families from the rate increases on their energy bills and the rise in price of energy intensive goods, essentially reimbursing them for the additional costs. Since lower-income Americans tend to spend new disposable income quickly (and benefit the most under this plan) we can realistically expect a jump in consumer spending as a result—an economic bonus we wouldn’t get from giving away the credits.

Some energy executives have argued that consumer rates will go up significantly more if permits are auctioned. This argument lacks merit. In a competitive market, giving away permits to producers will not reduce energy rates. In such markets, the price of a good is set by the marginal costs of producers, not the fixed costs. The carbon cap will increase the marginal cost of electricity because it will require a new input: carbon permits.

Transferring permits to producers in bulk for free will not affect the marginal cost calculation because those permits can be sold on the market for value, so their use will have an opportunity cost regardless if they were received for free or not. The free permits are equivalent to a transfer of wealth to shareholders but irrelevant to consumers.

The exception to this rule is in regulated markets, where local utility regulators could ensure that consumers benefited from the permit auctions. But only a portion of the country is served by such regulated monopolies, and even in regulated areas, it is far from certain that regulators would ultimately protect consumers.

Instead of giving away permits to energy producers, which produce no benefit for many consumers and uncertain benefit for others, President Obama proposes to directly refund revenues from increased energy prices to Americans through a broad-based tax credit. This is a much more sure-fire way to protect consumers than giving away permits to utility companies.

No one is saying there won’t be growing pains that come with transitioning to a cleaner environment. There will be winners and losers. But it is important to be clear about who those winners and losers will be, and how we can reduce the burdens on the most vulnerable populations.

Auctioning every allowance under a cap-and-trade system is absolutely critical to reduce heat-trapping emissions and revitalize our economy.

The most effective way for the market to set an appropriate price on pollution would be to auction off 100 percent of the allowances. Such an auction would require industries to accurately assess, from the very start of a cap-and-trade program, the cost of reducing emissions and the price they would be willing to pay for allowances. Conversely, giving away allowances for free would distort the market and slow down the development and deployment of clean technology.

Second, an auction would be a major source of revenue that could benefit the public. That funding should be used to achieve needed heat-trapping emissions reductions and boost the economy, particularly by investing in rapid and nationwide deployment of renewable energy and more efficient vehicles, appliance and building technology. Auction revenue also should be used to help vulnerable communities and workers transition to a new green economy, protect tropical forests that are so essential to reduce heat-trapping emissions and help people and wildlife adapt to climate change.

We will increase our chances of meeting emissions reduction targets if we invest auction proceeds in programs that promote renewable energy sources and encourage citizens and businesses to adopt energy efficiency technology, which would lower energy demand and save money. Using auction revenue wisely is a key way to protect the planet at the lowest possible cost.

To preserve the global competitiveness of American manufacturers and prevent carbon “leakage,” cap-and-trade emission credits should not be distributed through an auction but instead should be allocated to covered industries in proportion to their recent emissions history.

Allocating credits in this manner preserves funds that regulated industries will need to pay for the investments to reduce our greenhouse gas emissions. While an auction does generate revenue for the federal government, it does so at the expense of the manufacturing industries that are most exposed to international competition.

When considering the amount of credits different sectors should receive, particular attention should be paid to maintaining a sector’s global competitiveness. Energy-intensive manufacturers such as pulp, paper, packaging and wood products makers, who face foreign competition and cannot easily pass on increased costs to customers, should receive an allocation adequate to mitigate the costs of the cap-and-trade regulation.

This becomes especially important when one considers that energy-intensive manufacturers would not only face the added cost of their own emissions credits, but would also pay higher prices for the energy they buy from their public utilities, since utilities can pass on the costs of their emissions credits to their customers in the form of higher rates.

If credits are distributed by auction, the expense could pose potentially devastating financial burdens to forest products companies—even before they spend a single dollar to comply with the cap. If credits are auctioned for $30 to $50 per ton, as many experts project, the forest products industry’s cost for this single business expense alone would consume from 60 to 100 percent of the entire industry’s estimated net income for 2008.

If the combined cost of a cap-and-trade system eliminates paper and wood products manufacturing in the U.S., there will be a net global increase in carbon emissions since these products will simply be manufactured in countries without carbon caps. The increased carbon emissions resulting from this “leakage” will produce the exact opposite outcome that a U.S. cap-and-trade effort seeks. Instead, the only domestic outcomes will be a weakened U.S. economy and millions of unemployed manufacturing workers.

Though it may seem counterintuitive to some, preserving the competitiveness of the American forest products industry and preserving the carbon reduction goals of a cap-and-trade program are aligned. Preventing the unwanted affects of carbon leakage means nurturing a climate in which manufacturing can continue to thrive in the United States.

To efficiently manage our greenhouse gasses and let the market operate efficiently, ultimately we need to auction the permits in a cap and trade program. While some in industry are opposed to auctioning - that opposition is in contradiction to other positions industry takes on how markets should operate. However, as some industry representatives have noted, it might be prudent to have a transition period so that the costs of reducing emissions does not hit the economy all at once. This does not mean that all the permits need to be given away at the beginning - there is a middle ground between the positions as we transition too full auctioning. In the early stages there can be a mix of allocated and auctioned permits, based on formulas developed by economic models of impacts and costs for different regions and industries.

Certainly there will be political horse-trading in the decisions of how much to allocate and permit, but we can set up an objective set of criteria that can help ease the transition to a future which responsibly allocates environmental costs and levels the playing field between high carbon-high polluting processes, and low carbon-low polluting processes. While we could spend months arguing whether to auction or allocate - I think it is likely that we can come to a consensus that auctioning is more economically efficient and we can spend these months coming up with a formula that creates a meaningful and swift transition from nothing today, to a fully operational, economically efficient market for reducing greenhouse gas emissions.

The short answer is they both are right. NARUC approved a resolution in November 2007 that stated that IF Congress adopts a cap-and-trade policy, a permit auction is ultimately the most efficient way to reduce emissions from the electricity sector. However, during the transition to an auction model, it makes sense to distribute allowances within the sector at no cost to maintain reliability and keep costs down as much as possible.

We understand the concerns that this approach could lead to a windfall, which is why NARUC has been advocating that any allocated allowances distributed to the regulated electricity sector should only go to the Local Distribution Companies that are overseen by State public utility commissions. Because State regulators will be responsible for determining the pass through of the added costs of complying with the new carbon regulations to consumers, allocating free allowances to the LDCs will ensure that States can also pass through any benefits as well. These benefits can come in the form of lower rates, increased investment in energy efficiency, or other green programs that advance the welfare of utility consumers. Allocating free credits to any other entity in the electricity sector, such as the owners of generating plants, poses the risk of the windfall profits seen in the European Union.

NARUC took this position because in traditionally regulated States, generators are predominantly owned by the vertically integrated utilities and therefore any proceeds from free allocations they would receive would be reviewed and acted upon by the State commission. This is not the case in restructured States, where the generation is owned and operated by a third party. If these generators were given free allowances, their value would not be available to mitigate consumer compliance costs. However, if the credits are allocated to the LDCs in these States, the State Commissions will be able to capture the value of these assets for retail consumers.

We need a cap on global warming pollution to mobilize clean energy investments that create jobs, increase our national security, and protect our planet. Polluters must finally pay for their emissions to our atmosphere by buying carbon allowances.

NRDC believes firmly that emission allowances are a public resource and their value should be used in the public interest. Giving all the allowances away to polluters would be a costly mistake. In 2005, the EU opted for the politically expedient path of giving nearly all their carbon allowances away for free. Many firms that received free allowances still raised prices for consumers based on what they would have cost to buy--resulting in billions in windfall profits.

Instead of grandfathering all allowances, we should use their value for three primary purposes: Investments to kick start the transition to a clean energy economy; dividends to consumers through tax rebates and other means; and adaptation assistance for vulnerable communities and natural resources.

The appropriate mix of investments, dividends, and adaptation assistance will change over time. For instance, directing investments into clean energy is most important in the early years of the program when it is essential to break down long-standing barriers to broadening efficiency and scaling up renewables. The need for adaptation assistance will rise over time. It is impossible to assess decades in advance what the priorities for the revenue will be. That’s why we should transition to a full auction that returns the money directly to consumers after about 15 tears.

Whether Congress decides to auction or distribute allowances for global warming pollution and regardless of how it decides to divide the value among investments, dividends, and adaptation, there is one thing I want to emphasize: the most important environmental driver in all of this is the cap itself.

Without a cap, there will be no emissions reductions and there will be no allowances to divvy up. As environmental advocates, we recognize the mechanism is secondary to the objective: reducing global warming pollution.

While the United States needs to enact a climate policy that will slow, stop and reverse the growth of greenhouse gas emissions, energy intensive industries in the U.S. that manufacture commodity products (chemical, steel, cement, paper, etc.) will be particularly challenged by countries not committed to a GHG reduction path. As a result, there is a risk that “leakage” can occur, shifting U.S. industrial production and GHG emissions to countries not entertaining a climate protection program.

That is why our government needs to be thoughtful when designing an environmentally protective and economically sustainable climate policy. A significant portion of free allowances in the early years of a cap and trade program would help to ease the financial impact of cap and trade on industry, not to mention consumers and other business sectors.

Additionally, the direct allocation of allowances combined with the targeting of auction revenues would reduce the cost of cap and trade and accelerate the deployment of energy efficiency and GHG-reducing technologies. This can lead to “green” jobs that would create economic opportunity for our nation’s workforce and businesses as we transition to a low-carbon economy.

Given the aggressive near-term targets embraced by President Obama and many in Congress, this approach is reasonable as we could systematically move toward a 100 percent auction and the free distribution of allowances could be phased out over time. By establishing an orderly and predictable schedule of GHG emission reductions, the private sector will be able to lead the development and deployment of innovative energy and carbon reducing technologies of the future, and not be financially burdened by a sudden auction of federal permits.

With the urgent need to transform our economy, secure our energy future and reduce GHG emissions, any approach embracing a full auction of allowances will harm energy intensive manufacturers, cause unnecessary delays in Congress, especially the quest for 60 votes in the Senate.

The Wilderness Society supports President Obama’s approach—auctioning 100 percent of emissions permits—because we believe that evidence shows it is the wisest policy.

We’ve seen that the other approach—giving away free permits to polluters—has not worked well in Europe, creating immediate windfalls for the polluters without any commensurate public benefit. We should avoid making the same mistake, and pass a climate bill that not only ends the free dumping of harmful pollution into our air, but also ensures that the public, not the polluter, benefits from the initial auction of valuable carbon allowances.

When polluters are given pollution permits for free, they can receive a windfall by raising prices immediately whether or not they have made any new investment in reducing carbon pollution. If, on the other hand, emitters of global warming pollution buy a permits at auction, the value of the auctions can be invested in ways that benefit all of us. President Obama has proposed such an approach: a “cap, auction, and invest” program that makes polluters pay while protecting our most vulnerable populations.

We believe this is the right approach to global warming legislation—an approach that sets a cap on carbon pollution and auctions all permits for the maximum public benefit. We support using carbon auction revenues to:

· invest in equity by protecting our poorest and most vulnerable citizens and communities;

· invest in innovation by funding the research needed to speed the transition to a clean energy economy; and

· invest in the natural resources and ecosystems that protect all of us.

These critical public benefits simply could not be realized if permits were given away, rather than auctioned, to polluters.

One of the most vexing climate issues is the potential for cap-and-trade legislation to cause the transfer of U.S. greenhouse gas emissions to nations that have no – or less stringent – emissions caps. This phenomenon, known as border “leakage,” could also occur between U.S. states if greenhouse gas regulations vary from state to state. Leakage occurs because energy produced without emissions caps is typically less expensive; other things being equal, energy use (e.g. for manufacturing production) occurs where energy costs are lower. The unfortunate consequence of leakage is that it subverts the purpose of climate legislation: reducing emissions. Unless climate policy is carefully constructed to avoid leakage, a cap-and-trade bill may actually increase global emissions as manufacturing production goes to areas of the world with less stringent emissions controls and higher “carbon intensity.” Any greenhouse gas reduction efforts made by the United States could be more than offset by higher emissions elsewhere around the world.

The competitiveness of energy-intensive U.S. industries is another major leakage issue. The independent, nonpartisan research organization Resources for the Future (RFF) noted that domestic companies competing in global markets could be disadvantaged by a cap-and-trade program. There could be significant adverse effects on “energy-intensive, import-sensitive industries, on domestic jobs, and on the nation’s trade balance.” RFF found that over the long term, the leakage rate for the few most vulnerable industries – including chemistry and plastics – could be as high as 40 percent in the case of a unilateral $10 per-ton CO2 price.

The Administration’s budget includes details on cap-and-trade legislation and the revenues generated from such a program. The budget states that cap-and-trade could be implemented “through a 100 percent auction” of emission credits and that the revenues would go toward clean energy investment or “returned to the people.” Unfortunately, a program with both a 100% auction and no revenue returned to energy-intensive manufacturers, as the budget describes, would result in leakage of emissions and jobs overseas. A 100 percent auction would do nothing to fix leakage impacts of the program, nor would it help level the field for energy-intensive industries so that U.S. production, jobs and emissions are not driven offshore, to where carbon intensity is higher. It’s vital that any cap-and-trade program call for the free distribution of emission credits to energy-intensive industries so long as U.S. manufacturers are at a competitive disadvantage. Free distribution of credits under such circumstances could help avoid emission leakage, unintended increases in global greenhouse gas emissions, and erosion in U.S. competitiveness and jobs.

ACC analysis indicates that a proposal like the one in the Administration’s budget would impose more than $7 billion in new costs on the business of chemistry in the United States in year one. Over the 10-year period, the total cost would be $68.7 billion. These costs would drive some chemistry production offshore to more carbon-intensive economies.

There are other good reasons for the free allocation of emission credits under a cap-and-trade program. Climate policy should encourage production in industries that contribute to climate protection. Chemistry is a climate solutions provider: our products go into some of the most widely-used products for energy efficiency and renewable energy, including building insulation, solar panels, wind turbines, lightweight vehicle parts, compact fluorescent light bulbs, lithium-ion batteries, low-rolling resistance tires, automotive and industrial lubricants, and thermal coatings. We’ve improved energy efficiency in our operations by more than half (53%) since 1974. Our greenhouse gas emissions fell 13.2 percent between 1990 and 2007 – a reduction exceeding the Kyoto Protocol target. As an industry with close to 850,000 jobs and tied to 96% of U.S. manufactured products, policies such as free distribution of emission credits would be good for economic recovery, too.

The simple answer to the question, “Should industry pay to pollute?” is yes. Giving pollution permits away for free is a fool’s errand: it will not generate the funds necessary to address the severe impacts of climate change, reduce the cost to consumers or support investments in solutions to reduce global warming pollution.

Our natural systems, upon which we all depend for survival, are already showing the signs of climate change – from longer droughts to bark beetle infestation devastating some western forests. The country’s natural ecosystems and biodiversity are the backbone of a vibrant economy and public health. According to scientists on the Intergovernmental Panel on Climate Change, we stand to lose up to 37% of species if we don’t act with all due speed.

The Congressional Budget Office acknowledges the folly in giving away pollution allowances, “A common misconception is that freely distributing emission allowances to producers would prevent consumer prices from rising as a result of the cap…Producers would pass that opportunity cost on to their customers in the same way they would pass along actual expenses.”[i]

Pollution allowances have a monetary value and giving them away for free to companies based upon their pollution history – often called “grandfathering” – will only result in “windfall” profits for these companies, not lessen the impact on consumers. This is because companies will charge the prices that the market will bear, not reduce their prices based upon the value of the allowances they receive. This reality has been born out in the European Union’s emission trading system where the vast majority of pollution permits were initially given away for free.

By contrast, auctioning pollution permits has the potential to produce billions of dollars a year in revenue needed to address climate change’s impacts, alleviate the impact on vulnerable consumers, and reduce greenhouse gas emissions. Industries that are degrading our natural resources must effectively pay, through a permitting system, to safeguard the natural resources base that supports all life. These are the systems that clean our drinking water, purify our air, pollinate over a third of the food we eat, inspire medical innovations, and provide countless other services, all performed by the natural environment…for free. We must invest in protecting and restoring these systems that are threatened by climate change.

The air belongs to all of us. Auctioning pollution permits is a fair approach that ensures producers pay for the damage their pollution is having on society. Auctioning permits will also generate the revenues necessary to reduce the emissions driving climate change, offset the impacts on consumers, and safeguard and restore the natural world that sustains all of us and future generations.

[i] Congressional Budget Office. “Trade-Offs in Allocating Allowances for CO2 Emissions.” Economic and Budget Issue Brief, April 25, 2007.

The President’s plan for auctioning 100 percent of carbon allowances is nothing more than an unfair carbon tax, the bulk of which will be borne by electric customers in the 25 states that depend on coal for most of their electricity.

It will redistribute wealth from these states in our industrial heartland to states less dependent on coal on the West Coast and Northeast. This will punish coal states for decisions approved by state utility commission’s decades ago when building coal plants was a key part of our national energy policy. The 1974 Arab Oil Embargo discouraged the use of oil in power plants. The Fuel Use Act in 1978 prohibited the use of natural gas in power plants until 1985. Three Mile Island stopped new nuclear power development in 1979. Each of these milestones was pivotal to energy policy that encouraged the expanded use of affordable and available domestic coal to drive our economy.

Auctioning all carbon allowances at $20 per ton as the Office of Management and Budget uses in the President’s budget plan, would see our electric rates increase approximately 40 percent in Indiana, 30 percent in Kentucky, 20-25 percent in Ohio, and 15 percent in the Carolinas.

If these unfair price increases weren’t bad enough, the main focus of the Administration’s climate plan isn’t even on the environment. Some 85 percent of the $650 billion raised from auctioning allowances over 10 years would go to programs that have nothing to do with climate change. Only about 15 percent would go to clean energy research and development.

Rather than this huge transfer of wealth that pits region against region, there is a better way: We can allocate allowances initially at no cost as we did with the 1990 Clean Air Act Amendments—a highly successful approach that is cutting our nation’s sulfur dioxide from coal-fired power plants by more than half.

The Clean Air Act worked because consumers were protected from big price jumps through the use of allowances. We can provide consumers the same protection as we did under that program by allocating allowances to our nation’s Local Distribution Companies, as called for in the United States Climate Action Partnership’s blueprint for legislative action to Congress.

Electric rates still increase under this approach, but far more reasonably and gradually to protect consumers and the economy. And carbon emissions still decrease at the same pace as a 100 percent auction system. As a long time supporter of cap-and-trade, this is the approach we need—especially in a deepening recession.

The auction versus allocation decision should reflect lessons from the financial crisis. We need a liquid and efficient market in both carbon allowances and derivatives. And we should be realistic about how perceived risk can spiral through the securities markets and threaten the viability of companies - including, potentially, emitters sensitive to carbon prices.

From a financial markets standpoint three things are critical: 1) a healthy “float” of outstanding allowances, 2) time for the capital markets to adjust to emitter auction funding, and 3) some degree of price certainty for the emitters most negatively impacted. If the base case is to auction off all 5.75 billion allowances, have one year outstanding at the outset, and create a first year funding requirement of $115 billion (at $20 per ton) - then we should seriously consider a less risky base case.

If we are going to give allowances free to emitters, then doing more sooner increases the “float” and makes the market less dependent on OTC or non-physically settled derivatives. We can also grant Allowance Purchase Rights (APRs) to give price protection to those most negatively impacted - while creating a large listed options market that can be used by emitters to manage their abatement risk.

An example of such a plan, where less than 20% of the 38-year allowance value is given free to emitters, might be as follows:

•Grant 60% of the first 5 years worth of allowances free at the beginning of the initial 5-year period (ideally pro-rata to baseline or by some other algorithm), then 30% at the beginning of the second 5-year period, and 15% at the beginning of the third. Thereafter, 100% auction.

•Grant 6 billion APRs to emitters most negatively impacted by the policy, allowing them to purchase underlying allowances from the Government at a fixed price of $15 to $20 per ton expiring in 5 years. Then grant 3 billion APRs at the beginning of the second 5-year period, and 1.5 billion at the beginning of the third. The APR’s would be freely tradable.

•Conduct annual auctions in a smaller size as reduced by free allocations - and by the exercise of APRs at the end of each 5-year period. At 5.75 billion initial allowances and an 80% reduction by 2050 (and assuming all APRs are exercised), the net size of auctions in the first 10 years would be about 2.2 billion tons per year, with 3.2 billion for the second ten years.

•Real dollar Government revenue from this plan would be $44 billion in 2012 rising to $64 billion by 2021, and then exceed $90 billion thereafter (assuming a $20 initial price and 4% real appreciation). It doesn’t hit the White house $79 billion draft budget number for 2012 but arguably revenue raised in this matter is more certain.

Notwithstanding all the relevant economic or philosophical comments we will have on today’s blog, the financial aspects of the auction versus allocation decision are critical to efficient policy.