Electricity in New Hampshire - Cap and Trade Overview

There's been some discussion on cap-and-trade legislation out of Washington lately, and this could have an important impact on electricity rates in NH and on how we generate power in the next 10-20 years.  I'm starting with a quick and very simplistic primer on what a cap-and-trade system is.  If you already know what it is, you can skip this post.

New Hampshire in general, and PSNH in particular, is highly dependent on fossil fuels to provide the electricity we need to run our industry and to keep our homes comfortable.  Unfortunately, while burning fossil fuels can be a great way to produce low-cost electricity, doing so emits pollutants that can be harmful to our health and to the environment. 

Economics has a term for situations when the parties engaging in a transaction don't bear the full costs of the transaction.  These transactions are said to have "externalities." In the case of power plants using  fossil fuels, the costs of the pollution that's emitted  aren't paid by either the power producers or the power consumers.  Because someone else pays the bill (the folks down wind in the next state), the producers and consumers don't have any incentive to limit the pollution or find a better way to make power.  It's as though I had the right to dump my trash in my neighbor's back yard.

When externalities exist, usually government regulation can be used to fix an otherwise broken market system.  The idea is that regulations could be made so polluters pay for the damage that their pollution causes.  In a perfect world, those payments would go to the folks injured by the pollution in the downwind states.  It makes a ton of sense at a high level, but of course, the devil's in the implementation.

Imagine a world where we knew, down to the penny, how much damage 1 ton of CO2 emissions would do to our health and to the environment.  In that case, we could just introduce a carbon emissions tax that charges polluters that exact amount for each ton of CO2 that they emit.  Sounds simple right?  The problem is we don't know how much the damage from a ton of emissions costs, and even if we did, changing the system overnight to price in that damage would cause a big shock and could have a devastating impact on our economy.

Instead, legislators in Washington are working on a system called cap-and-trade.  Under this system, rights to emit carbon are created by the government, almost like dollar bills.  Each year, the government would print a certain number of emissions permits, and then somehow distribute them, probably by selling them.  Everyone who wants to emit a ton of carbon has to get one of these permits.   So just like an eBay auction, polluters bid on the carbon permits.  Since there's a limited supply of permits, some polluters may not get one, and will have to find another way to run their business without emitting carbon.   In the real system, permits are sold years in advance so polluters can have time to either buy a permit or clean up their emissions.  Also,  the permit buyers might not be polluters at all.  They could be speculators thinking that the price of the permit will go up as  the year it "matures" approaches.  They're hoping to sell their permit to some hapless power plant owner that didn't plan ahead.

Anyhow, the idea is that companies will change how they do business and pollute less (by installing scrubbers, etc) because if they don't, they'll have to pay for their pollution.  They could either spend the money on a permit, or on a scrubber.  If the scrubber costs less, they'll do that.  In some situations it may be economically optimal for some firms to continue polluting, but at least they'll be paying the full cost for the right.  It might turn out that once the costs of pollution are factored in, some businesses will raise prices, or even go out of business.  It sounds harsh, but the idea is to make markets work by including all the costs of production, even pollution, into the pricing of products and services.