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Carbon Cap-and-Trade: The Economic and Airline Industry Implications
By Vaughn Cordle, CFA / March 9, 2009
Obama’s new budget expects to collect $646 billion in "climate revenue" and, even as financial entities benefit from a
new source of (trading emissions) revenue, this activity has nothing to do with improving energy efficiency. Increased
energy costs, regardless of their source, force companies to become more efficient. Obama’s $646 billion in climate
revenue reflects new energy costs that will drive efficiency, not the trading of emissions allowances.
The cap-and-trade approach has two key characteristics. Unlike a tax, it starts with a target for emission cuts and uses
the market for trading of the emissions allowances. The targeted level of emissions is set for the purpose of reducing or
ameliorating atmospheric warming, although even the staunchest supporters of reducing carbon fuels will admit that
even aggressive action will have, at best, a minuscule effect on average global temperature. Those that disagree with
this assessment will point out that only a very small degree increase in temperature could be devastating, so even a
“miniscule effect” on global temperature could be significant. Regardless, in the last 100 years, the average global
temperature has risen only half a degree. A carbon tax can achieve the same thing as cap-and-trade with significantly
less complexity and mitigation costs.
The problem with the cap-and-trade is that the government will influence and set the prices of emission allowances
and the trading conditions, so the supposed “market” for emission allowances will be a function of politics, forever
subject to influence-peddling. It could be said that the biggest problem with the cap-and-trade method is its
dependence on political deceit.
Like a tax, the cap-and-trade will raise the costs of using fossil fuels; to have any effect, it will have to increase the cost
to consumers high enough to make them reduce consumption. This process can be illustrated with the airline industry.
If our initial estimates are correct, based on adoption of EU guidelines, for every block hour of flight above a certain
emissions allowance, the average U.S. airline’s fuel expense will increase 23%. To offset this extra cost, fares will have
to increase on average of 4%, resulting in a 3.5% reduction in traffic. The reduction in traffic, in turn, results in a reduction
in capacity and fuel consumption and the desired decrease in emissions. However, the trading of emission allowances
will not reduce the cost to the passenger any more than a straight tax would. Moreover, airlines and other businesses
vary in their fuel efficiencies. As an example, Northwest's CO2 emission per block hour is the worst of the big airlines at
131% of the average of the top 15 airlines, while Continental's is 107%. Jetblue's younger and more fuel efficient fleet
gives it an advantage and a 78% rating. A cap-and-trade, or tax, will result in age discrimination as the older and more
unionized airlines will pay more in relative terms.
Regardless of efficiency, the absolute cost will be 23% more in fuel costs for all airlines. The assumed 3% reduction
in emissions [above the allowance level of emissions] may be a start, but it is not likely to make any meaningful dent in
terms of reducing average global temperatures. It will have a much greater impact on jobs and the economy. It matters
not whether the increased cost of fuel comes in the form of a simple tax or cap-and-trade: the reduction in consumption
will be the same.
A new study by Bryan Buckely and Sergey Mityakove of Clemson University examines seven assessments of the cap-
and-trade legislation that is most like Obama's proposal and concludes that mitigation costs will be "huge." Those
government-imposed costs will have the effect, but not the appearance, of a tax. The cap-and-trade scheme provides
Obama and Congress cover through the illusion that cap-and-trade means that someone other than the consumer (or
taxpayer) bears the costs.
In the airline industry, average fares are highly correlated to costs and only a small fraction of higher energy costs will
be passed along to the shareholders. It must be noted that institutional investors (pooled funds from retirees and
individuals) and small investors alike own shares in companies that consume energy. They too will bear the burden of
the new energy costs. Higher energy costs results in a negative "wealth effect" that reduces disposable income, and
this in turn reduces economic output and jobs. Obama's $646 billion in climate revenue is really a cost that reduces
other consumer expenditures by almost 1% per year. Absent the taxpayer-financed stimulus package (20% expansion of
government) this new energy tax will result in 1.35 million more private sector jobs lost. However, promoting energy
efficiency to reduce carbon emissions growth is clearly the right policy choice given our dependence on foreign oil and
the global warming threat. Moreover, given the magnitude of the current economic crisis; government-sponsored
environmental jobs can help reduce future energy consumption and, at the same time, offset massive job losses that
have accelerated over the last several months.
Obama promised not to raise income taxes by a "single dime" except on the wealthy in a budget that assumes
"climate revenues" totaling $646 through 2019. Cap and trade, however, is nothing more than a broad-based tax that
impacts everyone, wealthy or not. With a little math by yours truly, it's easy to conclude that passengers on U.S. airlines
will pay almost $9 billion in new “taxes” (through 2019) in the form of increased prices because of cap and trade. Of
course, the less wealthy passengers pay more relative to their income, so this is nothing more than a stealth tax that is
also regressive. A little more math tells the real tale: The climate revenue increases taxes on working men and women
by an average of $486 per year. Taxing the middle class, and even the poor, is the only way this government can pay for
its aggressive social agenda and massive budget deficit.
The bottom line: The cap-and-trade scheme is regressive tax in disguise. The money won't come from companies: it
will come from consumers of carbon energy and products that use carbon energy in their manufacture. A straight
carbon tax highlights who really pays the new environmental policy costs and removes the political deceit. Politicians
are simply trying to fool taxpayers and consumers with this clever sleight of hand.
By Vaughn Cordle, CFA / March 9, 2009
Obama’s new budget expects to collect $646 billion in "climate revenue" and, even as financial entities benefit from a
new source of (trading emissions) revenue, this activity has nothing to do with improving energy efficiency. Increased
energy costs, regardless of their source, force companies to become more efficient. Obama’s $646 billion in climate
revenue reflects new energy costs that will drive efficiency, not the trading of emissions allowances.
The cap-and-trade approach has two key characteristics. Unlike a tax, it starts with a target for emission cuts and uses
the market for trading of the emissions allowances. The targeted level of emissions is set for the purpose of reducing or
ameliorating atmospheric warming, although even the staunchest supporters of reducing carbon fuels will admit that
even aggressive action will have, at best, a minuscule effect on average global temperature. Those that disagree with
this assessment will point out that only a very small degree increase in temperature could be devastating, so even a
“miniscule effect” on global temperature could be significant. Regardless, in the last 100 years, the average global
temperature has risen only half a degree. A carbon tax can achieve the same thing as cap-and-trade with significantly
less complexity and mitigation costs.
The problem with the cap-and-trade is that the government will influence and set the prices of emission allowances
and the trading conditions, so the supposed “market” for emission allowances will be a function of politics, forever
subject to influence-peddling. It could be said that the biggest problem with the cap-and-trade method is its
dependence on political deceit.
Like a tax, the cap-and-trade will raise the costs of using fossil fuels; to have any effect, it will have to increase the cost
to consumers high enough to make them reduce consumption. This process can be illustrated with the airline industry.
If our initial estimates are correct, based on adoption of EU guidelines, for every block hour of flight above a certain
emissions allowance, the average U.S. airline’s fuel expense will increase 23%. To offset this extra cost, fares will have
to increase on average of 4%, resulting in a 3.5% reduction in traffic. The reduction in traffic, in turn, results in a reduction
in capacity and fuel consumption and the desired decrease in emissions. However, the trading of emission allowances
will not reduce the cost to the passenger any more than a straight tax would. Moreover, airlines and other businesses
vary in their fuel efficiencies. As an example, Northwest's CO2 emission per block hour is the worst of the big airlines at
131% of the average of the top 15 airlines, while Continental's is 107%. Jetblue's younger and more fuel efficient fleet
gives it an advantage and a 78% rating. A cap-and-trade, or tax, will result in age discrimination as the older and more
unionized airlines will pay more in relative terms.
Regardless of efficiency, the absolute cost will be 23% more in fuel costs for all airlines. The assumed 3% reduction
in emissions [above the allowance level of emissions] may be a start, but it is not likely to make any meaningful dent in
terms of reducing average global temperatures. It will have a much greater impact on jobs and the economy. It matters
not whether the increased cost of fuel comes in the form of a simple tax or cap-and-trade: the reduction in consumption
will be the same.
A new study by Bryan Buckely and Sergey Mityakove of Clemson University examines seven assessments of the cap-
and-trade legislation that is most like Obama's proposal and concludes that mitigation costs will be "huge." Those
government-imposed costs will have the effect, but not the appearance, of a tax. The cap-and-trade scheme provides
Obama and Congress cover through the illusion that cap-and-trade means that someone other than the consumer (or
taxpayer) bears the costs.
In the airline industry, average fares are highly correlated to costs and only a small fraction of higher energy costs will
be passed along to the shareholders. It must be noted that institutional investors (pooled funds from retirees and
individuals) and small investors alike own shares in companies that consume energy. They too will bear the burden of
the new energy costs. Higher energy costs results in a negative "wealth effect" that reduces disposable income, and
this in turn reduces economic output and jobs. Obama's $646 billion in climate revenue is really a cost that reduces
other consumer expenditures by almost 1% per year. Absent the taxpayer-financed stimulus package (20% expansion of
government) this new energy tax will result in 1.35 million more private sector jobs lost. However, promoting energy
efficiency to reduce carbon emissions growth is clearly the right policy choice given our dependence on foreign oil and
the global warming threat. Moreover, given the magnitude of the current economic crisis; government-sponsored
environmental jobs can help reduce future energy consumption and, at the same time, offset massive job losses that
have accelerated over the last several months.
Obama promised not to raise income taxes by a "single dime" except on the wealthy in a budget that assumes
"climate revenues" totaling $646 through 2019. Cap and trade, however, is nothing more than a broad-based tax that
impacts everyone, wealthy or not. With a little math by yours truly, it's easy to conclude that passengers on U.S. airlines
will pay almost $9 billion in new “taxes” (through 2019) in the form of increased prices because of cap and trade. Of
course, the less wealthy passengers pay more relative to their income, so this is nothing more than a stealth tax that is
also regressive. A little more math tells the real tale: The climate revenue increases taxes on working men and women
by an average of $486 per year. Taxing the middle class, and even the poor, is the only way this government can pay for
its aggressive social agenda and massive budget deficit.
The bottom line: The cap-and-trade scheme is regressive tax in disguise. The money won't come from companies: it
will come from consumers of carbon energy and products that use carbon energy in their manufacture. A straight
carbon tax highlights who really pays the new environmental policy costs and removes the political deceit. Politicians
are simply trying to fool taxpayers and consumers with this clever sleight of hand.
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