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Cap and Trade or Cap and Close?

Posted by Larry Doyle on June 30, 2009 8:18 AM |

Politics is a dirty business, as is pollution.  Mixing the two is a very dirty and potentially explosive proposition. Let’s try to shed some light on this corner of our economic landscape.

For evidence of this ‘dark and dirty’ enterprise, we need look no further than the energy bill recently passed by the House and on its way to the Senate. This legislation, formally known as the Waxman-Markey Climate Bill but commonly referred to as ‘cap and trade,’ was recently highlighted by Bloomberg reporting Big Oil’s Answer to Carbon Law May Be Fuel Imports.

Whenever I assess an industry, I initially think of a few basic factors, including:
1. product
2. cost of sourcing product
3. cost of developing or refining product
4. targeted market for product
5. potential profit margin
6. ability to scale the business (i.e.  grow the enterprise)
7. barriers to entry for competition

These basic business principles apply to virtually every business enterprise in the world. Any good businessman is always looking to cut costs, increase profit margins, and increase market share.

The goal of cap and trade, minimizing greenhouse gas emissions, is worthy. All other things being equal (our age old economic term, ceteris paribus), who would not be supportive of minimizing these emissions? As we know, though, all other things are NEVER equal. Let’s review our basic business principles.

> What are the costs of minimizing these emissions?
> How are those costs allocated?
> How do those costs impact the sourcing, refining, and delivery of product?
> What are the alternatives for producers to lessen their overall costs and maximize return on capital?

While politicians and others unfamiliar with basic business principles may view the economy from a static standpoint, Bloomberg provides real insight from those “on the ground”:

America’s biggest oil companies will probably cope with U.S. carbon legislation by closing fuel plants, cutting capital spending and increasing imports.

“It will lead to the opportunity for foreign sources to bring in transportation fuels at a lower cost, which will have an adverse impact to our industry, potential shutdown of refineries and investment and, ultimately, employment,” Mulva said in a June 16 interview in Detroit. Houston-based Conoco Phillips has the second-largest U.S. refining capacity.

The same amount of gasoline that would have $1 in carbon costs imposed if it were domestic would have 10 cents less added if it were imported, according to energy consulting firm Wood Mackenzie in Houston. Contrary to President Barack Obama’s goal of reducing dependence on overseas energy suppliers, the bill would incent U.S. refiners to import more fuel, said Clayton Mahaffey, an analyst at RedChip Cos. in Maitland, Florida.

Politicians may view those within the oil refinery industry as unfairly biased in offering their opinions, and that the social beneftis of the legislation outweigh the costs.

To fully measure the costs, it is critically important to assess the overall market and the ability for producers to move operations. If a company is effectively held captive here in the United States, meaning the consumers of this product are largely American and the ability to source the product is largely restricted to America, then legislation of this sort is viable. However, neither of those factors are true in this situation.

I believe this legislation will drive business overseas and along with it jobs and revenues. Are those costs factored into this legisaltion? No way.

What then would I recommend?

1. provide tax incentives for refiners to operate more efficiently in emitting greenhouse gases. Offset the costs of implementing these efficiencies via the benefit of the tax incentive.

2. work towards global implementation of this policy. Without global agreements on this front, refiners will increase operations in regions with lower costs.

3. promote the clean development of greater oil production facilities here in the United States to lessen our dependence on foreign oil. This oil production can be offshore or in Alaska, both of which are viewed as fertile oil fields.

Embrace business, regulate it appropriately, and help our economy grow. I believe this cap and trade legislation will do the exact opposite which is why I would categorize it as ‘cap and close.’


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