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June 27, 2009

Cap and Trade Will Severely Harm the Steel Industry

Dian L. Chu, 06/27/09

Landmark legislation to curb U.S. greenhouse-gas emissions was approved by the House of Representatives in a close vote late Friday, June 26, 2009. Obama and other Democratic leaders insisted it will spur job-creating investments in "green" technologies, while lessening U.S. reliance on foreign oil. The numbers are staggering.

Obama's recently unveiled cap-and-trade plan would raise $645 billion in revenue from government-run emissions auctions over eight years. The nonpartisan Congressional Budget Office (CBO) projected the bill to have an annual economy-wide cost in 2020 of $22 billion, or about $175 per household. However, the CBO study failed to consider the broader effect of the legislation on employment or GDP. The hit on the U.S. GDP is the real threat of the bill.

A cap-and-trade system is simply a mechanism to put a price on emissions in order to compel businesses and consumers to emit less. That is, it's essentially an emissions/energy tax, since almost all economic production activities are powered by combusting fossil fuels (coal, oil, and natural gas), a process that emits greenhouse gases. Once a scarce new commodity, i.e., the right to emit carbon, is created, and businesses are mandated to buy it, the costs would inevitably be passed on to all consumers in the form of higher prices. Everyone would feel the pinch. These higher prices on electricity and gas will show up in the manufacturing sector from food to cars, all the way down to electricity bills and at the gas station. The hardest hit would be on the working families, which is about 95% of the U.S. population. As higher prices are passed along to the consumer, consumers will cut back on spending, which in turn will reduce production resulting in fewer jobs or higher unemployment. Some companies will instead move their operations overseas creating further loss of jobs.

One may also take a look at similar policies already implemented elsewhere. For example, in Europe, cap-and-trade has failed to deliver on climate change. It yielded windfall profits for utilities, but few reductions in emissions or investments in clean technology. Britain's Taxpayer Alliance estimates the average family there is paying nearly $1,300 a year in green taxes for carbon-cutting programs in effect only a few years. Spain has been touted as a global example in promoting renewable energy to create green jobs. But research shows that each new job cost Spain 571,138 euros, with subsidies of more than one million euros required to create each new job in the wind industry. Moreover, the programs resulted in the destruction of nearly 110,000 jobs elsewhere in the economy, or 2.2 jobs for every job created.

Business groups in the U.S. are split on the measure. Utilities that stand to benefit from the free-permit program support it. The U.S. Chamber of Commerce and the National Association of Manufacturers lobbied against it. The oil-refining sector that will receive 2% of the free permits, denounced the measure as "an abject policy failure." Steel companies also opposed the measure. The domestic steel industry would be one of the hardest hit sectors and could be severely impacted under the cap-and-trade system. The integrated mills such as U.S. Steel Corp. (X), AK Steel (AKS), ArcelorMittal (MT) and OAO Severstal would be among the biggest losers because they produce steel using iron ore and coke. The main input material, coke is made of carbon. If steel companies are mandated to reduce carbon-dioxide output or pay more for their emissions, they would be forced to raise prices or cut production. Under the worst case scenario, the integrated steel operations would move to developing nations without carbon restrictions, such as Brazil. In this case, the carbon emissions wouldn't be reduced, but U.S. jobs would be lost.

On the other hand, minimills, like Nucor Corp (NUE), and Commercial Metals Company (CMC) make new steel by melting down scraps. Re-melting steel emits nearly 66% less carbon dioxide in the production process. Nucor Corp. (NUE) is now the largest producer of domestically made steel, having supplanted U.S. Steel (X). However, it is not feasible to switch domestic steel operations entirely over to the minimill process, because some types of the more rust resistant steel, such as cans for food, still have to be made through the integrated steel process. While minimills wouldn't be affected as much as integrated mills by the legislation, they still oppose the current plan. Both camps are concerned the bill could give a competitive advantage to firms in countries that don't operate under emissions caps.

Another potential problem area: the House bill has a provision that would impose tariffs on goods imported from countries that don't match U.S. carbon dioxide restrictions, like China and India. Naturally, these countries would retaliate by putting tariffs on U.S. exports, which could provoke a global trade war. Protectionism deepened the Great Depression, just as climate protectionism would worsen the current recession.

Although it isn't clear how much of the House bill will survive in the Senate, in the case of climate change, we need to create strong incentives to increase energy efficiency throughout the economy and to invest in new clean-energy infrastructure. Cap-and-trade is an ineffective tool for that, because it does not reliably end fossil fuels' price advantage. Given the current economic crisis, an expensive energy policy is a very bad idea. Most economists agree that the simplest, most efficient system to reduce carbon emissions is via a direct tax, a political impossibility in the U.S.; therefore, we ended up with the cap-and-trade system. Just as the stimulus program has very little allocated to projects that will actually create jobs to revive the economy, the current cap-and-trade system, instead of being an effective clean air policy, is just another tax burden on both businesses and consumers.
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Item Reviewed: Cap and Trade Will Severely Harm the Steel Industry Rating: 5 Reviewed By: EconMatters