Tuesday, July 7, 2009

Cap and Trade: The Conservation Price Increase Wave

How you do you see energy prices increasing due to Cap and Trade? What kind of costs will households face with the new energy tax?

The $179 per year Obama Administration estimate per household or the $1300 per year Heritage Foundation estimate?

Let us take an average of the two estimates and go with a $740 energy tax increase per household due to Cap and Trade.

If the assumption above of $740 is our base line, consider another wave influencing price: the results of Consumer Energy Conservation in the environment of Public Utilities.

Please consider the following:

(a) The Raleigh, NC (Triangle Area) had a prolonged drought. Citizens were asked to conserve water. Commercials ran on TV to conserve water. The Governor went on TV many times and asked for water conservation,

(b) People did in fact conserve water,

(c) After the drought ended consumers continued to conserve water as the State of NC fostered a water conservation program on a continuous basis pointing to the probability of future droughts,

(d) The infrastructure and labor of the Raleigh, NC water system was based on "X" revenue per year. The treatment plans, sewers, water lines, etc. required "X" revenue to cover financed infrastructure (Bonds) and variable costs such as maintenance of the infrastructure, supplies, and labor,

(e) The conservation of water created "X-2" revenue.

(f) The cost of a unit of water was then increased to cover the lower demand for water as the water system could not meet its expenses given the new level of revenue due to conservation.

Going back to our above assumption of $740 tax increase on energy prices. Wouldn't a rational consumer of energy reduce consumption to save money (conserve)? Its not that the consumer voluntarily wants to conserve, but the consumer is forced to conserve due to their budget which is constant in the short run and being faced with the new higher energy tax.

Looking merely at Electric Prices, a consumer in the short run can quickly unplug unused items, turn off lights, wash laundry on cold, etc., etc.. The consumer clearly has the ability to conserve.

As mentioned above, Public Utilities such as Water and Electricity have a rigid cost structures in the short and medium run. The cost structure is based on constant or increasing revenue. If Cap and Trade is passed, and consumers begin to conserve due to the new tax on energy, then revenue will fall for the Electric Utility.

The Electric Utility, faced with declining revenue and rigid costs in the short and medium run, will petition for a price increase to bring revenues back to pre-conservation levels.

Hence the Cap and Trade energy tax increases price which leads to conservation which leads to another price increase. Therefore, the $740 estimate above is really $740 + the public utility conservation effect.

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