Nails in the Cap and Trade Coffin

We may never see cap and trade in this country.

Those are words I never thought I'd write.

In fact, I've been touting the benefits of a cap and trade market since 2007. But new ideas, unraveling facts, and recent events have changed my thinking.

So today, I'm publishing my first ever mea culpa.

Carbon Top Stocks Should Still be Priced

To be clear, I'm not saying that carbon should have a price. By all means, it should.

What I'm saying is that cap and trade isn't the way to implement it.

At the end of the day, carbon dioxide is a harmful waste product that needs to be handled. Companies don't get free passes for treating and disposing of other waste streams their businesses generate. Why should carbon be any different?

Not charging companies for emitting carbon is giving them free reign over something they cannot and will not ever own: the atmosphere.

We don't let companies freely dump waste into rivers or lakes... We don't allow companies to dump waste in forests... So why, then, are we still letting companies dump a known pollutant into the atmosphere unchecked?

This is why everyone speaks of how cheap coal is. It's not really that cheap, we just don't include the price of carbon in its costs.

Carbon isn't a business externality — meaning, companies that produce it can shift the cost to society — and it can no longer be treated as such.

The Trouble with Cap and Trade

Many issues have arisen as Europe and Asia implemented their post-Kyoto cap and trade schemes.

Chief among them has been fraud.

Last week, Spanish police arrested nine people for committing cap and trade fraud valued at $67.54 million. Arrests have also been made in Britain, with ongoing investigations in France and the Netherlands as part of an in-depth investigation into carbon fraud estimated at $6.75 billion.

Carbon fraud is committed, according to Reuters, when companies buy carbon emissions permits in one country without paying value-added tax (VAT), and then sell them in another adding tax to the price but pocketing that difference for themselves.

The complexity of the system, in addition to the fraud itself, is another knock against cap and trade. With highly bureaucratic language and complicated rules, cap and trade hasn't delivered the intended results.

Instead, the unintended result of lining the pockets of lawyers and trading firms has been more common.

What's more, a cap and trade system is volatile by definition. Allowing traders to bid on the price has caused wild swings in the price of a ton of carbon. Again, this is good for traders — but not beneficial for the energy companies that make important business decisions based on the price of carbon.

Lastly, the costs and revenues associated with cap and trade aren't having the desired effect. The costs are being passed on to consumers, which is the complete opposite of what was intended. And the revenues, like I said, are going to lawyers and tax consultants instead of facilitating the growth of low-carbon technologies.

For all those reasons, I'm recanting my early support for pricing carbon with a cap and trade scheme. A carbon tax should be used instead.

Benefits of a Carbon Tax

For starters, a carbon tax immediately alleviates the concern of fraud. There are no projects to certify. And there are no carbon credits to be verified and sold. A tax eliminates the ability to profit, which eliminates the motive for fraud.

A carbon tax would also provide a reliable pricing mechanism. Rather than credits that fluctuate with investor sentiment, a tax would levy a constant cost for carbon that utilities and energy companies can use to plan long-term projects.

And the cost of a carbon tax won't be passed on to consumers. Instead, revenue generated from a carbon tax would be returned through dividends or used to offset other taxes, like payroll and sales tax.

A carbon tax can also be implemented more quickly, more cheaply, and with fewer convolutions than cap and trade.

And finally, a carbon tax can be used to put a price on carbon from all sectors that generate it. Cap and trade only applies to large sources of emissions like power plants.

As you can see, the case for a carbon tax is compelling... And there would still be plenty of profit implications for individual investors.

The Tax that Drives Profits From Top Stocks For 2011

In my early days of support for cap and trade, I was touting the personal profits it could deliver by investing in carbon credit verifiers and trading firms.

I now see that that thinking was a symptom of cap and trade's bigger flaws: It shouldn't benefit those types of companies; it should benefit clean energy companies.

Instead of paying for carbon permits, a tax would force utilities and manufacturing businesses to adopt more sustainable practices. That means more investment in efficiency and clean energy sources like the smart grid and wind and solar. A tax will also allow investors to focus only on technology solutions, rather than quibbling with paper-pushers.

And that's what Green Chip is really all about: profiting from cleantech solutions.

In short, moving away from cap and trade and toward a carbon tax would allow the energy world to focus on solutions for the problems at hand, instead of wasting precious time and money hammering out rules and regulations and cutting through red tape.