President-elect Obama has made it clear that he intends to tackle energy security and climate change. He’ll focus on investments in renewable energy, creation of millions of jobs aimed at improving infrastructure (including energy efficiency improvements) … and creation of “an economy-wide cap-and-trade program to reduce greenhouse gas emissions 80 percent by 2050″. While there are clearly many competing priorities at the moment, the general expectation is that Obama will follow through on these commitments and, in particular, that the US will pass cap-and-trade legislation by the end of 2010. We won’t try to engage in political prognostication here, but we do think it’s important to get a sense of what this will mean for businesses and the economy. Specifically, what will it mean to implement a carbon cap-and-trade scheme – or, more generally, a price on carbon?

At the highest level, let’s start by trying to attach an economic value to a carbon price. According to the EIA, total carbon dioxide emissions in the US were just over 6 billion metric tons of carbon dioxide in 2007 . So, take whatever your favorite carbon price is, multiply by 6 billion, and that’s roughly the annual economic impact. A few possibilities:

• $22 Billion. In the latest auction for allowances (equivalent to one short ton of carbon dioxide, or approximately 1.1 metric tons) for The Regional Greenhouse Gas Initiative (RGGI, for short – the first carbon compliance market in the US) held on December 17, 2008, the price per allowance was $3.38. That translates into a price of about $3.73 per metric ton of carbon dioxide. Using that price we arrive at the above economic impact of a little over $22 billion.
• $120 Billion. The largest existing cap-and-trade implementation is the European Union’s Emissions Trading System. According to Point Carbon, prices for a metric ton of carbon dioxide in that system have ranged between about €15 and €16 per metric ton over the last month. At an exchange rate of about $1.36 per euro, that translates into more than $20 per ton. Longer term, prices per ton have ranged as high as about €25, which would increase the US impact to about $200 billion.
• >$300 Billion. According to a 2007 analysis by McKinsey & Co., the U.S. could abate about 50% of total greenhouse gas emissions at a marginal cost of $50 per ton. Thus, if we use the cap-and-trade system to achieve that abatement, the cost per allowance would need to be at least $50 in order to create the required economic incentive to adopt greenhouse gas abasement approaches, yielding an economic impact from the cap-and-trade system of more than $300 billion. And, in fact, there’s no real assurance that US companies and consumers would actually implement the required changes just because it’s economically advantageous. The result: the real allowance cost required to achieve the desired greenhouse gas reductions could actually be much higher.

With numbers like these, carbon cap-and-trade will clearly have a significant economic impact on US businesses and global competitiveness. But which industries will be most affected? And what kinds of actions will they take to respond? And, ultimately, how can we ensure that any such mechanism achieves its desired greenhouse gas reduction objectives without unduly affecting firms’ ability to compete on the global stage?