Markets with transparent supplies and demands are extremely efficient and responsive markets.  Perhaps no market epitomizes this as cleanly as do electricity markets, where suppliers announce the amount of electricity they can produce and at what cost to auctions that are run almost hourly to meet the consumers’ fluctuating demand.  The bids are compiled and the contracts are awarded to the several companies that can produce the needed amount of electricity for the lowest cost. 

However, not all electricity generators are created equally, and often the cheapest sources cannot meet demand on their own, and other more expensive sources must be added until the demand is met.  Once the demand is met by using the lowest cost suppliers, the most expensive supplier in that mix sets the price the whole group will earn.  This is termed the “market clearing price.”

This is relevant to our discussion of cap and trade costs to consumers for two reasons, one which produces the intended goal, and the other which produces windfall profits with no discernable benefit to the average consumer.  The costs associated with a cap and trade system (buying the allowances and buying new equipment to avoid emissions) will raise the cost of carbon based electricity generation, which sets the market clearing price for electricity a great majority of the time (as often as 70% for coal alone in one regional electricity market[1]).  By raising the cost of the most expensive supplier in most of the country’s energy mix, the price the other suppliers in that mix are able to charge also increases, even for those that do not emit carbon such as nuclear and hydropower generators.  This means the consumer is paying to cover the carbon emitter’s efforts to avoid carbon emissions, but also pays windfall profits to those companies that were not emitting carbon in the first place.

The figure below illustrates the market clearing price for a generic electricity market, and effects of increasing production costs on carbon based generation.  The difference between the two lines is the cost increase of complying with a generic cap and trade scheme, and demonstrates the windfall profits that can be expected by non-carbon emitting companies for no discernible change in economic activity.