As we have seen in previous articles, the cost associated with cap and trade regimes are often disproportionately borne by the lowest segments of the economic distribution, and the benefits most often accrue to those in the highest segments.  This is true whether the allowances are given away for free by or purchased from the government.  The mechanism by which this phenomenon operates is explained by the Congressional Budget Office in its recent analysis of Waxman-Markey: 

“The cost of obtaining allowances would be passed into prices in most cases because that cost would raise firms’ variable production costs (that is, the costs to produce additional units of output). In contrast, the receipt of allowances that is not linked to the quantity of output would represent a reduction in firms’ fixed production costs. Businesses generally do not change prices in response to changes in fixed costs as they do in response to changes in variable costs.  Therefore, the value of the allowances received would generally accrue to shareholders (or perhaps workers in some cases).”[1] 

In plain language this means the companies are expected to take the excess wealth generated from their free allowances and transfer it to their shareholders instead of reducing the prices they charge consumers.  Conversely, the costs of complying with the regulations are passed on to their customers regardless and are not expected to be paid for with reduced profits. 

Indeed, the cost of complying with the program is passed along to consumers whether or not there is a net cost borne by the company or not.  When a company is given free allowances, the government expects the company to return some of those allowances to meet their statutory CO2 reduction requirement.  However, since the allowances have a real value on the open market, the company experiences an opportunity cost by not selling them to some other company.  This means a company’s bottom line profit is lower than it could be, and especially so relative to their competitors who could also—and may well be—selling their allowances on the open market.  To compensate the firm for the wealth they might have gained had they sold their allowances, the firm raises the prices they charge consumers, and passes the wealth to their shareholders.  Synapse Energy Economics, Inc., an energy consulting firm, explains the mechanism thusly: 

“The approach that yields the highest cost for consumers is allocation of allowances for free to generators. This is because consumers in deregulated regions will pay much more than the cost of mitigation in increased energy costs, whether or not generators themselves pay for the allowances. Unregulated generators will include the opportunity cost of allowances in their offers to sell electricity, as they should if the underlying economics of cap-and-trade are to function. Thus allocation for free to unregulated generators represents an additional source of windfall profits for their shareholders, and is not necessary to offset costs associated with emission regulations.”[2]