Republican presidential candidate Donald Trump's recent collapse in the national polls has caused the odds of a Democratic sweep of the White House, Senate, and House of Representatives in November's elections to narrow substantially over the last week. While the weight of probabilities continues to be for a split government, the Democrats are now widely expected to take the White House and Senate, while the likelihood that they take the House of Representatives has increased from 9% last month to 29% earlier this week, according to Predictwise.
Talk in the policy community has quickly turned to envisioning what type of energy and climate measures the Democrats would take following a successful November sweep. While Hillary Clinton made favorable comments regarding domestic oil and gas production at private (and highly-paid) speeches given over the years to business audiences, the Democratic path to victory in the House of Representatives would come at the expense of moderate Republican seats. The Wall Street Journal has suggested that President Clinton would be forced to rely on her party's radical Sanders-Warren wing to pass legislation in such a scenario, and it would likely insist on stiff environmental measures in exchange (especially given outrage among the Sanders-Warren wing following the release of Ms. Clinton's private speech excerpts).
Talk has already started that Ms. Clinton and her allies in Congress would quickly restart work on comprehensive cap-and-trade legislation following a full sweep. America narrowly avoided the creation of a similar program in 2009 in the form of the American Clean Energy and Security Act, informally known as Waxman-Markey after its sponsors. Barack Obama had recently moved into the White House and the Democrats held a majority in the House of Representatives and a supermajority in the Senate. This legislation was passed by both bodies, albeit in slightly different forms, just before the summer recess.
The Democratic leadership made the decision to save the conference at which both versions of the bill were to be reconciled until after the recess. Senator Ted Kennedy of Massachusetts succumbed to a brain tumor over the break, however, temporarily depriving his party of its filibuster-proof supermajority in the Senate. This deficiency was made permanent after the GOP did the unexpected and won the special election for Mr. Kennedy's seat. (Mr. Kennedy's seat was lost to his party after the Democrats nominated one of the least-effective candidates in recent history, Martha Coakley, to fill his spot. Ironically, cap-and-trade is back in the discussion because the Republican presidential candidate is behind in the polls in an election that, by all indicators, should have been in the bag for the GOP from the beginning of the campaign.) The Obama administration's Clean Power Plan, which is currently tied up in federal court, is the culmination of his threat to resort to executive action in the event that Congress failed to move forward with cap-and-trade after Mr. Brown's election. While regional carbon markets are operating on both coasts, a national carbon price has long since died a quiet death in Congress.
Back from the dead?
Mr. Trump's lengthening odds of winning in November as measured by the prediction markets and various political models have provided environmentalists with new hope that Waxman-Markey, or at least a similar incarnation, could be on the brink of rising from the grave (and just in time for Halloween, no less). Amy Jaffe wrote in the Wall Street Journal last month that a tax or price on carbon emissions in the U.S. is now "close to inevitable" in an article that has gained new life this week. George Banks's riposte that GOP opposition in Congress makes such a result unlikely is a little less convincing than before as the chances of a Democratic sweep have increased.
Proponents of cap-and-trade in the U.S. further point to the fact that a majority of utilities and energy firms either employ a carbon price in their internal budget models or will do so by 2018. Ms. Jaffe estimates that oil and gas firms employ internal carbon prices ranging from $40/ton to as much as $80/ton. For comparison, the European Union's Emissions Trading Scheme has carried a price of around $6/ton for the last several quarters, and even California's carbon price has struggled to exceed $13/ton for the last three years. If correct, then Ms. Jaffe's estimate indicates that these oil and gas firms have vastly overestimated the willingness of policymakers in even the most politically-green developed economies to mitigate their greenhouse gas emissions.
Big Oil: Aye! The People: Nay!
Assuming that a Democratic sweep occurs (which, I should add, continues to be unlikely, albeit far more likely than a month ago), then the political will could exist to implement Waxman-Markey version 2.0. This is especially true if, as had been expected among political analysts even before Mr. Trump's recent swoon in the prediction markets, the next Senate ends the filibuster, thereby eliminating the need for a Democratic super majority. Even two of the world's largest publicly-traded oil and gas firms, Exxon Mobil (NYSE:XOM) and TOTAL SA (NYSE:TOT), have actively supported a U.S. carbon price for at least a few years now (although cynics argue that this stance could change when Republicans are no longer in a position to block such a measure). But are American voters ready for a return of Waxman-Markey?
Interestingly, given the presence of support from both politicians and Big Oil, the answer appears to be in the negative. A recent poll conducted by the University of Chicago and the Associated Press found that only 25% of Americans expect the world to achieve the greenhouse gas emission reduction targets established by the COP21, or Paris Climate Agreement, let alone the targets necessary to keep atmospheric CO2 below 450 ppm. That is not to say that Americans believe that climate change is a hoax, with fully 77% of respondents saying that "climate change is happening" and a clear majority (65%) agreeing with the statement that "climate change is a problem that the U.S. government should address."
This support for action to tackle climate change quickly disappears as its costs to households increase, however. 57% of respondents expressed support for a carbon price if it increased their household's annual electricity bill by $12. This majority became a minority (39%) when that cost increased to $120, and only 1 out of 6 respondents continued to show support when the cost increased to $480 annually. This is actually lower than in 2009, when 58% of Americans were willing to incur annual household cost increases of $120 to combat climate change. Support among American voters, in other words, has declined even as global support for emission-reduction measures has grown (2009 was notable for the failed Copenhagen negotiations, for example, whereas the 2015 Paris Agreement has been quickly ratified by its signatories).
Threading the needle
There is a third option, albeit one that has little support from the U.S. political left. A carbon price is a classic example of a Pigovian tax, which is a levy that is imposed on a market activity that incurs a negative externality. Taxes necessarily inhibit the behavior that they are imposed upon, making income taxes something of a necessary evil for generating tax revenue. Carbon prices (and carbon taxes) can be set up in such a way as to be revenue-neutral and therefore not impose additional costs on taxpayers. For example, the tax revenue generated from the carbon price can be offset by reductions in income taxes. Economically this is a very efficient measure, as a tax on a behavior that policymakers do not want to discourage - working - is replaced by a tax on a behavior that policymakers do want to discourage - the emission of greenhouse gases. When integrated oil and gas firms such as Exxon Mobil state that they support cap-and-trade, they are really referring to a revenue-neutral measure. In theory, this is something that all stakeholders can support: Republicans since it is revenue-neutral, Democrats because it discourages emissions and business because it provides a level playing field.
Unfortunately for the global climate, a revenue-neutral cap-and-trade program is not good enough to receive unanimous support. Specifically, environmentalists prefer to see a revenue-positive program since the additional taxes can be directed toward clean energy R&D, subsidies and economic redistribution. (Waxman-Markey was revenue-positive.) Certainly the former is important, given that existing renewable energy technologies are inadequate at the role of completely replacing fossil fuel technologies. It is unfortunate that this pursuit of perfection has prevented enough of a consensus from being reached to permit the implementation of a merely "good" measure such as a revenue-neutral program, however.
Implications for investors
This situation creates an interesting situation for investors. Revenue-positive cap-and-trade legislation is extremely unlikely to make it through Congress if the GOP retains its majority in the House of Representatives, as is still probable (if less probable than before). Republicans can certainly claim that they are simply expressing the will of voters given persistent opposition in the polls to a revenue-positive carbon price or tax. On the other hand, if the Democrats do sweep in November, they will undoubtedly claim a popular mandate that, for emission reduction measures at least, does not appear to exist.
This raises the prospect that its politicians will resort to less conventional and, by extension, less visibly costly measures of reducing emissions. As I detail in an earlier article, recent trends indicate that these measures could utilize Department of Justice investigations into and large penalties being levied on oil and gas companies such as Exxon Mobil, Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP), since these firms are the largest U.S. reserve-holders. Such efforts would still cause costs for consumers to increase, of course, but in a less visible manner than as a line item on a household's monthly utility bill. The Sanders-Warren wing of the Democratic party has already expressed strong support for such unconventional measures on the grounds that any increase to fossil electricity capacity (natural gas included) after next year will cause the so-called "global carbon budget" to be exhausted.
It is more likely than not that the Democrats will win both the White House and a Senate majority in November's elections, giving the U.S. political left a majority in the Supreme Court as well after Justice Antonin Scalia's empty seat is filled. All indications point to new policies being implemented to reduce the country's greenhouse gas emissions in accordance with the Paris Climate Agreement. What form those policies take, on the other hand, will depend on whether the Democrats sweep in November and how contentious the final result is (Mr. Trump has already hinted at reproducing the type of political uncertainty that reigned in November 2000 if the presidential election is even remotely close).
A revenue-neutral cap-and-trade program of the type that U.S. oil and gas majors have assumed will exist is the most feasible option given popular opposition to a revenue-positive program, although this will likely require Republican support to offset a lack thereof from the Democratic party's radical wing. On the other hand, a contentious end to the dirtiest presidential election in recent history and/or a sweep by the Democrats would result in a potential gridlock that the Democrats would break by resorting to the type of unconventional measures that the oil and gas sector fears most. The events of the weeks after the election results are announced will be as important an indicator of the oil and gas sector's regulatory prospects in 2017 and beyond as Election Day itself.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.