The impact of a carbon cap-and-trade system on electricity prices depends on both the stringency of the cap and how easy it is for utilities to shift away from fossil fuels. Under a cap, power prices will rise until electricity demand falls by enough—or a sufficient amount of renewable generation is brought online—that the demand can be met without going over the carbon cap. Whether carbon-emissions permits are auctioned or given away for free has no impact on this market-clearing electricity price.

The auction-or-giveaway question does, however, have a significant impact on power-company profits. When pollution permist are given away for free, power companies get to raise prices but don't face a correspondingly large increase in their expenses. With auctioning, they raise prices by the same amount, but their expenses go up as well. There's a March Madness analogy here: A ticket scalper is going to charge the same amount—the going black-market price—whether he's selling a ticket that he found on the ground or a ticket that he bought. He's just going to turn more of a profit if he found it on the ground.

So it should come as no surprise that the electric industry is strongly in favor of the free allocation of carbon permits, or that they've hired an alarming number of lobbyists to convince Congress to give away permits for free. What's more interesting is the news, reported in this Greenwire story, that the electric companies might be starting to squabble among themselves over the question of just how to distribute those free permits.

The current position of the Edison Electric Institute (EEI), the trade lobby that represents about 70 percent of the U.S. electric industry, is that emissions permits should be given away according to a complex formula that allocates some permits on the basis of total electricity sales (a method that would favor efficient utility companies) and some on the basis of historical carbon emissions (a method that would favor the biggest polluters). But utilities with a coal-heavy generation mix would prefer that all of the permits be given away on the basis of historical emissions. It now appears that at least one of those utilities is ready to jump ship. Earlier this week, the CEO of American Electric Power, a coal-dependent utility company that's a member of the EEI, sent a letter to Congress saying that all permits should be allocated on historical emissions. The letter was enough to make other utility CEOs wonder out loud whether the industry's united lobbying front was starting to fall apart.

It will be interesting to see if the utility companies can hold their coalition together, because what they're facing is a real-life prisoner's dilemma—one in which hundreds of billions of dollars are likely at stake. There's a temptation for individual utility companies—or groups of like-minded utility companies—to defect from the consensus and propose methods of carbon-permit allocation that would give them more free permits than their competitors. But if too many companies chose to defect rather than cooperate, it will become evident that any method of free distribution is ultimately arbitrary and has no bearing on anything besides the wealth of utility company shareholders. You might as well go through the phone book and allocate all of the emissions permits to people whose last name ends in "I."

Here's hoping that the utilities turn on each other, because so far they've been pretty successful in their collective disinformation campaign aimed at convincing lawmakers that free allocation of permits will somehow lessen the impact of cap and trade on consumers. Several members of the "Gang of Sixteen," the group of moderate Democratic Senators who opposed the Lieberman-Warner cap-and-trade bill, seem convinced that cap and trade with some free allocation of permits is the respectable centrist position rather than a naked giveaway to industry. And environmental groups aren't helping to clarify matters when they argue that there are environmental reasons for auctioning (there aren't, as Robert Stavins explains) rather than just equity reasons, which ought to be compelling in themselves. Obama may be pushing for 100 percent auction, but in Congress—which is where it really matters—it is still the power industry's game to lose.

(Flickr photo credit: Wigwam Jones)

--Rob Inglis