First Thoughts
  By Dan Gilmore - Editor-in-Chief  
  August 13, 2009  
  The Supply Chain and Cap and Trade  

“Sustainability” is already having a major impact on supply chain strategies and practice – but we may only be at the tip of the iceberg (is that iceberg melting or not, as an aside?).


For now, at least in the US, the Green supply chain movement has been driven largely by the opportunity to reduce operating costs (e.g., use less fuel) and, in many cases, a public image sort of thing, however sincere a company is about their efforts. Plus the pressure from Wal-Mart and a few others.


But now, for the first real time, US companies have the specter of some kind of actual, additional cost associated with carbon emissions – and the impact there could be substantial.


A few months back, I realized that for all the talk about “cap and trade,” hardly anyone actually had much of an idea what it really meant, including me. I even recently heard a Wal-Mart Sustainability executive say much the same thing.


So, a few things have happened since then: 

Gilmore Says:

If something is actually done, there is now a real cost to carbon emissions in the supply chain, costs that are especially unpredictable with cap and trade.

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We sub-title it “the Green Supply Chain 360°” because we are going to cover all sides of Green issues – it will have lots of news and examples, but also a variety of points of view on such topics. That balance is actually hard to find out there.


Back to cap and trade. I will do as best I can to summarize it here. A good, more in-depth description is in the Letter; even more in the report, both available at


At a high level, there are two approaches to using government policy to reduce carbon emissions: a carbon tax and “cap and trade.” While it seems most (but not all) experts believe a carbon tax would be more efficient and effective, cap and trade is the more likely of the two to be enacted in the US because it doesn’t contain the dreaded “tax” word, and, in my opinion, because legislators realize it is the one that actually gives them more power to make decisions on a continuous basis.


“Cap and trade” is by far the more complex of the two systems. It is a system that, in the end, is focused on the quantity of CO2 emissions. It would, ultimately, set a maximum of the allowable emissions in a base year and, in theory, ratchet that level down over time towards some long-term goal.


At the same time, a number of “permits” or “allowances” are created that, in total, equals that cap. They are distributed in some way (that’s where the fun begins), ranging from an auction, to free distribution, to some sort of a formula.


Because emissions are fixed, the permits begin to take on a value – and can cause some unusual things to happen. In the Cap and Trade versus Carbon Taxes report, we walk through an example in detail, but in summary, if two companies must each reduce carbon emissions, and one can do it much cheaper than the other (let’s say Company A), then Company A may sell one of its permits to Company B, rather than use the permit it has.


Why? Say the cost for reducing its own emissions is $50,000. But perhaps the market value for a permit is now at $100,000. Maybe it would cost Company B $125,000 to reduce its own emissions internally. So they are happy (sort of) to pay the $100,000 for a permit instead.


The key point: Company A actually netted $50,000 on the deal (it spent $50,000 internally, but sold a permit for $100,000.)


As you can imagine, all sorts of weird things can therefore happen. Just as an easy example, what if it is a brutally cold winter, and utilities and business are using a lot more energy to keep everyone warm, emitting more emissions than expected. The market price of permits could skyrocket.


A carbon tax, by contrast, is a price-based approach, rather than the direct quantity of emissions targeting focus of cap and trade. Under this system, a tax is placed on fossil fuel producers or importers at a rate that reflects the amount of carbon that will be emitted when the fuel is burned or used – data that is readily known across various oil-based fuels, natural gas, coal, etc.


That tax will be passed on by producers/importers in the form of higher prices. The higher prices should work in the market as a disincentive to businesses and consumers to use fossil fuels, or push them to move to fuels that emit less CO2.  


I hope I haven’t lost you yet.


Here, I believe, are several of the most important points out of this:


The Devil is in the Details: Under either program, the details can make the change a major burden and even competitive threat to businesses, or be more of just a nuisance, or somewhere in between. The details are critical – which is why a 1000-page bill that no one understands could be a disaster – or simply a waste of time (only political comment I will make here). As a simple example, at what levels would a carbon tax be set? Under cap and trade, how will permits be distributed/sold/allocated – and how will emissions really be measured? Will there be favoritism to certain industries, etc.


Depending on the Details, the Impact on Supply Chain Design and Execution Could be Substantial: If something is actually enacted, there is now a real cost to carbon emissions in the supply chain, costs that are especially unpredictable with cap and trade. On the flip side, in some cases there is even the potential for a company to profit from carbon efficiency by selling permits (some critics are actually warning of windfall profits for some companies that are basically being handed to them by the government).


So, carbon emissions and their costs would have to be directly integrated with supply chain decisions – and modeled and “scenario planned” the way many companies do now with fuel prices. What used to be the low-cost supply chain design may no longer be. And guess what – with a given SC design, you may be locking in a cost structure 10 years from now that you can’t really guess at today, as we don’t even have any law yet and the future price of permits and abatement are total unknowns.


Cap and Trade is Complex and Will Take Years to Really Move Forward: A carbon tax is far simpler, and could be enacted easily using existing tax system means. Cap and trade has many, many more moving parts, as should be clear. Lots of work for lawyers, consultants, and Wall Street types.


The Offshore Question Needs to be Dealt with: Unfortunately, the easy answer for many companies may be to stop producing products domestically – voila, a whole chunk of carbon emissions are gone. (As an aside, there could be other odd effects, like dramatically downsizing office space and more people working from home.)


India and China have both recently given mostly a cold shoulder to any notion of fixed caps for them, putting economic growth clearly as priority 1. So, we have and will get more calls for some sort of “carbon tariff,” under which we will somehow determine how much duty to add on to imported products, depending, I guess, on what country they came from and maybe even what factory. This would be to try to level the playing field versus the additional cost US companies are bearing under cap and trade or a carbon tax. Good luck figuring that one out.


We Will be Adding Still More Complexity and Volatility Into the Supply Chain: As hopefully is clear.

There’s a lot more, but I am out of room. Hope I was able to shed some light on these critical issues. A lot more in the SCD Letter, Cap and Trade Report, and new Green site. You can count on us to give you the information you need here on all sides of the issues.


Did we add any clarity around understanding cap and trade and carbon taxes? What are some key points you would add? Do you expect the impact on supply chains to be significant? How can we plan well today with this type of uncertainty? Let us know your thoughts at the Feedback button below.

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