The Copenhagen meeting on global climate change failed in part because economists’ blather about “efficiency” distracts from the real issues.
Wednesday, January 6, 2010 at 05:35PM After the failure in Copenhagen to reach an agreement to save the planet, pundits are grappling with the question, "Now what?" Typical are this op ed by Joe Stiglitz and this post by Robert Stavins. I react below to Stiglitz's (perfectly mainstream) suggestion that we proceed by getting every nation to adopt the same "carbon price" (whether by taxes, tradeable permits, or otherwise), and he suggests $80 per ton of CO2. Essentially, I'm saying—for the nth time—that economists don't understand the real world.
In addition to the very real political problems, there is a very practical problem that I guess is too mundane and simple for the pundits, economists, and other policy experts to discuss: At no point in time can there be a single carbon price that makes sense for both coal and petroleum. A carbon price that will kill off coal entirely will make no noticeable dent in petroleum consumption, and we need to reduce both dramatically. Here's the arithmetic.
According to EPA (see Figure ES-6), combustion of fossil fuels in the electricity generation and transportation sectors accounted for 62% of all US CO2 emissions in 2006. (Industry was 19%, and agriculture, commercial and residential were all single digits.) Electricity generation is overwhelmingly a coal problem—accounting for 83% of CO2 emissions from this sector. A ton of typical steam coal contains about 1400 lbs. of carbon, which will turn into 5,133 lbs. (2.57 tons) of CO2. If CO2 is assessed at $80 per ton, the price of a ton of coal would increase by $205. Since the national average coal price was $31.26 in 2008 (EIA link), that price increase would cause electricity generators to close their coal-fired plants as soon as possible and switch to natural gas, renewables, and (maybe) nuclear.
In contrast, $80 per ton for CO2 would raise the price of gasoline by only $0.80 per gallon (a gallon of gasoline generates ~20 lbs. or 1/100 of a ton of CO2). Obviously, that won't discourage use of highway fuels very much even though it would cost $110 billion per year in the aggregate. (EIA says US gasoline consumption is 138 billion gallons per year.) That's almost $1,000 per family per year and almost as much as the AIG bailout, and there's no substantial benefit. According to CBO, even a CO2 price of $191 per ton would not significantly reduce US gasoline consumption, in the short term or the long term, leaving its current 28% contribution to CO2 emissions to continue unabated.
Economists are guilty of setting a "perfect" efficient market-based system at war with "pretty good" solutions for the CO2 emissions problems. The most affordable solution for petroleum is CAFÉ standards (but if we make them as stringent as we need to, we'll have too much refining capacity, not a congenial thought for those still in my former industry). The most affordable and politically possible way to deal with coal may be to buy the mines and turn them into parks because anything else that comes close to making coal uneconomical will result in massive, protracted litigation about compensation for a "regulatory taking." The whole legislative conversation about markets, offsets (preserving rain forests, etc.), and carbon capture and sequestration ("CCS") grows out of the fantasy that we can achieve adequate CO2 emissions reductions without shutting down all coal mines and closing many refineries. We can't. Deal with it.
A version of this post appears as a comment on Mark Thoma's blog here.
Skeptic
From my response to an email correspondent who asks about my calculation of 80 cents per gallon and finds it hard to believe that would not significantly reduce demand:
My 80 cents per gallon calculation is just $80/ton x the CO2 yield of one gallon of gasoline (20 lbs.). I understand it is recommended that the carbon price be imposed as far upstream as possible for administrative reasons. I assume that means it would be imposed on the production or importation of crude oil, and at that level $80/ton of CO2 would be about $30-35 per barrel. If owners of crude oil at various stages have enough market power, they’ll try to pass through not only the carbon price but their additional inventory holding costs, but it’s also possible that the whole carbon price cannot be passed through and that producers will have to offset in the wellhead price some portion of the carbon price. So how about 80 cents per gallon at the pump plus or minus 20 cents?
Why would you find it hard to believe 80 cents a gallon would not have significant effect? Crude oil prices reached $147 in July 2008 and gasoline consumption hardly wavered: 
Distillate volumes varied more because they are used in trucks and other businesses which are more sensitive to economic conditions than consumers. The Great Recession officially started in December 2007 and was depressing consumption even before the oil price peaked.
But, you might argue, that’s just the short-term effect; when people understand gasoline will always cost 30% more than they’re used to, they’ll opt for more fuel efficient cars when it comes time to trade. I agree. But, according to OMB, existing CAFÉ standards are going to cause that result anyway. The more fuel efficient cars and trucks will presumably cost more, and the gas hogs will presumably cost a lot more so manufacturers can ration them to make their CAFÉ numbers. Adding artificially high motor fuel prices would presumably push people to choose the same more efficient new vehicles, but they will also be paying more to operate them (nearly $1,000 per year in my calculation). Also, the prices of new fuel efficient passenger cars should be higher than in the CAFÉ-only scenario because people will want those vehicles more and the gas hogs less.
I’m not actually opposed to a carbon price on petroleum products. I’m only opposed to the belief that carbon prices of $50 or $100 or even $200 per ton of CO2 will dramatically reduce the amount of petroleum consumed. I’ve been following this issue for about three years and have read stuff from lots of carbon price proponents and I’ve never seen any analysis with prices, vehicle miles traveled, MPG, etc. that predicts a big reduction in demand. It’s all just arm-waving, which is the reason I wrote this post—to try to get policy grounded in some quantified costs and quantified benefits. Further, squeezing coal out of the mix may INCREASE the demand for distillates, which can after all run gas turbines as well as natural gas. Having the same CO2 price on petroleum as on coal might help mitigate that tendency, and that would be a reason to do it. I think reducing US dependence on oil, especially imported oil, should be a priority—not to prevent global climate change but to put our balance of payments more in order and to reduce the vulnerability of our economy to big petroleum price spikes (which always cause recessions). Reasonable people can disagree about that as a policy goal, but there’s a lot less room for a data-backed argument about the effectiveness of highway fuels prices to achieve that goal, imho.
Skeptic
Trucks and SUVs over 8,500 pounds gross weight including Hummer H-1 and H-2 (H-2 rated 10 mpg city and 14 mpg highway) and Ford Excursions (rated 8-10 mpg city and 12-14 mpg highway) have not been subject to CAFE standards, but the demand for them fell so much when fuel prices began to rise from $1.50 in 2003 to over $3.00 in 2007 that they have been dropped from Detroit's product lineup. The vast majority of SUVs (including Hummer H-3, Ford Explorers and Expeditions, Cadillac Escalades, and Lincoln Navigators) have been subject to the light truck CAFÉ standards since 1979, and the standards were raised starting in 2004. But even before the CAFE increases could have much effect, there was a shift in buyer preference away from SUVs, toward passenger cars. (The passenger car market share hit an all-time low of 45% in 2004 and has since climbed back to over 50%, according to CBO.) Therefore, it seems these changes in consumer preferences should be attributed to fuel price changes and only slightly, if at all, to CAFE standards. But the key question is how much these price changes, or additional increases from carbon pricing, will increase fleet fuel economy when consumers have fully reacted to them.
Obviously, increasing fuel prices have a much bigger impact on the behavior of people who own gas hogs than they do on the owners of fuel efficient vehicles. If you buy a lot of gas, a small price increase may make a big difference to you on a monthly or annual basis. If you buy only a few hundred gallons per year, you may be relatively indifferent to price changes. In other words, the more efficient your current vehicle is, the bigger gasoline price increase will likely be required to motivate you to switch to a more efficient vehicle. Assuming 12,000 miles per year, here's how MPG rating translates into gallons per year and declining impact of price increases with increasing MPG.
|
MPG rating |
Gallons per year |
Annual fuel cost at $2.00 per gallon |
Annual fuel cost at $3.00 per gallon |
Annual cost increase caused by $1.00 price increase |
Could save at $3.00 per gallon by substituting a vehicle that gets 10 MPG more |
|
10 |
1200 |
$2,400 |
$3,600 |
$1,200 |
$1,800 |
|
20 |
600 |
$1,200 |
$1,800 |
$600 |
$600 |
|
30 |
400 |
$800 |
$1,200 |
$400 |
$300 |
|
40 |
300 |
$600 |
$900 |
$300 |
$180 |
|
50 |
240 |
$480 |
$720 |
$240 |
$120 |
|
60 |
200 |
$400 |
$600 |
$200 |
At 12,000 miles per year, the owner of a (discontinued) Ford Excursion will have to buy about 1,200 gallons of gasoline, whereas the owner of a Cadillac Escalade hybrid (rated 22 MPG) would only need to buy 545 gallons. At $3.00 per gallon, that's a difference of $1,965 per year; at $4.00 per gallon, $2,620 per year. Apparently, tens of thousands of buyers were influenced by economics like that, drying up the market for extreme gas hogs. To take the next big fuel economy step would involve switching to something much smaller like the Ford Escape hybrid (rated 32 MPG). That would save an additional 170 gallons per year, $510 per year at $3.00 per gallon and $680 at $4.00 per gallon, which is only 26% of the savings of switching from the Excursion to the Escalade.
Going toward the bottom of the table, the owner of a Toyota Prius (rated 46 MPG) uses only 261 gallons of gasoline per year. If that owner switched to a plug-in auto that used no gasoline at all, his/her annual gasoline cost savings would be only $783 at $3.00 per gallon and $1,044 at $4.00 per gallon. In this price range, it's hard to see much incentive for a Prius owner to make that change unless the plug-in auto has identical or more desirable characteristics and is subsidized in some fashion.
Notes: The national average gasoline price spiked at over $4.00 per gallon in 2008 and is now $2.81, per EIA. The CBO economic and budget issue brief, Climate-Change Policy and CO2 Emissions from Passenger Vehicles is an excellent meta-analysis and summary of CAFE, carbon pricing, and gasoline price elasticity as they relate to passenger vehicle fuel consumption. EIA projects that the effects of growing population and vehicle fleet will just be offset by the mandated fuel economy of the new CAFE standards. Link. Thus, whether or not there is a cap/trade program or other carbon price mechanism, it appears there will be no reduction (or increase) in US use of petroleum over the next dozen years and that our contributions to GCC from petroleum use will also be stagnant. It's all about coal.
Skeptic
Robert Stavins discusses some of the pending legislative and regulatory alternatives for addressing global climate change here. Using the same basic insight about the relative impact of carbon pricing on coal and other fossil fuels, I posted the following comment on the Stavins piece on Economist' View.
The closer we get to the real issues, the more interested I get in GCC legislation. Although showing promise, Stavins is still behind the curve in that regard.
There is probably no more important political fact than that carbon pricing is very bad for coal interests, nearly neutral for petroleum, and very good for natural gas. This results from starting by appeasing the god of economic efficiency with a system that generates a single price for all CO2 emissions regardless of source. That leads to the drama in Congress about trying to prevent the shuttering of the coal mining industry and write-off of coal-fired power plants (e.g., by making it possible to substitute “offsets” by “preserving” Amazon rain forests, etc.) and/or obscuring the attack on coal by assigning to the “market” responsibility for determining outcomes (so that elected representatives of the people can deny responsibility for lost livelihoods). A more realistic legislative approach might be to buy all the coal mines and turn them into wildlife preserves and soccer fields.
In support of the first sentence above, consider the following. According to CBO, a price of $191 per ton of CO2 would not reduce consumption of highway fuels at all below what they will be under existing CAFÉ standards. To see why this is so, consider how the $80/ton price recently proposed by Joseph Stiglitz would affect coal and gasoline. A ton of typical steam coal contains about 1400 lbs. of carbon, which will turn into 5,133 lbs. (2.57 tons) of CO2. If CO2 is assessed at $80 per ton, the price of a ton of coal would increase by $205. Since the national average coal price was $31.26 in 2008, that price increase would cause electricity generators to close their coal-fired plants as soon as possible and switch to natural gas, renewables, and (maybe) nuclear.
In contrast, $80 per ton for CO2 would raise the price of gasoline by only $0.80 per gallon (a gallon of gasoline generates ~20 lbs. or 1/100 of a ton of CO2). Obviously, that won't discourage use of highway fuels very much even though it would cost US consumers $110 billion per year in the aggregate. In the US, about 60% of petroleum is converted into gasoline; other major products are motor diesel, jet fuel, home heating oil, and a variety of industrial uses, none of which were addressed by the CBO report; however, I doubt a price increase of 20-30% in these fuels would dramatically reduce consumption of them either, but you use your own business judgment. Bottom line: a price of $80/ton of CO2 could cause an INCREASE in consumption of petroleum products as utilities switch from coal fired units to gas turbines (which were originally designed to burn petroleum distillates, not natural gas, in the stratosphere).
So why does the petroleum industry seem so upset by cap/trade? I suggest they are not really upset but are just routinely opposing and exploiting opportunity. They have a budget and team for federal government relations and will devote it to whatever issues on are on the table, which at the moment includes threatened government “interference” in their business—even if the “interference” might help their business. In contrast to this routine opposition, if you want to see what a petroleum industry full court press looks like, if you want to see the sky over DC darkened by corporate jets and the finance chairs of Senate re-election campaigns worked to exhaustion booking contributions, bring a repeal of the IRC oil depletion allowance close to a floor vote. Furthermore, it is routine in Washington to demand something of value in exchange for any legislative initiative that can be plausibly claimed to have an adverse effect on one's industry. This isn’t a crisis for the oil industry—it’s an opportunity.
From EPA’s most recent report on US contributions to global climate change, using 2006 data: CO2 accounts for 85% of total greenhouse gas emissions, 94% of which come from burning fossil fuels, and about 41% of that comes from coal. If petroleum consumption will not change substantially and natural gas consumption will increase, any aggregate net change must come from reducing coal consumption. Legislation that does not respond head-on to this reality may pave the way to re-election of incumbents but won’t ameliorate the GCC problem.