Saturday, June 5, 2010

President Obama calls for a price on carbon. Will it work?

Posted by Dave Rochlin -

In a recent speech at Carnegie Mellon University, President Obama called for a price to be put on CO2 emissions, in order to move us on the path towards renewable energy. He figures the market will help do the rest.

" ...the only way the transition to clean energy will succeed is if the private sector is fully invested in this future, if capital comes off the sidelines and the ingenuity of our entrepreneurs is unleashed. And the only way to do that is by finally putting a price on carbon pollution."

A price on carbon has dual purposes:
  • It raises the cost of energy, which should encourage conservation.
  • It closes the cost gap between fossil fuels and alternative energy.
But will it work?

According to the most recent EPA greenhouse gas inventory, US greenhouse gas output is 7 billion tons a year. At a price of $25 per ton -- as envisioned in the Kerry-Lieberman American Power Act -- the total added cost if we priced all US emissions would be $175 Billion dollars per year, or about $1750 per household per year. Of course we won't be charging for all emissions....more likely just those above our 17% reduction cap, so the short term number (in grossly oversimplified terms) is really more like $350 per household....and that's only if we were not simply giving away all the permits. And in the long term? The senate bill targets an 80% reduction by 2050...but I'll believe that commitment when I see it.

I suppose this could show up as an additional $.25/gallon at the gas pump, or perhaps another $.01- $.02 per KwH for electricity. More likely, a lot of it would be buried in the cost of all the things we buy...carbon pricing by a thousand paper cuts!

When I talk about offsets (which I do a lot), I often have people tell me that a carbon tax is a much better answer, because it sends clear signals about the cost of consuming energy. So let's look at some major sources of emissions to see what pricing carbon might do:

Driving (roughly 20% of US emissions)
I really doubt that adding another $10 per barrel to the cost of oil is going to change driving habits or vehicle choices much. Demand only seems to change with massive ($30 or more per barrel) type price shocks, and even then only temporarily. If you don't like a Prius at $60 per barrel, you probably still don't like it at $70. Rather than carbon pricing, we either need to tax the real price of oil (including military expenditures, health costs, and deficit-related currency weakness) or simply rely on higher mandates on gas mileage, like the ones the EPA just enacted.

Flying (roughly 3-5% of US emissions)
Much of the cost of flying is fuel related, and this is an area where carbon pricing could have the greatest impact. While 10% at the gas pump does not scare drivers much, a 5% or 10% increase in the price of flying has a big impact on demand....there are plenty of pricing studies that confirm this. But even in this case, the drop in passenger miles would probably not hit the 17% reduction target. Of course airlines are already looking for exemptions to cap and trade in both the US and Europe. Perhaps we need some sort of mandatory fuel targets (per passenger) for airplane flights?

Electricity Generation (roughly 30% of US emissions)
For a home using 9,000 KWH per year, the carbon penalty would be around $15 per month. Most homes could easily save this much by using cold water for washing clothes and changing out a few lightbulbs, or shutting off vampire appliances and computers. And yet most of us don't. We don't seem to be that rational when it comes to electricity.

The utilities would look at both cost per kWH and capital expense, if it is a purely market based decision. Many uilities don't really compete, so any cost increases would simply be passed on anyway. This makes it rational to avoid new capital expenses, and stick with the old power plants. Emissions and renewable energy targets and other mandates (like additional scrubbers) could be much more impactful.

Industrial Energy Use (roughly 10% of US emissions)
Businesses have gotten smart about energy use in a big way. The more energy intensive the business operation, the more they are conserving in order to cut cost. But if they are taking action anyway, how much more impact will carbon pricing have? For those on the margin (less energy intensive businesses) some may start to care. But the big polluters are already paying attention to conservation. The senate bill also has some trade protections (carbon tariffs) so simply raising prices on goods and services ever-so-slightly is an need to worry about foreign competition.

Agriculture (roughly 7% of US emissions)
This sector seems to be given a waiver: If so, the CO2 equivalent of agriculture related Methane (21 times that of CO2) and Nitrous Oxide (310 times that of CO2) will not be priced. Need I say more?

Another big issue is that the price on carbon - as envisioned in current climate legislation - will go right back into the pockets of US consumers, either in the form of rebates or in defict reduction that will keep both taxes and inflation down. So the more we reduce our consumption or switch to renewables, the less we get back in rebates....sort of a reverse incentive.

While I think capturing the true cost of energy is an important step, I am not all that optimistic that carbon pricing alone will change behavior. What are some other options? Here are a few I can think of:

Conservation Capital
There's a high ROI on energy reduction (which would be even higher if energy costs go up due to carbon pricing.) But many changes require upfront capital. How about a low interest or no interest capital fund or Fannie-Mae type system for businesses and households to fund conservation and energy retrofits? This scheme is already being considered for residential solar.

Hard Targets
We could simply set renewables and emissions targets, as has been done with automobiles. If the market knows that a utility needs to get to 20% renewables in ten years, the "ingenuity of entrepreneurs" that The President referred to will kick into high gear an compete vigorously for a piece of the pie, lowering costs and increasing innovation.

Cost Transparency
Better feedback on energy use and costs would lead to better decisonmaking. Let's hook those smart meters into our thermostats and iphones, so we can see at anytime how much we are spending on power. And instead of an MPG gauge on cars, how about a taxi-meter style read out that shows how much we are spending on gas as we drive? These sort of in-your-face mechanisms are more likely to change behavior.

Spend Intelligently and Holistically
While we are pricing carbon at $25 or higher, I can think of an amazing innovation that 'eats' carbon for $10 per ton, and has years of successful field trials. It's called a tree, and we are losing as much as 80,000 acres of them each day. Trees also can preserve biodiversity and provide income in poverty zones. Using less and cleaner energy is a worthwhile goal, but a planet covered with solar panels and turbines instead of trees is not the kind of future we should aspire to. It's all about balance.

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