4. Carbon Pricing…: The Scope of a Comprehensive Climate and Energy Policy
(originally published on February 20, 2009)
Why Not Bring Positive Externalities Into Market Pricing?
One of the limitations of carbon pricing is that, as a support for renewable energy or other clean generation technologies, it is a roundabout and scattered means of “leveling the playing field”. Energy markets that still enjoy the climate-altering bonanza of fossil fuels are generally less excited from a narrow utilitarian perspective about renewable energy without heavy policy support, excepting in some areas large onshore wind projects. One of the motivations in carbon pricing is to level the field by attaching so significant a carbon price to fossil fuels that renewable energy will be competitive with or gain a market advantage over fossil fuels. As renewable electric generation technologies in general require some form of storage to generate energy in a way that is exactly equivalent or superior to fossil resources as well as perhaps new infrastructure like transmission, the cost of accessory technologies would also need to be accounted for in order to truly level the playing field. This carbon price would need, in the case of some renewable technologies, to be at least one order of magnitude higher than we expect that price to be (expectations run between $10 to $20/tonne CO2).
The price gap between sources of renewable energy and fossil energy has to do both with the sunk costs of an economy built around fossil fuels plus the comparative physics of renewable vs. fossil energy. Renewable energy is generally diffuse, except in some extreme locations; otherwise, if it were not diffuse, most living creatures would not have been able to evolve in such a high-energy and therefore harsh. To capture large swaths of renewable energy requires the building of large facilities that then concentrate or store the energy for use. These large facilities mean that renewable energy generators require a large up front investment that ultimately, if planned right, returns many times the amount of energy and money that was invested in it but over a period of years. To surmount this hurdle requires a commitment on the part of policymakers and regulators to renewable energy that operates in a longer time frame than that dictated by fluctuations in the energy markets. In addition, most renewable energy comes in the form of an energy flow rather than an energy store, which is the form of fossil and nuclear fuels. Tapping into energy flows to do useful work requires a different engineering orientation as well as additional energy storage devices.
Energy markets, represented by energy traders and energy consumers, remain relatively unmoved by these technical and physical challenges related to the price gap between fossil and clean functional replacements for fossil generators. The focus of markets is upon the current availability and pricing of energy assets, products and services. For a longer term view of energy whether fossil, nuclear or renewable to be incorporated into markets almost invariably requires the support and direction of government, either through subsidy or regulations. The recent drop in oil prices due to the economic downturn has endangered and postponed plans to build renewable generators, as even with the current tax incentives, these investments look less attractive than business as usual. As with many capital intensive industries, investors need assurances that the long-term investment in large and expensive facilities will pay off over a period of decades.
While a full accounting of the negative externalities of fossil fuel use would put renewable energy in a very favorable light, the sudden application of these costs to the entire economy that is dependent on fossil fuels for 85% of its energy would penalize most energy users severely and disrupt the economy in ways that are not intended by even the advocates of an aggressive carbon pricing regime. Historically, policymakers have attempted to incentivize renewable energy development by rewarding renewable energy developers with incentives that can viewed as way to price in at least some of the positive externalities related to renewable energy: notably its clean-ness, local or regional origin and its sustainability.
Most studies of the relative cost of various carbon emissions reductions solutions place renewable energy at a significantly higher level than many readily available energy efficiency technologies that under many circumstances now pay for themselves without any aid. So a carbon price that is designed to level the playing field for some energy efficiency measures, would be far lower than one that made renewable energy projects “win” over existing or even some new fossil resources. The exception to this are large onshore wind projects that would receive a substantial boost from a lower carbon price, though wind alone cannot, at least with our current technology, fully displace fossil resources.
The foreseeable initial carbon price will also not yet spur some of the more aggressive energy efficiency measures in the area of space conditioning, which accounts for 30% of total energy use in the US. Ground source heat pumps and solar adsorption cooling are technologies that can radically reduce building energy use but currently offer paybacks in the region of 8 to 12 years depending on the space conditioning load of the building and the climatic zone. For some building owners these are already affordable but may require an additional incentive for them to consider a new technology. Again, leveling the playing field for these promising technology through disincentivizing fossil fuels may not lead the market to embrace a new paradigm without incentives.
The most direct method of incentivizing renewable energy development is by creating a wholesale electricity rate structure that assigns higher and more secure long-term value to energy generated by different renewable technologies, allowing project developers to get financing for their large upfront fixed capital costs. The renewable energy payment systems, also called “feed in tariffs” are one means by which legislators and power system regulators have rewarded renewable energy generators for their positive attributes. Most often, however, the form of this reward is not by enumerating and pricing the specific positive externalities but by using the formula “cost of generation plus a reasonable profit” averaged across an industry at a given point in time. “Cost plus reasonable profit” is the formula used for building large one-of-a-kind structures either in power generation or construction that because of their uniqueness cannot find a workable price via the market. The security of this arrangement, guaranteeing them a premium rate for their electricity generated over a period of 20 years, enables project developers to at least survive and with greater cost efficiency to thrive as businesses. The fixed premium rate allows for cost recovery plus a reasonable profit on the initial investment in the renewable energy facility.
The additional cost of the premium payments are pooled among all electricity ratepayers which raises electricity costs slightly. However, this rise in electricity rates can also have the virtuous effect of encouraging more energy efficiency, so a renewable energy payment system can create a virtuous economic circle.
Other methods of incentivizing renewable energy development have proved to be less reliable. Tax credits that have been part of the US toolkit to incentivize renewable energy on and off for 30 years have provided some help but have varied in their effectiveness, in part because they draw on revenue from other parts of government budgets which can lead to disputes about which program deserves to be cut in favor of favorable tax treatment for renewable energy. Furthermore, these credits have not had the same stimulative effect as feed in tariffs to jump starting a renewable energy industry. With the current financial crisis, there is also a major shortfall of tax equity, meaning a dropoff in firms and investors that have made their money elsewhere and seek investments in renewable energy as a tax benefit. If tax benefits are to continue providing an incentivizing effect for renewable energy, other credit instruments like a federally guaranteed renewable energy bank or renewable energy payment systems would need to pick up this shortfall.
Another area where positive externalities can be brought into the market by policy is in the introduction of zero emissions vehicles to the road, most notably electric vehicles. The initial investment in batteries as opposed to a gas tank, as with renewable energy, adds a sizeable increment to the cost of a vehicle despite its overall lower cost of ownership. Proposals that offer tax credits or rebates to individuals and businesses that lower this hurdle would again be offering a payment for a positive externality that the market currently does not recognize. Current economic stimulus packages proposed by the Obama administration as well as the US Senate, include tax incentives for electric vehicles calibrated to the amount of all-electric range these vehicles offer.
In the area of energy efficiency, rebates for new technologies have also proved to be a means to generate new markets for somewhat more costly technologies with positive externalities. California’s energy efficiency rebate program has helped that state level its per capita energy use over the last 30 years and has helped drive the US market for energy efficient devices and innovation.
The relentless focus of policy on a disincentive (the carbon price) ignores key aspects of human psychology within which a combination of incentives and disincentives enables optimal learning rather than the simple application of either one or the other. The current low ranking of climate change in polls of people’s concerns during the current downturn may have something to do with the general message of restraint that has been paired with climate change rather than opportunity and hope. If we think about it, children raised only on disincentives (guilt, shame or punishments) or only on incentives (praise, bribes) are likely to end up twisted or lacking self-discipline in ways that are myriad and complex. Beyond what can be achieved through information, persuasion and expressions of intent, a coherent mixture of carrot and stick approaches seems commonsensical to healthy growth and learning. As we are entering a new world in transforming the basic energy foundation of our economy from carbon to non-carbon sources and energy use constraint, we and our economic growth engines stand in ways like children before our own demand for energy and the need to change it. Surely we should apply our best understanding to this task and not just one fraction of what we know.
A Comprehensive Climate and Energy Policy
If we turn our focus from a singular catastrophic market failure to multiple market failures, the form and timing of climate and energy policy initiatives will start to match more closely the actual physical array of assets with which actual real economies are currently working. The notion of a singular market failure, however huge, bears with it the unspoken assumption (not necessarily a belief of Nicholas Stern) that markets are otherwise self-sufficient and well-functioning. We have seen that in fact markets, along with their strengths, are, in most sober assessments of economic history, failure-prone or critically dependent on non-market institutions in a number of areas, some which were outlined earlier. To some, this sounds like heresy but this sensitivity to criticism of markets is more a function of the recent tendency towards hagiography of the market mechanisms rather than the product of a honest effort to balance their benefits and weaknesses.
The monocular or central focus on carbon pricing as a climate policy has borne the traces of the neo-classical economic “tail” wagging the climate and energy “dog”. An allegiance to an economic theory that overvalues market mechanisms has seemed to have shaped climate policy more than a consideration of the on-the-ground facts. The notion of the singular market failure leads to the overvaluation of carbon pricing as the prime means to achieve a carbon neutral society. As we are now experiencing a sea change in our economic common sense, it makes sense to revise climate policy in response to this sea change.
Rather than simply a choice between political preferences or allegiances, there is a concrete difference in how these economic theories and by extension the resulting policy instruments interact with the target of their regulations and investments. A carbon pricing system acts upon the economy as a series of individual (inclusive of corporations as “individuals”) actors or “atoms” which respond to the price signal in their own unique ways. A policy orientation that seeks to re-engineer and re-organize economic systems like infrastructure that requires the coordination and cooperation of individual actors and “parts” of the system, interacts with the world as ensembles of actors rather than a series of independent individual actors. A dogmatic allegiance to the monetarist/supply side view prohibits or proscribes the latter orientation. A realistic assessment of the tasks ahead will require both kinds of orientation to the world built into climate policy.
A Policy Orientation Commensurate with the Task
Changing our ways of using energy and land is a huge task, a task that advocates have for some understandable reasons attempted to minimize. Exosomatic energy, energy that comes from non-food sources like fossil fuels, nuclear fuels and renewable energy, has been the primary support for economic development over the course of the various industrial revolutions of the last two centuries. Up to a certain, fairly high, minimum of energy use, economic development and wealth correlates with exosomatic energy use. The heroic narrative of increased technological sophistication and human ingenuity has hidden the brute facts of rising consumption of what have been largely fossil fuels. That one person can now do the work of fifty or one hundred manual laborers has everything to do with the continuous availability of concentrated energy products or services at a fairly low price. Our economic system is also based on an agricultural, food and fiber system that not only is highly dependent on fossil fuels but also uses land in ways that do not conserve the soil or stabilize atmospheric concentrations of greenhouse gases.
The scientists who have documented our contribution to a changing climate have endured much criticism for suggesting that the energy and land-use foundations of our economy are endangering the long-term sustainability of the earth. However, understandably, they have not also wanted or been able at one fell swoop to outline how we might reverse the political and economic orientation of our society, which at the time was praising markets and the pursuit of narrow self-interest perhaps leavened with voluntary charitable or altruistic acts. Both Al Gore and Jim Hansen, the two main targets of much criticism and scorn, have made the goals we have increasingly clear but have, in my opinion, at times held back from exploring the scale and extent of the work and expenditure needed to do an “energy transplant” on our society from dirty to clean energy sources.
If in fact, the future of the world and all of what might be considered human wealth depends on reducing carbon emissions, isn’t it worth it for us to pay something towards that goal? Policy recommendations should reflect the seriousness of that goal and a recognition that most people should contribute something towards that goal, as it benefits them. Policy suggestions that minimize the cost or need for participation by a majority of the population in building this new energy basis for our societies are selling people short.
Public Expenditures…for What?
Currently it appears as though as a nation we will spend somewhere between one and four trillion dollars to bail out the banking system after it rushed earlier this decade to take advantage of some highly risky opportunities to make a profit. Yes, borrowers are also partly to blame for buying houses which they couldn’t afford, but financial common sense had been sacrificed several years before by the leaders of the financial system and by regulators who did not believe in regulation. We may never see concrete results from this massive expenditure of tax payer dollars only that we may have prevented a full-scale collapse of the financial system and economy into chaos.
An even more controversial area to discuss is the degree to which the government should commit resources to the already overweighted housing sector, now in a deep crisis. Not only has the economy expanded in the area of finance but also became overly dependent on housing and real estate before the big crash of 2008. Many Americans were simply not earning enough money to afford the homes that were being built or sold in the last few years of the bubble. Should a large portion of our public assets be committed to propping up home values beyond the ability of Americans to pay for those homes through income from other sectors of the economy? A balance may need to be struck between managing the crisis, future housing needs, real estate as investment, and non-housing sectors of the economy.
On the other hand, a transformation of our energy and transport system will boost an underweighted area of our economy. I have termed the US historical relationship with energy, the “Cheap Energy Contract” which restricts the amount of money that the energy sector can charge per unit energy; to build a clean energy economy quickly, there will need to be revenue from a variety of sources in excess of what we currently spend to build the useful infrastructure required. Industrial and construction jobs, far from being part of our past, may become again part of what helps bring living wages and buying power back to the American consumer, independent of commercial and residential real estate and finance sectors.
Furthermore, our infrastructure is deteriorating and as noted in Part III, inadequate to the task of reducing carbon emissions. There is no other way to pay for some of this infrastructure other than through public funds and it will serve the public and other businesses well to have a better rail system, a cleaner electricity and energy system, and avoiding dependence on the fossil fuel roller-coaster. Therefore everything speaks for a substantial commitment of public funds to these public goods which support the economy as a whole, especially now that we are in search of the economic solutions to our dire situation. In the end, the amount of
A Climate and Energy Policy for the Committed and the Indifferent
Currently climate change ranks as one of the last concerns in polls of American public opinion, despite the commitment of the Obama administration to take steps towards reducing carbon dioxide emissions. The task then for both climate activists and the new Administration is then to construct a climate policy that, in addition to educating the public about the dangers of continued unchecked carbon emissions, makes it worthwhile for people to care about climate change.
An important element of the existing climate action proposals is that they both try to lower their profiles in terms of fiscal impact and rely largely on “negative reinforcement” or punishment of “bad behavior” in relationship to emitting carbon. While the small minority of the population that is appropriately terrified of the effects of climate change or has enough financial liquidity to pay the penalties is accepting of these disincentives, the vast majority either doesn’t understand the proposals or is worried about their impact on their personal finances. A vocal minority opposes any and all climate regulations or regulations in general, and are increasingly a force to be acknowledged in passing but not taken into consideration in formulating effective policy.
What I am calling a “Comprehensive Climate and Energy Policy” is designed then to be an instrument that addresses the concerns of the vast majority of people who care about their communities and families but is not yet predicated on an overwhelming concern for the climate. A Comprehensive Climate and Energy Policy, relying on both incentives and disincentives, will help address the more pressing concerns of Americans as well as be a more effective means to achieve many of the goals of the climate action community. Including areas where there is overlap between the goals of these communities can help create momentum for our economy in general and in particular, towards an economy that emits less carbon into the atmosphere.
The Green Jobs movement, led by among others Van Jones, has pioneered this approach to climate policy with an emphasis on the jobs generated by building a new clean energy infrastructure. One of the products of a Comprehensive Climate and Energy Policy would be the stable domestic jobs that Jones and others have called for.
If general economic theory needs to borrow from Keynes as well as neoclassical economics, shapers of climate and energy strategy may be then freer to choose the appropriate instruments for the many tasks related to building a post-carbon economy. In a society dependent upon market exchange of goods and services, economic policy and with it climate and energy policy are meant to address failures within the spontaneous commerce of markets to deliver goods and services that are vital for economic and social wellbeing.
We have located here not one but approximately three and half market failures that are relevant to climate and energy policy which specifically address the challenges related to our upcoming climate and energy challenges in the US.
- Externalizes costs of climate change attributable to carbon emissions
- Externalizes costs of infrastructure building and maintenance and high fixed capital costs of long-term private capital investment
- Deployment of capital intensive clean energy technologies
- Coordination of management and finance of upgrades to electric grid.
- Re-design and electrification of transport infrastructure
- Externalizes costs of scientific research and development
Rather than subsume all of these challenges under “1”, a comprehensive climate and energy policy is able to flexibly address the existing challenges in a given context by applying measures where needed to reduce carbon emissions with the goal of a carbon neutral society
The value of a comprehensive policy becomes clear if we look at national differences in emissions level, infrastructure and other sunk costs, and overall level of economic development. In Switzerland, for instance, per capita carbon emissions are approximately one quarter of those in the US. Much more densely populated, Switzerland already possesses an almost entirely electrified rail network and adequate public transportation in many of their cities and towns. Electricity in Switzerland is generated largely via hydro and nuclear. Already possessing an infrastructure than can be configured for lower or zero-carbon emissions, a carbon pricing regime may help Swiss consumers and businesses utilize that infrastructure even more efficiently and use energy more efficiently. By contrast, the United States has a long way to go in building an infrastructure with a similar capability.
With 4 times the population of the US and 150 times the population of Switzerland, India possesses still different challenges as it is both a rapidly industrializing and a less-developed country depending on region, economic sector and social class. India has a per capita emissions level one quarter of that of Switzerland and one sixteenth that of the US but because of its massive and growing population is starting to contribute substantially to overall worldwide carbon emissions. The Indian government and the world development community would like to see the average Indian make substantial strides in terms of their overall welfare and use of services with a stable level and even a decrease in net per capital carbon emissions. In the last few years before the current downturn, there has been a move by the rapidly growing Indian middle class to emulate the petroleum and energy consuming ways of the West including the use of petroleum-fueled automobiles. Because of its high population density, it would make sense for India to build a potentially zero-carbon electric public transport system, as there would be literally no physical space in India to build a car culture like that of North America, even if all those vehicles were zero emissions. Carbon pricing alone will neither inspire nor finance such a massive undertaking. On the other hand, within the carbon trading system, some projects have been built as part of the “Clean Development Mechanism” and some version of this may remain a source of investment for projects that can show a quick reduction in carbon emissions.
The “hard problem” of rapidly industrializing and less developed countries becomes a little easier if we don’t assume that governments in those countries are passive bystanders or simply funnels for a global carbon pricing regime. The Indian government, as will other governments, need to devise national and regional strategies that rely on public was well as private funding of low- and zero-carbon facilities.