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Carbon Tax Center

Pricing carbon efficiently and equitably

Senate Warned: Cap & trade Volatile, Offsets Ineffective

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CTC Washington rep James Handley shares his notes from yesterday’s Senate Energy & Natural Resources Committee hearing on price volatility and cost containment for cap & trade:

I was encouraged. Many Committee members seem interested in working to make cap & trade more like a price mechanism via a “price collar.” “Revenue recycling” also came up. “Carbon tax” was discussed more than I’ve heard since the House Ways & Means hearings last spring. There was considerable candor and minimal posturing. My summary is a bit long, but the entire hearing was compelling and perhaps significant. I’ve bolded some of the highlights.

(Chairman) Sen. Bingaman: Price volatility as well as total cost, important concerns…

Sen. Murkowski: Climate is serious problem. Alaska witnesses. One reason Lieberman-Warner failed is that it didn’t control costs adequately.

Opening Statements:

Brent Yacobucci, Congressional Research Service: Price collar (floor & ceiling) most comprehensive way to control volatility and overall costs. Ceiling / safety valve is cash payment in lieu of buying allowances. RES passed by ENR does include “safety valve.” Lower limit, — reserve price. ACESA strategic reserve– not certain effective.

Eileen Claussen, Pew Center on Global Climate Change: Cap provides way for gov’t to set limit, business to meet limit with flexibility. Price of offsets and low carbon technology determine allowance price. EIA says if int’l offsets barred, would increase allowance price 65%. Low carbon tech– CCS and nukes would reduce climpliance costs. Multi-year banking provides “when” flexibility for redxns in cap/trade. Advantage of cap — slow economy carbon price drops– automatic adjustment. C-tax would require gov’t to intervene. Strategic reserve pool similar to price cap– w/o detracting from envt’l integrity.

Michael Wara, Stanford University (Law): Researched emissions trading, offsets under (UN, EU) CDM. Two conclusions: 1) offsets cannot provide cost control and environmental integrity. 2) price collar can provide both. Need durable program, thru 2050. CDM experience suggests that env’tl integrity [of offsets] difficult to measure. Establishing envt’l baseline — difficult. Hardest in heavily regulated sectors. E.g., China, energy sector already regulated, includes subsidies, regulations that already favor renewables and nat’l gas. Can’t determine if benefits are additional. Difficult to produce large enough quantity of credits/ offsets (to manage allowance price). ACESA 20 – 50 times larger than CDM and need higher envt’l integrity. ACESA dependent on offsets. Most redxns — offsets, rather than covered entities. Quantity certainty in doubt. (Price) collar = superior price control. Use $ from price collar to fund GHG reduction projects. Recommends collar instead of offsets.

Joseph Mason, Louisiana State University: Two approaches: quantity (cap/trade), price (carbon tax). Cap/trade assumes banking and borrowing can be optimized. But central banks’ experience with monetary policy shows that controlling money supply (or allowance supply) is very problematic. Bagehot’s rule: liquidity crisis addressed by “lending freely at a penalty rate.” Fed’s “discount window” for lending to banks not used much now. Similarly reserve requirements not used to control monetary policy. Tools for monetary control not well understood and can be gamed by speculators — might try to run up prices to game the bank. banking leads to hoarding, attempts to corner markets. Expiration dates on permits call to mind Zimbabwe’s currency which has expiration dates. Convoluted market design is un-necessary, carbon tax accomplishes directly. Borrowing institutional structures from one realm (monetary system) and applying to another (carbon trading system) rarely works. Tax achieves goal of price certainty.

Jason Grumet – Bipartisan Policy Center: Support price collar, strategic reserve and aggressive oversight of market. Tremendous uncertainty — offsets. 1 billion very unlikely to be available.

Q/A:

Sen. Bingaman: Int’l forestry projects — need to fund. Offsets?

Wara: Need 1) objective baselines, quantify offsets, 2) solidify property rights in develping countries. W/o certainty of prop ownership, more uncertainty about land use. Major developing co’s — delicate issue = land titles.

Grumet: largest source of int’l offsets = forestry. but not avail next 12 – 36 mos.

Claussen: Real possibility, US engage in int’l forestry regime.

Bingaman: EU not recognizing foresty offsets b/c no baseline. Domestic offsets?

Wara: Ag offsets very difficult to do well. Already have programs for tillage. Can monitor smokestack. Field isn’t smokestack. Soil varies, history varies, water, weather… many quantification problems.

Sen. Murkowski: House bill relies so heavily on offsets. People at home scratching heads. How does it work? Rob’t Shapiro (former Clinton Admin) says “trillion dollar mkt securitized by Wall St.” How avoid? Carbon Tax?

Mason: to stabilize prices, (carbon) tax avoids problems. Offset verification, similar problems to mortgage verification. reckless to go into new market. Prop rts critical. must be stable to sell meaningful offset. Developing co’s have political instability. Big investment in offsets could lead to another bailout. Parties (buyer and seller) have incentive to overstate value, game system.

Grumet: Bipartisan carbon tax proposal would gain steam if someone would propose. short of that, collar = elegant solution. reduces potential for malfeasance.

Sen. Cantwell: Mason’s testimony is “music to my ears”. Specificity in EU. Enron needed “the tape” of “get grandma” to trigger investigation. Now see problem in EU. System inherently favors special interests. Predictability = different way.

Mason: Insulate mkts from those w/ overt interests. In Britain, speculators intervened to push strategic reserves. Tax doesn’t need to be set to internalize all costs. Even nominal “user fee” encourages some behavior change. Might get 80% of benefit with moderate price. Can do today.

Sen. Cantwell: Benefit of floor?

Grumet: Wall St / spec interests. but also want to stimulate innovators. floor reduces price uncertainty– now investors must assume zero carbon price. $10 could do a lot.

Wara: Floor means (green energy) investors can go to bank and borrow. EU — downside risk actually greater than hi prices.

Sen. Corker: Rube Goldberg notion – vehicle. price volatility. Why don’t climate chg advocates level and say we need higher C price? floor would reward investors. Why not tax? (I restrained my impulse to applaud.)

Claussen: Would support carbon price / tax if high enough to get redxns. Offsets are low cost reductions.

Sen. Corker: Isn’t a tax a better approach? Aren’t int’l offsets just wealth transfer abroad? Why not recycle revenue into our economy?

Wara: “Vast majority” of reductions would be offsets (under ACESA).

Sen. Corker: Safety valve + price floor, in essence carbon tax. Wish public could hear all this.

Sen. Shaheen: Not sure public should hear. Public would be concerned. how set prices? Market? How do cap and limit prices w/o interfering in market?

Grumet: “Interference” with volatility is salutory. Set floor at $13 – 15 and ceiling at 2x, eg $28 would get redxns. $20 price makes electric convert. $25- 30 sustained.

Claussen: support price floor (but not ceiling). Hard cap, too high. strategic reserve better than price ceiling.

Sen. Shaheen: how set floor?

Grument: price needs to support technol investors. clarity that there will be a price would help a lot. eg $10 floor rising 5 – 10% would be very meaningful. if too low, lose potential to encourage innovation. rate (eg $8 vs 15) is political decision, but certainty is very imp’t.

Mason: Price is zero now. dithering– waste time, investment. Objects to cap/trade because of well identified externality problem. do not know what right amount of carbon is. (unlike acid rain.) could start with modest carbon tax, and later change to quantity-based system.

Sen. Stabenow: quantify Ag offsets. Sec’y of Ag doing great job. Price collar– agree floor and ceiling. also support offsets. Wara — critical of offsets. “Smart design choices” eg re deforestation. Would you eliminate offsets? CBO found that w/ offsets, allowance price in 2030 ~ $40/T. w/o offsets, $138/T. Share Corker’s observation — int’l offsets– want reductions where “ton of carbon = ton of carbon.” Offsets vs Collar?

Wara: Both design, better than offsets alone. mulitple parties favor cheap offsets. Buyer and seller. regulators have wide discretion. pressure to create credits. favor creation over integrity. Price collar improves integrity of offsets– greater incentives to regulate effectively.

Grumet: Need both. But concern re offsets as (sole) containment. Pressure, low qual offsets. undermined if collar, not unlimited offsets.

Sen. Barrasso (R-Wyo): concern Wall St gaming. cap/ tax green collar crime. abuse, UK suspended energy auditor (Guardian article). SGS suspended 2d company suspended. Another Enron situation?

Wara: SGS suspension = positive step. previously auditors impunity. need incentives for auditors. adequate, no. but improvement, yes.

Mason: pattern familiar financial crisis. 1400 pages (ACESA) lots of places for influence and holes. too little environmental effect for too much cost. Chicago climate exchange hired lobbyists – want lax rules for trading, offsets, early action credits, don’t want limits on who can trade. banks supply credits for allowances.

Sen. Dorgan: day trading oil very volatile. collar discussion. lack of confidence in mkt. not support $1 trillion new mkt. diminishing product year by year. “rolling seas of cap & trade” set price. estimate size of market and range of volatility?

Mason: $1 trillion is under-estimate. volatility — hard to see mkt w/o volatility. if we don’t like volatility, we shouldn’t choose market to set price. will bail out when price goes up (?) energy cos can trade, arbitrage opp’ys.

Sen. Dorgan: derivatives / swaps have already in EU. new products. hang US growth on this? prefer “carbon fee”?

Grumet: since BTU tax, don’t say “tax”. if serious about problem, then support carbon tax. if not, have to fix market.

Sen. Dorgan: regulation of markets, pathetic.

Grumet: collar is training wheels for mkt. balance mkt.

Sen. Dorgan: need to talk about all alternatives– regulation and carbon tax as well as cap/trade.

Sen. Bennett: conclusion of Mason (p 20) “hinging econ growth on complex contract and market design both of which have yet to be tested in the real world”. Any cost / benefit on cap/trade, or carbon tax or command/control?

Wara: NYU law school did cost/benefit analysis of cap/trade and found very positive.

Clausssen: lost of analysis re costs but few on benefits. but believe benefits far exceed costs.

Yacobucci: range of benefit is very wide.

Sen. Bennett: Temp redxns– wide “delta” —  impact on Temp de minimis.

Grumet: Must assume US is leading world. same as any big problem, hunger, poverty, war… price collarwould avoid underminining econ strength. then support taking 2d and 3d steps.

Sen. Bennett: problem– US leads but no one follows, then stuck with program.

Claussen: w/o US action, no world action. if we do act, then (others actions) depend….

Sen. Bennett: Visited EU. $20/T trading. advice they gave– “go slow, start small.”

Sen. Bingaman: “Well we’re certainly following that advice.” (laughter)

Sen. Murkowski: cost concern. mechanism to recognize recession?

Grumet: econ has changed discsn. if pass law now, effective maybe 2014. recession will be past. uncertainty in carbon mkts is deterring investment now.

Wara: Health care analogy apt. existing system — EPA will regulate under CAA. not as if nothing there. do nothing is not an alternative. EPA proceeding.

Sen. Cantwell: transition– EPA estimates $1.4 trillion int’l offsets under ACESA. What could we buy here with that?

Wara: EPA unrealistic. low cost offsets. presumes $1 billion T/yr. Thinks will be much smaller.

Mason: property laws. change rules. no property tax, owners sit on land and don’t use. immediate benefits from carbon price. US shipping pelletized wood to EU for offsets. Where does that make sense?

Sen. Corker: not enough offsets? assuredly “enough hucksters” to sell trillion $ figure. way to benefit taxpayers– rev-n carbon tax, no $$ leaving economy.

Grumet: right goal exactly. challenge– how to give back equitably. (ACESA) efforts to divert allowances to utilities, state regs on utilities — rev’s to ratepayers. cap / dividend?

Mason: Markets — no boundaries. Taxes do (have boundaries).

Wara: distn of revenue. complicated. firms have some (legit) claims. households also. taxes theoretically better. but not necessarily simple. want single rate. hard to do in real world. EU– not simple. $ for adaptation. tax scheme will want exemptions. should explore tax but won’t be simple.

Sen. Corker: Ancillary goal of cap/trade. takle in $ then spend $6 trillion in last year.

Sen. Bennett: “Trust fund” / ear mark defeats appropriations discretion. EU covers utilities not automobiles. why? they only have accurate data on utilities. Saw big pickup truck with sticker “this truck is offset by… ” XYZ website. Real? Accurate data?

Claussen: EU over-allocated. system failed. now have data.

Wara: US EPA doing inventory— reporting GHG emissions. EU mobile sources already taxed. Germany equivalent to $220/T. states regulate at refinery. RAC [Refiner Acquisition Cost & volume of crude oil, reported to EIA] = good data. at pickup truck — not good data.

No Magic Price Point for Kicking Carbon

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A visitor to this site asked, “Do you have analysis saying at what price on carbon the economic dispatch charge for coal will equal and exceed that of other electricity- generation sources such as wind?” Here’s our reply, co-written with our Washington, DC rep, James Handley.

The carbon price level for breakeven isn’t one number, but a continuum.

Start with the demand side: with just a modest carbon emissions price, many steps to improve energy efficiency become more attractive. But the more costly ones obviously require a higher expected price.

Consider driving. There are an almost infinite number of ways for individuals to burn less gasoline. They range from buying a less-gas-guzzling car (which itself occupies a continuum: miles-per-gallon varies across the spectrum of available autos, and drivers can accelerate scrapping their current car for a more-efficient one), to driving less consumptively, driving less (by taking transit, walking, cycling or carpooling), and simply traveling less (by taking fewer and/or shorter trips).

critical_mass_vancouver_sockeyedGasoline use for driving is socially determined as well. Actual and expected gasoline prices strongly affect the choices available to us as individuals and how we relate to them. Decisions to forego discretionary trips — to the faraway mall, soccer game or social occasion — that can appear selfish or bizarre when gas costs a buck-fifty, become more socially acceptable when the pump price hits three dollars. Similarly, rising fuel prices help shift car manufacturers’ engineering and marketing decisions toward fuel conservation. Ditto for voters’ support of local and national governments’ funding of transit and so-called liveable streets.

There is no magic fuel or carbon price threshold at which these changes kick in (and below which, they don’t). This isn’t to deny tipping points. Indeed, we hinted at them just above. But fuel use is so varied and diffuse that there’s a spectrum for tipping points as well as for individual decisions. The carbon price that leads one car manufacturer to push fuel-efficiency to the fore will be different for its competitor, and similarly for transit providers, not to mention the cultural forces that bear so heavily on driving and other energy uses.

The same applies to the supply side, as illustrated by wind power. Wind farms at the choicest sites kick in at a fairly low carbon price. Indeed, the rapid rise of wind-powered generation — it accounted for 1.8% of U.S. electricity output in the first quarter of 2009 — attests to wind power’s steadily improving economics, although the federal Production Tax Credit, now 2.1 cents per kWh of wind output, obviously plays a critical role. According to the American Wind Energy Association, wind farms at high-wind sites are generating at 5 cents per kWh, just a bit above the average “all-in” cost of coal-fired power. On the other hand, falling prices of natural gas recently prompted T. Boone Pickens to delay his highly touted plan to build giant wind farms in Texas.

The point is that wind farms’ generation costs traverse a very broad range. Equally important, so do the costs of the existing coal-fired generators that the wind plants are intended to displace. Rather than operating at a single average cost, the U.S. coal plant fleet generates at a wide range of costs depending on plant efficiency, age, fuel supply and even the hour-to-hour loading level on the individual plant.

Accordingly, we should visualize wind’s capacity (and, solar plants’ as well) to displace coal- and gas-fired generation, not as one “bar” on a graph straining to inch out another, but as a series of curves that will cross and re-cross at thousands of points. The higher the carbon price, the more points at which the renewable sources will undercut the traditional fossil-fuel sources.

Finally, the same will also apply to carbon capture and sequestration. Should it ever prove technically feasible on the large scale required, the costs of CCS will not be one number but a range, due to the influence of site- and process-specific costs.

The takeaway: there’s no market-clearing carbon emissions price to usher in some “breakthrough” and kick fossil fuels into history’s dustbin. A steadily— and predictably — rising price on carbon will do the trick. (To see how far and fast, download our Carbon Tax Impact Model and plug in your own carbon price.)

Photo: Flickr / Sockeyed.