Tag Archives: carbon policy

The UK’s commitment to carbon reductions?

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Lynne Kiesling

I’ll be interested to see how the political, economic, and environmental consequences of this weekend’s new carbon approach in the UK unfolds; according to the Guardian (and the too-much BBC that I listen to):

Cabinet ministers have agreed a far-reaching, legally binding “green deal” that will commit the UK to two decades of drastic cuts in carbon emissions. The package will require sweeping changes to domestic life, transport and business and will place Britain at the forefront of the global battle against climate change.

The deal was hammered out after tense arguments between ministers who had disagreed over whether the ambitious plans to switch to more green energy were affordable. The row had pitted the energy secretary, Chris Huhne, who strongly backed the plans, against the chancellor, George Osborne, and the business secretary, Vince Cable, who were concerned about the cost and potential impact on the economy.

However, after the intervention of David Cameron, Huhne is now expected to tell parliament that agreement has been struck to back the plans in full up to 2027. He will tell MPs that the government will accept the recommendations of the independent Committee on Climate Change for a new carbon budget. The deal puts the UK ahead of any other state in terms of the legal commitments it is making in the battle to curb greenhouse gases.

Not surprisingly, reactions have been strong. Take the Telegraph’s outspoken James Delingpole, for example:

But if what it says is even half way true, then David Cameron has made the most unforgivably damaging decision of his entire political career. It will delay our economic recovery, lay waste the British countryside and cement Cameron’s reputation as a man driven not by principle (as, say, Margaret Thatcher and Winston Churchill were) but by a grubby, son-of-Blair urge to keep clinging on to power at no matter what cost to the country at large.

While I agree that it’s unwise to base expensive policy changes on inconclusive science and on a false belief in our ability to control outcomes in complex systems, that statement does seem a bit hyperbolic.

I think this is happening in the context of some other political machinations, and it may not play out exactly as reported in the Guardian. But since in some ways the UK is a bellwether of carbon policy, this should be interesting to watch — are renewables sufficiently economically and technologically developed to meet demand at prices that customers are willing to pay? Will retailers and customers in the UK be willing to explore/interested in exploring the combination of transactive digital technology and dynamic pricing that may modulate that demand relative to forecasts based on old technologies? Will this lead to the perpetuation of government subsidies of the sort that are currently being debated in the US?

Another Waxman-Markey blemish: reinforcing the obsolete utility business model

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Lynne Kiesling

Over the past few days Josh Blonz at Common Tragedies had a couple of posts (here and here) about the permit allocation issues in the Waxman-Markey bill, and yesterday Tim Haab picked up the conversation thread. They are both focusing on the welfare and efficiency implications of the proposal to allocate permits to “LDCs”, local distribution companies — in other words, regulated utilities. The social engineering objective of the bill’s authors is, apparently, to use the economic regulation under which such companies operate as a constraint to prevent the utility from using carbon pricing as a justification to raise the retail price of electric power service to, in particular, residential customers.

The posts and the associated comments flesh out two of the pricing issues here. First, Josh focuses on the fact that even with the allocation of permits to LDCs, pricing carbon will increase the price of all goods that use carbon-intensive production methods, so that means that the prices of consumer products will rise (Josh’s “indirect” costs) even if their retail electricity prices (“direct” costs) do not. Second, Rich Sweeney’s comment on Tim’s post points out the distinction between using the allowance revenue to reduce the fixed portion of the retail electricity bill (the wires charge) or the per-kwh electricity price. I think the idea is that if a LDC’s activity is sufficiently low-carbon that it can sell some of its allocated permits, how will they return that revenue to their customers?

But this discussion, and the (extremely flawed) Waxman-Markey bill on which the discussion is based, take some pretty serious regulatory and industrial organization questions for granted. For an extreme example, let’s take Texas, which is the only state in the US that has created a successful and competitive retail electricity market. The only regulated entities in the Texas market are the wires companies (transmission and distribution utilities, or TDUs, in the Texas lingo). Thus in the Waxman-Markey formulation, the entities that would receive allocated carbon permits would be these wires companies — the TDUs are the LDCs in Texas (they are also LSEs, or load-serving entities; this industry suffers from acronym proliferation that only an engineer or a bureaucrat could love!). This implies that any financial impact of the revenue from selling permits would show up as a reduction in the wires charge, not the electricity price. So far, so good, for keeping marginal incentives intact.

There are still two questions here. First, exactly how can a regulated wires company increase its carbon productivity/decrease its carbon intensity? The decisions it can make within the firm don’t really have much carbon impact, unless the wires company is allocated some right to the carbon effects of building transmission out to isolated renewables locations. But I think that whoever is building that wind farm or solar thermal installation would want to claim all of those rights, so there’s room for conflict (and/or Coasian bargaining) here. Second, Rich’s comment presumes that the wires charge is fixed, which has been the case for decades — but it’s not at all clear that a fixed charge for the transportation service is economically efficient. In fact, there’s a substantial congestion-related argument that the wires charge should be a two-part tariff, with a fixed component and a volume component that reflects congestion (and provides the signal for investment in wires capacity). With such a wires pricing structure, it complicates the permit revenue rebate transaction, particularly since this is still all intermediated through the state regulators.

At the other end of the spectrum, the relationship seems to be more straightforward in the states that continue to be vertically integrated and fully regulated, at least in the short run. In that case, regulators retain firm control over all of the decisions and pricing along the entire value chain, from generation through end use. But that’s actually where my biggest objection to the LDC proposal kicks in

My biggest objection to the LDC proposal is this: by presuming that the existing utility industry structure is going to persist and by conditioning what are meant to be long-lived carbon permit transactions on the continuation of the LDC-customer regulated transaction, the Waxman-Market bill actually entrenches the utility business model even further than it already is. Despite the fact that retail service provision can be a competitive industry and the only remaining “natural monopoly” network cost structure features in this industry are in the wires portion of the value chain, the obsolete vertically-integrated business model persists in about half of the states in the US. Smart grid technology, particularly the meter and myriad end-use applications and devices, reinforce the potential competition in retail electricity markets. Consumers and entrepreneurs would benefit from reducing entry barriers in retail electricity service provision.

The Waxman-Markey LDC proposal stifles that evolution of the electricity industry away from its historical, regulatorily-embedded vertical integration. By presuming the persistence of a regulated LDC with a retail relationship with end-use customers, the Waxman-Markey bill reinforces and exacerbates that persistence beyond its already overdue obsolescence. It contributes to regulatory and organizational inertia.

If you expect/hope to see more product differentiation and more vibrant retail products and services involving electricity service, the Waxman-Markey LDC proposal will work in precisely the opposite direction. I sincerely hope I am wrong, but the history of politics and institutional inertia in this industry suggest that I am not.

Waxman-Markey is really a command-and-control energy bill? No, say it ain’t so!

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Lynne Kiesling

While we’re on a carbon note … [sarcasm] yeah, I’m shocked, really, totally shocked that, as Virginia Postrel notes, the 946-page Waxman-Markey House energy bill proposal is really a piece of command-and-control legislation.[/sarcasm]

The WaPost notes that the “cap-and-trade” bill sponsored by Henry Waxman and Edward Markey is, in fact, loaded with all sorts of direct federal regulation of a decidedly dictatorial command-and-control nature.

Virginia goes on to point out the most disturbing thing, which is the idea that provisions are being inserted into the bill with the expectation that most members of Congress will not read what they are going to vote on. And this Washington Post article provides some more details on how much lobbying and special interest money is being directed at modifying, crafting, and word-smithing the bill to ensure that the economic effects go to those interests who expend resources to develop political capital:

But as the legislation’s chances improve, corporations, environmentalists and other interest groups have worked to put their imprint on the bill. The Center for Public Integrity said its review of Senate disclosure records showed that more than 880 businesses and interest groups have registered to lobby on climate change in the first quarter of 2009 — up more than 14 percent over the same time last year.

The groups include coal companies, investment banks, wind and solar firms, state governments, auditing firms and technology companies that might be part of the proposed trading system for carbon. An item inserted at the behest of Rep. John D. Dingell (D-Mich.) would give the auto industry $1.4 billion worth of extra allowances starting in 2012 when the cap-and-trade system takes effect, according to an estimate by the Union of Concerned Scientists.

[sarcasm]Yeah, I feel really confident in political processes. I’m sure that this political process will serve the interests of science, economic efficiency, and the environment. And I feel really, really well-represented in this process.[/sarcasm]

The economic and environmental value of forests

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Lynne Kiesling

The New York Times has an interesting article on how the growth of carbon markets enables us to quantify the environmental value of forests.

The researchers found that paying to conserve the forest was more valuable than plantations as long as poorer nations could earn $10 to $33 for each metric ton of CO2 saved. Currently a credit representing a metric ton of CO2 sells for about $20 in the European Union, which has the world’s largest greenhouse gas trading system.

In addition, the researchers found that peat forest areas, where stored carbon is most abundant and thus cheapest to manage, contained almost twice the mammal species density as other areas of forest.

Of course, anyone who has followed the development and the membership of the Chicago Climate Exchange will not be surprised by that finding; note the number of forestry members of the CCX. The CCX also illustrates the value of having private parties come together voluntarily to determine mutually beneficial use rights in the common-pool resource that is the climate system, even without a bureaucratically-determined cap.

Bootleggers and Baptists and carbon policy

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Lynne Kiesling

In today’s Wall Street Journal, Bjorn Lomborg has one of the clearest articulations of the bootleggers and Baptists dynamic in carbon policy, and nails one of the fundamental reasons why the Waxman-Markey bill is bad policy:

Naturally, many CEOs are genuinely concerned about global warming. But many of the most vocal stand to profit from carbon regulations. The term used by economists for their behavior is “rent-seeking.” …

U.S. companies and interest groups involved with climate change hired 2,430 lobbyists just last year, up 300% from five years ago. Fifty of the biggest U.S. electric utilities — including Duke — spent $51 million on lobbyists in just six months.

The massive transfer of wealth that many businesses seek is not necessarily good for the rest of the economy. …

The partnership among self-interested businesses, grandstanding politicians and alarmist campaigners truly is an unholy alliance. The climate-industrial complex does not promote discussion on how to overcome this challenge in a way that will be best for everybody. We should not be surprised or impressed that those who stand to make a profit are among the loudest calling for politicians to act. Spending a fortune on global carbon regulations will benefit a few, but dearly cost everybody else.

That pretty much sums up why I think that Congress can’t be trusted to design an economically beneficial carbon policy.

Can Congress be trusted to design effective carbon policy? I doubt it

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Lynne Kiesling

Friday’s Wall Street Journal editorial on cap and trade and the Waxman-Markey bill has prompted me to come out of the closet and say something publicly that I’ve been thinking for a couple of months: although I think that the most effective and economically efficient carbon policy is one that directly reflects the property rights issues inherent in common-pool resources, I don’t think we can, or should, trust this Congress to do the important, necessary objective institutional design to enable efficient carbon markets.

The fundamental economic problem in most environmental issues, including climate change, is ill-defined property rights. Either the inability or the unwillingness to define property rights is what creates inefficient overuse of common-pool resources.

In a complex and imperfect world, in which transaction costs are high enough and markets don’t arise organically to create opportunities to internalize these costs, we rely on collective action to create institutions to help us govern our use of common-pool resources. In general, policies that define use rights or property rights but do not stipulate how parties are to use the common-pool resource are the ones that have the best hope of coming close to dynamic efficiency. One reason that’s true is that it leaves opportunities open for entrepreneurs of all kinds to innovate and figure out novel ways to economize on the now-scarce right. When devising such policies, no bureaucrat can predict what those best responses and emergent creativity will be. These are the reasons why the EPA Acid Rain Program has been so successful at reducing sulfur dioxide emissions; defining SO2 emission rights and enabling their trade induced low-cost abaters to do so, and in many cases it took unexpected forms (including substituting low-sulfur Wyoming coal).

These are the theoretical reasons why I’ve always been inclined to prefer carbon markets over a carbon tax, despite their being indistinguishable on the blackboard. And, as I argued in this Reason panel a couple of years ago, both are prone to political manipulation, so in a non-Nirvana-fallacy, second-best sense I have argued for carbon markets because of their innovation and dynamic efficiency implications. This recent post from the New Republic’s environment blog provides a couple of good arguments for why carbon taxes won’t be any simpler or less manipulable. Even the imperfect outcome when the government sets the number of permits is a more direct reflection of the fundamental property rights problem than a Pigouvian tax would be. Of course, the collaborative process that the Chicago Climate Exchange members undertook to negotiate and determine a mutually agreeable carbon cap is the closest example we have to a full-on Coasean solution to determining these rights.

But then the past eight months happened — financial crisis, federal stimulus, and so on — and now we have the Waxman-Markey 648-page “discussion draft” climate change-focused House energy bill proposal (here’s the summary if your time and your stomach do not permit full ingestion of the complete draft). It has a renewable portfolio standard, lots of proposals to implement new building code regulations, and few specifics about designing carbon markets beyond a statement that 15% of them would be given to future participants as a political chit. Ezra Klein has a good post on this, with links, although he is more sanguine and more willing to accept incursions against individual liberty than I am. He’s also got a post on their legislative strategy that shed some light for me on my own opinion:

The American Clean Energy and Security Act of 2009 — otherwise known as the Waxman-Markey climate change bill — is not a cap and trade bill. Nor is it energy legislation. It’s not about modernizing the grid or promoting efficiency or encouraging renewables. Instead, it’s everything. Call it the Big Bill Strategy. And Waxman and Markey are perfectly explicit about this.

And, in the context of everything that’s come out of DC in the past eight months, this is where I get off the train. Congress’ bad behavior and poor decisions have finally accumulated to the point where I see them as utterly incapable of designing any kind of meaningful, transaction-cost-minimizing carbon policy. I’ve certainly become convinced that I do not trust them to design carbon markets. A carbon tax is still not a good policy, but the politicization of the potential carbon market and its bundling with other, inflexible energy policies will doom any carbon market that this Congress designs to a failure along the lines of the ridiculously over-politicized EU Emissions Trading Scheme.

While this bill is still just a House draft, the combination of the desire to leave most carbon-related items open to negotiation with the overwhelming urge to control and manage the individual decisions of millions of individuals suggests that Congress has neither the external incentives nor the internal motives to enagage in good, scientific, non-political institutional design to implement carbon markets.

So if I don’t trust them with carbon markets and I don’t advocate a tax, what do I propose? We’ve got regional markets that (after controlling for recession) are growing. The voluntary CCX market is growing both domestically and internationally (including China), adding members constantly. Other regional markets, such as RGGI and California, could over time grow along with the CCX into a set of integrated regional markets. Isn’t that how financial markets have always evolved througout human history? I’m not thrilled with that answer, but I think it’s loss-minimizing relative to the economic and environmental harm that a botched, overly-politicized federal carbon policy can induce.

Will pricing carbon raise electricity prices?

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Lynne Kiesling

UPDATE: Thanks to the commenter who alerted me that I mis-labeled my graph, and that equilibrium B should be at the intersection of S’ and D’. I may not get to update the graph Monday, my apologies.

There’s been an interesting discussion going on this week building off of a Sean Casten post at Grist, in which he states

For climate law to work, it must put a price on CO2 emissions. But there is no logical reason why that must imply an increase in energy costs, for the simple reason that energy is not CO2.

Rich Sweeney then picked it up at Common Tragedies, and the conversation in the comments on both posts has been good. The substance of what I wanted to add is already reflected in the conversation, but I’m going to say it in a different way, based on how I interpret Sean’s comment from his perspective.

For those who don’t know Sean, he is the President and CEO of Recycled Energy Development, which has a business model of capturing and recycling waste energy that occurs in large-scale industrial processes. Waste energy recovery reduces a firm’s energy costs by reducing the amount of electricity it uses per unit of production; consequently, it reduces GHG emissions. This chain leads to RED’s claim to reduce greenhouse gases profitably.

The value creation potential here, both economic and environmental, is enormous. Our energy efficiency of converting fuel into electricity is 33%, which means that 100 units (I’m going to be general here to stay away from getting too techy) of fuel go into the generator and 33 units worth of electricity is produced (then the losses continue down the supply chain, where ultimately that 100 units of fuel results in the use of 4 units of electricity to power an incandescent light bulb). That means that there is a lot of room to increase generation energy efficiency by recovering waste heat, using combined heat and power, district heating, and so on to put the waste energy to productive use.

I interpret Sean’s comment through this waste energy recovery lens, and I think he is making what I would call a general equilibrium point about how fuel markets could evolve and adapt to the carbon policy. Please also note here that I am abstracting from transportation and focusing solely on the use of carbon-based fuels to generate electricity for resale and for use in industrial processes. If we price carbon (for now assume away any difference between tax and C&T), the chain of effects consistent with his argument are

  • The fuel supply curve shifts to the left, reflecting the increasing marginal cost effect of the carbon policy
  • In expectation, seeing this potential effect, firms increase their energy efficiency and engage in more actions like waste heat recovery, shifting the demand for fuel to the left
  • Thus in equilibrium, fuel prices could be lower than they were before the initial equilibrium, if the magnitude of the demand shift is larger than the magnitude of the supply shift

Thus I think Sean’s point is that there is so much potential energy efficiency because the amount of wasted energy in the electricity generation system right now is enormous; this potential translates into a large demand shift response to carbon policy in carbon-based fuel markets. But that’s the unknown: if firms don’t respond to carbon policy by sufficient waste heat recapture and other methods that increase energy efficiency, then carbon policy would lead to an increase in fuel prices. I even drew a graph!

ee-graph

Thus I agree with the commenters who pointed out that we have to be really careful in distinguishing between costs and prices; carbon policy will unambiguously increase marginal costs in fuel markets, but if firms respond by shifting their demand, that cost increase need not translate to higher prices in fuel markets, which means that the firm’s fuel costs in their budget may not go up.

The other variable here is long-run population growth. As population grows, for how long will this potential energy efficiency potential be available to suppress the translation of carbon policy into higher fuel prices? But I do think that Sean is right, and that we have a lot of gains and value creation opportunities to capture.

So the big remaining challenge is that there are huge regulatory and cultural barriers to implementing the kind of energy efficiency and waste heat recovery techniques Sean advocates. Electricity generators are heavily invested, literally and metaphorically, in these inefficient large-scale central generation assets. The existing regulatory apparatus is built precisely to ensure that those firms earn a cost-plus rate of return on those assets, so they have little incentive to engage in waste heat recapture. Pricing carbon is likely to change that, but I’m skeptical that those are the places we will see big improvements in generation energy efficiency.

The other areas are places like Sean’s industrial customers, who have good economic incentives, and in areas where buildings can connect together to do distributed generation and combined heat and power within a microgrid structure. But there we run up against the century-old prohibition against anyone building distribution wires, especially across public rights-of-way, except for the government-granted monopoly regulated distribution utility. The potential energy efficiency gains from CHP in microgrids are substantial, and will enable the kind of effect that Sean’s describing to happen … but the distribution utility has every incentive to fight such innovations tooth and nail. They even go so far as to argue that consumers should not be allowed to do this because it will increase the costs of the system to all of the other customers who stay with the utility.

This is the pernicious conflict we now face between a cost-based regulatory system and energy efficiency. Until we have regulatory reform that breaks this vicious incentive cycle, Sean’s vision cannot become a reality.