Putting a Price on Carbon

Oil in the Spotlight

While oil prices have come down since their recent peak a few weeks ago, they remain in the spotlight.  This weekend, President Obama used his Saturday address to call for increasing drilling.  Coming on the heels of last week's grilling by the Senate Finance committee of the nation's top oil executives a propos of a proposal to end longstanding tax breaks for drilling, his remarks capture the frustration many people feel about rising gasoline prices.

Our anger would no doubt bemuse many overseas for US gas prices are low by global standards.  Indeed, as the attached graph shows, they are still less than those registered two years ago.  What is nonetheless frustrating about gas prices is their volatility.  Gas price shocks like hurricanes and flooding are hard to predict but when they occur,devastating.  The impact of the 1970s shocks are well understood: they launched stagflation in the US and Europe and inaugurated a huge transfer of wealth to the oil states that persists to this day.  But even the milder 2008 shock, some economists now believe, may have played a role in triggering the Great Recession.  And the story that many are using to explain the collapse, not just in oil prices but in commodity prices across the board in recent weeks, is expectations of a weak economy ahead--perhaps one deflated by high commodity prices over the last year.

As frustrating as oil shocks are, the record of efforts to address them has been more frustrating still. The 1970s oil shocks were bad but the famous lines at the pump that helped Ronald Reagan defeat Jimmy Carter were due not to the oil shocks but to price controls--a policy intervention that succeded only in creating shortages.  Worse, price controls were slapped on domestic oil but not foreign oil, and traders reaped millions by illegally recertifying shipments. 

In 1980, Congress passed a windfall profits tax on oil.  Given the huge profits by oil companies at the time, it seemed like sound economic policy  However, the tax applied only to domestically produced oil and, in retrospect, was a key step in accelerating our dependence on foreign oil.  More successful was the creation of the Strategic Petroleum Reserve and the creation of gas mileage standards. But neither of these has proved a silver bullet either.  The Reserve has yet to be tapped and the CAFE standards, while they have cut fuel use, by looking at the entire fleet are correctly criticized for allowing gas guzzlers to persist.

If controlling volatility in commodities markets has never been easy, it has become more difficult in recent years.  A series of commodity index funds launched by Merril Lynch but now owned by Goldman Sachs have become established vehicles for hedge funds and others to place large quantities of money, exacerbating movements.  Indeed one theory of the commodiites runup this past year is that it reflects global liquidity created by the QE2 program of the Fed that spent about $600 billion buying securities.   Indeed, the commodities crash last week, coincided with the end of QE2.  Yet another theory for the commodities crash is that authorities raised margin requirements on commodities traders.  The commodities "bubble" as some has described it has drawn comparisons with the financial and real estate bubbles, in particularly, in light of the IPO "at the top" scheduled this week by Glencore, the company started by Marc Rich decades ago after he fled the United States.

All of this is a way of saying that reining in oil and gasoline prices is not easy.  But given the devastation, price spikes can cause, it must still be attempted.  Perhaps the single most important thing we ought to do is reign in Opec, the organization that more than any other can alter the price of oil.  Secondly, financial regulators need to study more carefully how trading in commodity indices as an asset class can drive monetary movements with serious real world consequences.  Beyond that, we should be working over the long term to wean ourselves off scarce resourcs such as oil toward renewable resources.  That cannot happen overnight but it will be the only long term resolution to the problem of oil and gasoline price volatility.

Scoping Out Plan B for Climate Change

Beyond the public’s view, major players in the climate change debate are reassessing their options.  In fact, as the prospects of Congress approving a cap-and-trade system fade, discussion is shifting to “Plan B.”

One reason is that the version of cap-and-trade which just barely passed the House of Representatives a few months ago, the Waxman-Markey bill, made so many concessions to polluting interests that its support among environmentalists has eroded badly.   Here’s one indicator of just how weak the bill is:  When it passed the House, bond ratings for coal companies improved – a remarkable development given that coal-generated electricity is the single largest source of greenhouse gas (GHG) emissions.   In the Senate, progressives are said to be determined to oppose any legislation that ends up as weak as Waxman-Markey.   And the moderates and conservatives who make up a majority of the Senate remain wary of climate-change engineering in a cap-and-trade form, since it would both raise energy prices for average Americans and make those prices more volatile for business.   The upshot is that the prospects of corralling 60 votes for the Kerry-Boxer cap-and-trade bill in the Senate have faded to nearly zero.  

In truth, the support for a cap-and-trade system always has been limited largely to a handful of sources. There are two large environmental groups – the Natural Resources Defense Council (NRDC) and the Environmental Defense Fund (EDF) – wedded to the notion of dressing up a regulatory cap on emissions with market-based trading in the emissions permits, and the Wall Street institutions eager to get a piece of all that trading and the speculation and derivatives it would throw off.  In addition, a few large energy companies with major business lines in trading energy futures have been active supporters, as have some other companies confident they can exact the kinds of special exemptions for themselves that ultimately hobbled Waxman-Markey.   Even that limited base has been shrinking:  Wall Street support has become a big negative in the current political context, and there are reports that in the wake of Waxman-Markey, NRDC is now internally divided over the basic strategy.

With the fate of cap-and-trade in the Senate pretty much sealed – in effect, cap-and-trade’s third successive rejection by the Senate -- the debate behind the scenes is moving to the alternatives.   The two leading options are direct EPA regulation of GHG emissions or a revenue-neutral carbon tax.  The courts recently held that EPA already has the authority to regulate GHG emissions, and the eclipse of cap-and-trade will shine a new spotlight on this approach.  The alternative is one which a good share of the environmental community, most economists, and climate-change leaders like Al Gore have all supported:  Apply a tax to energy based on its carbon content, and recycle the revenues as cuts in payroll or other taxes.  Given how economically costly direct regulation can be – and the uncertainties about what such regulation would look like under the next conservative president, compared to our present liberal one -- its prospect could quickly expand support for a carbon tax program.  That approach also has the virtue of a successful record:  While Europe’s cap-and-trade system has yet to reduce European GHG emissions, Sweden’s 15-year experiment with carbon-based taxes cut the country’s emissions sharply even as its economy grew 50 percent larger. 

For its supporters, a carbon tax is simple, transparent, and produces a steady price for carbon which businesses can use to plan large investments in developing and adopting more climate-friendly fuels and technologies.  To its opponents, it’s just another tax.  That objection should be at least partly neutralized by recycling the revenues through other tax cuts – if the debate remains reasonable.  In the end, environmental and business leaders, and ultimately the White House, will have to defend a carbon-based tax against the forces of politics as usual, which in this time seem dominated by the power of entrenched interests and the partisan politics of just-say-no-to-everything.  If we can’t manage that, we may well lose the best chance in a generation to take serious action to defend he climate our children and grandchildren will inherit. 

Bipartisan Action on Climate Change Is Exciting, As Long As It's Also Multilateral

Over the weekend, Senators John Kerry and Lindsey Graham penned a joint op-ed in the New York Times that has made those of us who care about action on climate change pretty happy. The prospects of Republican support extending beyond the Snow-Collins duo to John McCain's best friend in the Senate this early in the process is exciting, to say the least. And the compromise that Graham wants isn't too far-fetched.

There is, however, one piece of the op-ed that has made many who understand that combating climate change is a multilateral challenge nervous:

Fourth, we cannot sacrifice another job to competitors overseas. China and India are among the many countries investing heavily in clean-energy technologies that will produce millions of jobs. There is no reason we should surrender our marketplace to countries that do not accept environmental standards. For this reason, we should consider a border tax on items produced in countries that avoid these standards. This is consistent with our obligations under the World Trade Organization and creates strong incentives for other countries to adopt tough environmental protections.

I agree that we can't sacrifice jobs to overseas competitors. Competitiveness is one of the best reasons to pass climate legislation that spurs innovation and deployment of a whole generation of low-carbon technologies domestically. That said, climate change is a pressing global challenge that inherently requires unprecedented levels of global cooperation, but the proposed punitive trade policies are expressly unilateral mechanisms. This is a policy mismatch that will not help us solve this challenge. 

If we want the developing world – from which the vast majority of emissions growth is expected in the coming decades – to be on board with creating a solution to climate change and to buy our climate-friendly goods, slapping a tariff on them right away is not the way to make friends and influence people. And it's not as if the United States has been leading on climate issues – Imagine the American response if Europeans had imposed these tariffs. I don't want to begin to imagine the retaliation that other nations may decide upon; what do we do if China and India – who already have high barriers to climate friendly technologies – decide that they're not quite high enough, especially for American goods?

Additionally, it's crucial to note that climate legislation already allots (as opposed to auctions) permits to energy intensive industries. Tariffs amount to a double correction. Here's leading international economist Jagdish Bhagwati at a recent NDN-New Policy Institute event speaking about the tariffs and the WTO compliance of a cap and trade regime:

Some important people are wary of or opposed to these tariffs: The head Intergovernmental Panel on Climate Change, Rajendra Pachauri, thinks they're a bad idea:

"This is a dangerous thing, and I think people in Congress must understand this," said Pachauri, who spoke with the AP after he addressed the National Press Club. "Please don't use this weapon. I'm afraid that those that have been pushing these provisions probably don’t realize that all of this can cause a major negative reaction," Pachauri added. "The United States has always stood for a free market system. … Legislation to move away from that principle is clearly counterproductive."

As does President Obama

At a time when the economy worldwide is still deep in recession and we've seen a significant drop in global trade, I think we have to be very careful about sending any protectionist signals out there. There were a number of provisions that were already in place, prior to this last provision you talked about, to provide transitional assistance to heavy manufacturers. A lot of the offsets were outdated to those industries. I think we're going to have to do a careful analysis to determine whether the prospects of tariffs are necessary, given all the other stuff that was done and had been negotiated on behalf of energy-intensive industries.

So certainly it is a legitimate concern on the part of American businesses that they are not disadvantaged vis-a-vis their global competitors. Now, keep in mind, European industries are looking at an even more ambitious approach than we are. And they obviously have confidence that they can compete internationally under a regime that controls carbons. I think the Chinese are starting to move in the direction of recognizing that the future requires them to take a clean energy approach. In fact, in some ways they're already ahead of us -- on fuel efficiency standards, for example, they've moved beyond where we've moved on this.

There are going to be a series of negotiations around this and I am very mindful of wanting to make sure that there's a level playing field internationally. I think there may be other ways of doing it than with a tariff approach.

I'm excited that the chances for getting climate change legislation through the Senate have grown, I just don't want to see them destroy the chances for multilateral climate action. Both are important for American competitiveness, jobs, and the creation of a low-carbon economy.

More Inconvenient Truths

Yesterday, the Obama Administration released a long awaited, definitive government report on the impact of climate change on the United States by region, economic sector and social outcome.  In what might be called an American version of the Stern report, prepared by 13 government agencies, it confirms the large existing body of scientific work on the reality of climate change and then specifically charts the impact on the United States today and far into the future.

Significantly, it argues that climate change has already impacted the US through heavy downpours, rising temperatures and sea levels, thawing permafrost, earlier snowmelt and alterations in river flows.  And change will accelerate in years to come.  Indeed, the report underscores that much of the impact of climate change will be via water.  In some areas, increased precipitation will stress water management resources, leading to flooding.  In others, it will lead to drought.  Changing water paterns will impact agriculture, coastal regions and public health.

If this report cannot drive home the point that the cost of climate change is far greater than the cost of a cap and market regime to address it, nothing may.  The real threat of climate change is that its mechanism for wreaking havoc is so broad: rain, rising rivers, drought and other changes in our overall habitat can seem too diffuse to pin on one cause.  This report shows that there is a cause, however, and it is greenhouse gases.

As the House prepares to debate the American Clean Energy and Security Act (ACES) next week it would do well recognize that the problems of climate change do indeed transcend regional or parochial boundaries and only the political courage to see the big picture, will enable America and the world to take the steps needed to solve this complex problem.


Passing Climate Change This Year

As I have been writing, the time has never been better to pass a climate change bill and if action does not take place this year, the prospects for passage are likely to decline.  Recognizing the threat of a bill passing, opponents have pulled out all the stops, while supporters are making a full court press to gain passage.  With a critical vote in the House coming as early next week, the stakes could not be higher.

Against this backdrop, yesterday, Al Gore's Alliance for Climate Protection released a new ad as part of its Repower America campaign to help rally support for the bill.

The ad shows a farmer talking about the need to do something about dependence on foreign oil.  He has a point.  It was President Nixon who first began to rail about dependence on foreign oil.  In the 40 years since, the problem has only grown worse.  And, of course, we now have to contend as well with the even more serious threat of global climate change. 

Here's the ad:

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