The EU’s Emissions Trading Scheme Has Been Voted Down

Summary.  The European Union instituted its Emissions Trading Scheme, using a cap and trade mechanism, in 2005.  Since that time, the Scheme has gone through periods in which the number of allowances was too high, resulting in excessively low values for their price. 

In a vote on April 16, 2013 the European Parliament defeated a proposed measure continuing to allot allowances to the emissions sources among the EU’s member nations, largely for economic reasons.  If allotments are not revived, the ETS will cease operations.  This would terminate one of the first multinational efforts to mitigate greenhouse gas emissions.
 

The ETS exemplifies the administrative and political difficulties facing cap and trade regimes.  Valuing carbon emissions is better achieved with a carbon fee.

 

Introduction.  The original members of the European Union (EU) in 1997 acceded to the Kyoto Protocol, an international treaty to limit emissions of carbon dioxide (CO₂) and other greenhouse gases (GHGs).  The Protocol entered into force in 2005.  Even before this date the now expanded membership of the EU undertook to establish an Emissions Trading Scheme (ETS) to limit GHG emissions through 2020, using a cap and trade market mechanism.  In such regimes allowances, once granted, can be traded or auctioned in an open market; this fixes a monetary value for them.

In the initiation phase of the ETS the EU allowed each member nation independently to establish the number of allowances (each permits release of one metric ton of CO₂).  As a result, too many allowances were granted, and the ETS market wound up valuing the allowances at a very low price, even approaching EUR 0 in one year.  In the second phase (2008-2012) the number of allowances granted was reduced, and the ETS market valued allowances at reasonable levels.  In the third phase, beginning in 2013, the EU began centrally to determine the distribution of allowances.

Unfortunately, the EU cancelled its most recent auction   in March 2013 because bids received were “significantly” below the actual market rate.  In 2013, the start of Phase 3, about 40% of newly issued carbon emission allowances were being sold at auction for the first time.  The rest are still distributed at no charge.  The price had fallen to EUR3.73 (US$4.86) a metric ton early in the year.  The price had been about EUR 25 in 2008.

Longer term the ETS price for emission allowances has fallen drastically, by 90%, in the last five years.  This is due largely to a drop in demand for energy among EU countries because of recessionary conditions.  This has led to an oversupply of allowances.  The ETS began to reevaluate its allocation of allowances, in an attempt to rebalance the trading system and maintain a price on emissions.

Unfortunately the EU has now voted against its cap and trade regime.  The New York Times reported on April 17, 2013 that the European Parliament had voted not to lower the number of carbon dioxide emission allowances to be granted going forward.  The Times called the result “a potential death blow” to the cap and trade emissions regime.  Even so, emissions from the EU had fallen by 10% between 2007 and 2012, at least partly because of weak economic conditions.  The Parliament gave greater weight to the desire to keep energy costs down in view of the economy than to the overarching need for the world to limit its emissions of GHGs.  After the vote, the value of an allowance fell 40% to about EUR 3 per metric ton.  It is estimated that in order to have an effect on curtailing emissions, the price would have to be about EUR 30 per metric ton or higher. 

Analysis

This blog has long advocated in favor of a direct fee on carbon fuel consumption, rather than implementation of a cap and trade regime, to put a price on emissions of GHGs and thereby lower the annual rate of GHG emissions.  This latest development in the EU, the failure of its policymakers to continue the ETS, shows that a cap and trade regime may continually be subject to political interference.

As written in a recent post a cap and trade regime has many disadvantages in comparison to a carbon fee.  Some of these are apparent when considering the EU.  The factors include a) a need to account accurately for baseline emissions from each identified source prior to placing the regime in operation; b) a continued need for monitoring emissions from each source as the regime operates; c) a need for a  mechanism to allot allowances both at the outset and in subsequent periods of operation; d) a mechanism or rule for distributing allowances, including determining whether to grant or sell them; and e) setting up the administrative offices needed to operate the regime.  It is seen from this incomplete list that a cap and trade regime presents many challenges, requires an extensive bureaucratic structure, and includes many opportunities for mistakes to be made, or for influence, that defeat the objective of constraining emissions.

In contrast, a carbon fee is extraordinarily simple in its operating features and is easy to implement.  For example, a low rate could be established at the outset, which would increase annually to a level at which it would have a meaningful effect in reducing energy demand.  Experience has shown (not discussed here) that a carbon fee is easy to apply, has a broad if not universal reach, and achieves its objective according to its magnitude.  It is clear that the simplicity and effectiveness of a carbon fee offers major advantages over use of a cap and trade regime.

Many commentators have urged use of a carbon fee to mitigate emissions. 

 

In summary, the simplest, most direct, and most effective mechanism for reducing dependence on fossil fuels and mitigate emissions of GHGs is to apply a carbon fee.  The time to begin abating humanity’s emissions of CO₂, a major greenhouse gas, is now.  The longer we wait, the more firmly we cement our dependence on fossil fuels, and the more difficult it will be to achieve meaningful mitigation of global warming.

 © 2013 Henry Auer

Choose a Carbon Fee, Not a Cap and Trade Regime

Summary.   Burning fossil fuels generates carbon dioxide as waste whose socioeconomic costs to humanity are not accounted for in the price of the fuel.   Reducing our dependence on fossil fuel use and mitigation of emission of greenhouse gases have led to valuing carbon either by a fee or use of a cap and trade mechanism; the additional value would limit consumption.  A carbon fee is easy to implement legislatively or administratively, and has been effective in reducing demand for fossil fuels.  Cap and trade regimes are in place in many jurisdictions around the world.  They are administratively complex and bureaucratically onerous, and can be unsuccessful in curbing fossil fuel use.  This post expands on these factors, and concludes that lowering the use of fossil fuels is best accomplished by imposing a fee on carbon.

 

Introduction. 

Human activity generates waste.  Significantly, as we burn more and more fossil fuels to produce the energy that powers modern life, we emit more and more carbon dioxide into the atmosphere.  This substance, an important greenhouse gas, is being released as the waste product of our energy economy.

 

It is imperative to treat manmade carbon dioxide as a cost-bearing waste product because of the harmful effects of the global warming that it produces.  These harms carry enormous costs with them.  Properly accounting for these costs would make it more acceptable to make the investments needed to reduce greenhouse gas emissions.
 

Policy directed toward reducing dependence on fossil fuels and mitigating greenhouse gas (GHG) emissions has long grappled with the alternative policies of imposing a carbon fee on fossil fuels and creating a cap and trade regime.  These may be viewed as policies that affect, respectively, the demand for, and the supply of, fossil fuels.  A carbon fee levies an added cost on fossil fuels directly.  The fee is passed through directly to the consumer, affecting demand. Cap and trade mechanisms, on the other hand, place upper limits on the emission of carbon dioxide (CO₂). 

This post reviews examples of both mitigation mechanisms.  Upon consideration we support the use of a carbon fee in preference to a cap and trade mechanism for mitigation.

A carbon fee is imposed on fossil fuels directly in accordance with the amount of CO₂ produced when burned.  The fee is imposed and collected at, or close to, the source of the fuel.  The value of the fee is then passed along as the fuel is transformed (petroleum to gasoline, for example), and/or transported (all fuels), and is ultimately paid by the consumer.  The level of the fee is set by policymakers, and typically is envisioned to start low and rise periodically until it reaches an intended level.  It is seen that a carbon fee is conceptually and operationally easy to implement.  Clearly the fee operates to constrain demand.

Under cap-and-trade major emitting facilities are allotted allowances each of which licenses the release of a fixed amount, say 1 ton, of CO₂ and other GHGs.  An administrative agency determines the total number of allowances (the cap) and the allotments for each period.  The cap is reduced year by year, thus constraining fuel consumption.  Ideally the emitters would pay for the allowances, frequently through an auction, but at the outset in many regimes they are distributed at no charge.  In any case, as the program matures markets are ultimately set up to auction annual allowances, and for trading them, thereby establishing a price for emissions.  The market price on carbon established in this market deters fossil fuel use. 

There are many problems with a cap-and-trade regime that make it difficult to succeed.  For example, if the supply of allowances is too high or the market demand is too low, their price will fall and the objective of reducing the rate of emissions of CO₂ will be discouraged.  For these and other reasons discussed below, operation of a cap and trade regime is complex, if not cumbersome.  A cap and trade regime may be intricate and top-heavy to administer.

Both cap and trade and a carbon fee assign a monetary value to the waste stream that emissions of CO₂ and other greenhouse gases represent.  This has not been done historically; CO₂ has not been considered to be a waste product of our energy economy whose disposal had to be priced into the cost of the fossil fuels.
 

Examples of using a carbon tax.

In Australia, Prime Minister Julia Gillard’s government enacted a carbon fee program in 2011.  Initially the carbon fee is US$23.15 per ton of carbon; much of the revenue is to be applied as compensation to businesses and consumers (“cap and rebate”).  After six months of operation, the electricity generation segment of Australia’s energy economy reduced its carbon emissions rate by 8.6%.  Emissions were 7.5 million tonnes lower in the second half of 2012 than for the same period in 2011.  This arose from a decrease in demand and an increase in residential rooftop solar panel use and increased energy-efficiency.   Some coal-burning facilities ceased operating, while more power came from increased hydroelectric generation.  The long-term goal is to reduce emissions by 33 million tonnes per year by 2020.

Gasoline fees are very effective in affecting drivers’ travel habits.  The graphic below, characterizing how per capita fuel use reflects the size of the gasoline fee,

 

Sources: New York Times presenting data from the U. S. Department of Energy and the World Bank; http://www.nytimes.com/interactive/2012/09/11/business/Fuel-Taxes-and-Consumption.html?ref=business  

shows that per capita use of fuel for driving in developed countries decreases as the amount of the gas fee increases.  The U. S. has the lowest gas fee, which is correlated with the highest amount of fuel used per capita (horizontal scale). As the gas fee increases (vertical scale), it is seen that most of the benefit appears to be attained by a fee level of about US$2.20 per U. S. gallon.  In Great Britain, where the gas fee is even higher, Ford, the American car maker, sells a model of its compact Focus whose efficiency is 72 miles per U. S. gallon.  In contrast, a Focus model sold in the U. S. gets only 33 miles per U. S. gallon.  Clearly, automakers already have the technology and capability to mass produce highly fuel efficient cars.  This shows that the current state of technology is sufficient to garner significant improvements today.

Gasoline prices affect consumption.   In the U. S. the price of gasoline has fluctuated considerably in recent years for reasons that do not include imposition of a carbon fee.  The Washington Post reported on April 17, 2012 that higher gas prices had led to reduced consumption, and to a move toward the purchase of more fuel-efficient vehicles.

A review of various studies of the interrelationship between price and consumption concluded that “we can be reasonably assured that a rise in gas fees, all else being equal, will cause consumption to decrease”. 

Examples of using cap and trade.

In the U. S. the Regional Greenhouse Gas Initiative (RGGI) encompasses nine northeastern states.  RGGI controls only for emissions from fossil fuel plants that generate electricity, and affects only larger power plants.  RGGI created a CO₂ cap and trade program, with the goal first of stabilizing and subsequently reducing the overall emissions from these plants.  Each state’s base emission amount was established at the outset, and is remaining fixed at that level from 2009 through 2014.  Starting in 2015, the allowances for each state are to be reduced by 2.5% per year, so that by 2018 the emissions will be 10% below the starting level.  Auctions for emission allowances occur quarterly.  RGGI estimates that the auction price increases the cost of electricity to the consumer by only 0.4% to 1%.

In its 19th auction, almost 38 million CO₂ allowances were sold, garnering about US$106 million, or US$2.80 per allowance.  The cumulative amount from all auctions is about US$1.2 billion.  The proceeds are used to rebate portions of electricity bills to consumers, invest in the region’s renewable energy economy, including job training for environmental jobs, and similar objectives.  RGGI has already invested in improvements that will produce significant reductions of CO₂ emissions and save the need for generating major amounts of electricity, as well as the thermal energy needed to drive the generators.

European Union (EU). Even before the entry into force of the Kyoto Protocol in 2005, the European Commission established its greenhouse gas emissions trading scheme (ETS) using a cap and trade market mechanism. As an accord intended to govern the operations of 27 sovereign nations, each country had to enact laws codifying the applicability of the ETS structure within its borders.

It covers at least 11,000 individual emission sources across the EU. The ETS is being implemented in three phases.

Phase 1, operating from 2005 to 2007, was characterized as a learning phase, and included such features as

• The level of the emissions cap was determined largely by each nation independently;
• It included only power plants with a capacity greater than 20 MW, and other industrial facilities; these represented 42% of emissions; and
• Allocations of emission allowances relied primarily on recent historical records; they were offered at no cost.

In Phase 2 (2008-2012), features that expanded on those of Phase 1 included:

• The level of the emissions cap conformed to the limits of the Kyoto Protocol; and
• Limits on emissions from air travel were to begin in 2012.

Phase 3 (2013-2020) departs from the earlier phases in important ways:

• National emissions caps were to be replaced by a single EU-wide cap; they decrease by 1.74% per year starting in 2010 with the objective of delivering 21% reduction referenced to 2005 by 2020;
• 90% of the allowances will be sold by auction rather than being distributed free of cost.

The performance of the ETS is shown below in the graphic.  Emissions allowances in a cap-and-trade regime were already in use in the EU prior to 2005. In Phase 1 it turns out that for a variety of reasons the auction market in these initial years established early prices as high as almost EUR30 (about US$39.20 at that time) per tonne of CO₂ equivalents (blue and lavender lines; tonne, a metric ton), which then fell to EUR0/tonne toward the end of Phase 1 (orange line; see the graphic).

 

CO₂ price evolution in the EU from 2003 to 2009.  Each period’s price performance is color coded as shown.  The pale aqua line represents futures trading for (the lower number of) allowances to be granted beginning at the start of Phase 2.  The EU-wide number of allowances for Phase 2 was 11.8% lower than for Phase 1.  Once Phase 2 began in 2008, the actual allowance price and the futures trading for 2009 allowances followed essentially identical paths.

Source: Estimations of carbon price in Europe, Nicole Dellero (2008)  http://ec.europa.eu/energy/nuclear/forum/opportunities/doc/competitiveness/2008-10-24/areva--co2prices.pdf.

 

The fall of the allowance price to EUR0/tonne in 2007 has been attributed both to a glut of allowances and to the impending economic slowdown preceding the world financial crisis of the coming years.  Of course, with allowances having no penalty value, emission sources were free to continue “business-as-usual”, rather than to curtail them.  On the other hand, when allowances had a significant price, businesses were able to pass along corresponding price increases to customers, which resulted in windfall profits.

The ETS had to cancel its most recent auction in March 2013 because bids received were “significantly” below the actual market rate.  In 2013, the start of Phase 3, about 40% of newly issued carbon emission allowances are being sold at auction for the first time.  The rest are still distributed at no charge.  The price had fallen by 5.6% to EUR3.73 (US$4.86) a metric ton, and reached a low on Jan. 31, 2013 of EUR3.42. 

Longer term the ETS price for emission allowances has fallen drastically, by 90%, in the last five years as demand for energy has fallen because of recessionary conditions among EU countries.  This has led to an oversupply of unused allowances.  The ETS is reevaluating its allocation of allowances, in an attempt to rebalance the trading system and maintain a price on emissions.

The state of California enacted its Global Warming Solutions Act in 2006, establishing mitigation goals through 2020.  The governor at the time, Arnold Schwarzenegger, extended the Act by executive order declaring further stringent mitigation objectives through 2050.  These actions are significant, because California constitutes about 1/6 of the U. S. economy in view of its large size and population.  The Act is also significant because in the U. S. it is the only economy-wide mitigation plan.  Inititally it covers most fixed point sources of emission, including electric generation plants and industrial facilities, beginning now (2012-3).  It will extend to refining and sale of transportation fuels (i.e., distributed sources) in 2015.  The mechanisms for undertaking its mitigation goals include a cap and trade system as well as continuing and expanding California’s historic, successful energy efficiency programs.  State officials and advisors are undertaking to learn lessons from the experience of the European Union’s ETS, seeking to avoid its mistakes.

The state established a rigorous survey of emissions from every potential covered installation in order to allocate emission allowances.  In its first auctions California sold 23.1 million allowances at US$10.09 each, in Nov. 2012, and another 12.9 million allowances at US$13.62 each at the second auction in Feb. 2013.  This works out to revenue from the first two auctions of US$409 million.

 

Analysis

Two major mechanisms have been devised to abate the emission of CO₂, a major greenhouse gas, (aside from the important contribution of increasing the efficiency of energy usage).  One, a cap and trade regime, operates primarily by capping the supply of energy.  (Of course the auction price imposed on allowances has the effect of raising the price of the energy purchased by the consumer, so cap and trade may also have elements of lowering energy demand as well.)  The second, a carbon fee applied in proportion to the amount of CO₂ emitted when the fossil fuel is burned, directly limits demand by raising the price paid for energy.

A cap and trade regime has many disadvantages in comparison to a carbon fee.  Some of these are apparent when considering the case of the European Union.  The factors, many of which are interrelated, include a) a need to account accurately for baseline emissions from each identified source prior to placing the regime in operation; b) a continued need for monitoring emissions from each source as the regime operates; c) a need for a  mechanism to allot allowances both at the outset and in subsequent periods of operation; d) a mechanism or rule for distributing allowances, including determining whether to grant or sell them; e) monitoring use of energy offsets by those installations unable to comply with emissions limits; and f) creating and maintaining the new administrative and bureaucratic offices needed to operate the regime.  It is seen from this incomplete list that a cap and trade regime presents many challenges, requires an extensive bureaucratic structure, and includes many opportunities for mistakes to be made that defeat the objective of constraining emissions.

In contrast, a carbon fee is extraordinarily simple in its operating features and is easy to implement.  A tax rate is established at the outset, covering most or all sources of CO₂ emissions.  In order to achieve its objectives, it would be optimal to start with an insignificant tax rate, and then have the rate increase annually to a level at which it would have a meaningful effect in reducing energy demand.  The example cited in the gasoline fee graphic above provides ample evidence that a carbon fee is easy to apply, has a broad if not universal reach, and achieves its objective according to its magnitude.  It is clear that the simplicity and effectiveness of a carbon fee offers major advantages over use of a cap and trade regime.

Many commentators have urged use of a carbon fee to mitigate emissions.  One of the most consistent over time has been Tom Friedman, columnist for the New York Times, most recently in this article.   His writing and that of others have considered the many uses to which the revenues from pricing carbon could be applied.  This post will not address that discussion; most alternatives are worthy ones.

 
The time to begin abating humanity’s emissions of CO₂, a major greenhouse gas, is now.  The longer we wait, the more firmly we cement our dependence on fossil fuels, and the more CO₂ accumulates in the atmosphere, exacerbating global warming and its damaging effects on human life and welfare.  The simplest, most direct, and highly effective mechanism for reducing dependence on fossil fuels and mitigate emissions of GHGs is to apply a carbon fee.
 

© 2013 Henry Auer

The Libyan Oil Crisis Argues for Developing Renewable Energy

Summary.  The present political crisis in Libya, which produces 2% of the world’s oil, has resulted in a sharp spike in the price of oil.   The U. S. is projected to need a slightly higher amount of oil in future decades, of which an increasing amount will be imported from foreign sources.  Because of a) a projected increase in production of oil world-wide from reserves that to date are undeveloped or unidentified, b) an increase in the number of cars world-wide, and c) a consequent strong increase in the price of oil, the U. S. will be sending large and increasing amounts of funds abroad to buy the needed oil.  In view of this situation, the U. S. should wean itself from its dependence on imported oil.  Burning fossil fuels contributes to global warming by emitting greenhouse gases (mainly carbon dioxide, CO2), which have recently been shown to contribute directly to weather extremes.  Forest fires, droughts and floods resulting as effects of global warming have enormous economic costs associated with them.  It would be beneficial instead to invest expenditures now to limit greenhouse gas emissions by imposing economic penalties for use of oil and other fossil fuels.  This could be achieved by a cap-and-trade mechanism, or through a carbon tax.  The revenues from these policies could be distributed to the treasury or the public, or be applied to support innovative research and development of renewable energy sources.  As many have said, “If not now, when?”

A Sharp Spike in the Price of Oil.  The United States, as well as other countries of the world, is addicted to fossil fuels for their energy needs.  The present political crisis in Libya, which produces 2% of the world’s oil, has led to a shock-provoked spike in the price of oil in the last few days (see the 1-year price chart in the graphic below).  On this day, February 23, the price peaked at $100/barrel; according to Barron’s.  As may be seen, the price increased sharply from about $88/barrel on February 16 to its present price in 1 week.

Crude Oil Price, US$/barrel

Source: http://online.barrons.com/data

This week’s events show that the threat of instability in a very small fraction of the world’s oil supply has a dramatic effect on its price.  This effect, on a percentage basis, is much more profound than the amount of oil potentially lost if Libya were to cease production. 

Increased Demand for Oil Predicted for the U. S. The consumption of oil in the U. S., and the amount projected to be needed in future decades, is shown by the dark red band in the following graphic.

Actual fuel usage up to 2009 and modeled projections after that date.

Source: U. S. Energy Information Agency Annual Energy Outlook 2011 – Early Release Overview.  http://www.eia.gov/forecasts/aeo/

The amount of oil that will need to be imported increases slightly over the period 2009 to 2035.

The world-wide production of oil, projected to 2035 by the International Energy Agency (IEA), is shown in the following graphic.  The dark blue band shows projected delivery from sources known today, and the light blue triangle shows expected but unproven delivery from oil reserves that remain to be identified or developed.  The gold band shows projected oil production from unconventional sources such as tar sands and shale oil.



Reproduced from World Energy Outlook 2010 © OECD/IEA.  http://www.worldenergyoutlook.org/docs/weo2010/weo2010_london_nov9.pdf



Increased Demand Due to Higher Numbers of Cars. Oil is used world-wide to refine gasoline for use as a vehicle fuel.  The IEA projects total vehicle counts in the world through 2035 in the following graphic, broken down by region.  (The OECD is the Organization for Economic Co-operation and Development, consisting of economically developed countries including the U. S., Europe, Japan and Australia.)  Non-OECD countries include India and Brazil, for example.

Reproduced from World Energy Outlook 2010 © OECD/IEA.  http://www.worldenergyoutlook.org/docs/weo2010/weo2010_london_nov9.pdf

It is seen that the projected number of vehicles almost doubles from 2008 to 2035, with significant increases coming from developing countries (orange and red bands).  They will require ever-increasing amounts of gasoline to fuel them.

Higher Prices Predicted for Oil As Demand Grows. As oil demand throughout the world increases in the next decades, the price can be expected to continue increasing.   Some predictions prepared by the U. S. Energy Information Agency are shown in the following graphic.  The various scenarios are to be discussed in the full version of the Annual Energy Outlook 2011.  The Reference scenario traces the projected price if minimum efforts are made to limit consumption.

Source: U. S. Energy Information Agency Annual Energy Outlook 2011 – Early Release Overview.  http://www.eia.gov/forecasts/aeo/pdf/0383er(2011).pdf

The increasing share of American need for oil coming from abroad, coupled with the anticipated increase in price as shown in the graphic above and the growth in the number of cars on the road, mean that over the coming decades, Americans will be sending many billions of dollars abroad to buy oil, in ever-increasing amounts,. 

Why Not Reduce Dependence on Oil? It is fair to ask, given these predictions of expanding demand and increasing cost, “Wouldn’t it make sense to adopt policies that wean the U. S. from its dependence on oil imported from abroad?” 

Global Warming from Man-Made Greenhouse Gases Is Already With Us. This blog has treated the effects of burning increasing amounts of fossil fuels on global warming in several earlier posts (see, for example,

http://warmgloblog.blogspot.com/2010/10/we-need-to-achieve-alternativesustainab.html ;

http://warmgloblog.blogspot.com/2010/11/steven-chu-u-s-energy-secretary.html ; http://warmgloblog.blogspot.com/2010/10/co2-bathtub.html ).   These offerings point out that it is crucial to abate greenhouse gas emissions as soon as possible, because the level of greenhouse gases that lead to global warming in the earth’s atmosphere continues to grow.  

Greenhouse Gases Are Directly Related to Extremes of Weather.  Reducing emissions is necessary because the atmosphere already has a high enough greenhouse gas content to cause severe climatic effects on the planet.   Indeed, two recent papers published in Nature show, for the first time, that greenhouse gases originating from human burning of fossil fuels has directly contributed to extreme weather events such as heavy rain and flooding in recent years (see Note 1).

Economic Basis for Addressing Global Warming Now.

Economic Damage Wrought by Extremes of Weather.  Forest Fires.  Droughts and floods have been predicted for the last two decades as part of the weather disruptions brought about by global warming.  Regions of drought make more likely the occurrence of severe forest fires, such as those in the western U. S. in recent years.  These destroy valuable commercial timber lands and private homes, and have required intensive fire-fighting activities.  Forest fires consumed almost 7 times more federal land during the 1987-2003 period than during the preceding 17 years, and has been attributed to global warming. Such events potentially have losses in the billions of dollars.

Agriculture.  Drought in the U. S. affects water resources that nourish urban areas and irrigate farms.  Limitations on drinking water, and restricted irrigation, lead to potentially large economic losses in water supply activities and lost agricultural yield.  Abroad, in 2010 severe droughts in Russia and Australia severely reduced wheat harvests, adversely affecting world-wide availability of food.  Wheat prices around the world have risen considerably as a result, including in the U. S.

Floods. Major floods in the U. S. (“100-year floods”) have occurred repeatedly in recent years.  Examples include Hurricane Katrina in 2005 and several floods in the Mississippi-Missouri river basin.  Hurricane Katrina was the costliest natural disaster in the U. S., and produced tragic loss of life.   Human suffering leads to economic loss, and the adverse economic impact on the New Orleans area has been huge.

Elsewhere in the world, the tremendous flooding of the Indus river basin in Pakistan may be at least partly correlated with global warming.  20% of the population of the country has been directly affected, and one estimate of overall long-term economic impact may be more than US$40 billion.  Although this occurred abroad, the U. S. is likely expected to contribute to major relief and recovery efforts, incurring unforeseen budgetary expenses.

By this selection of potential economic effects that may be attributed to global warming, it is seen that enormous economic expenses and losses have already occurred, and are likely to increase in amount and severity in coming decades, as a result of global warming.

Economic Incentive Policies to Limit Greenhouse Gas Emissions.  Unexpected economic burdens such as those sampled above may be considered to be one arm of a zero-sum scenario.  The other arm would involve undertaking planned investment expenditures to prevent global warming from occurring.  Policies to combat the emission of greenhouse gases include imposing negative incentives on burning fossil fuels and emissions of all greenhouse gases that add to the direct cost of using them.  This added cost, much of which would probably be passed along to the consuming public, has been a major negative political factor that has impeded enactment of policies at the U. S. federal level that would reduce greenhouse gas emissions.  (Other factors include the argument that developing countries like China and India, whose emissions have grown dramatically in the past decade, were excluded from coverage under the Kyoto Protocol.)   It would be more cost-effective, over the long term, to spend funds on these long-term preventive measures than to wait until we have to react on an emergency basis to climate-induced disasters.

Cap-and-Trade.  In the face of inaction at the federal level in the U. S., three regional agreements have been put in place in recent years: the Western Climate Initiative, the Midwestern Greenhouse Gas Reduction Accord, and the Regional Greenhouse Gas Initiative of the New England and Mid-Atlantic States.  All three of these accords rely on a cap-and-trade (market-based) mechanism to limit the emission of greenhouse gases.  Generally, the cap-and-trade mechanism works by issuing “emission allowances” to each industrial and commercial source.  The number of allowances establishes the cap, or upper limit, of greenhouse gas emissions across the program.  The cap is reduced each year.  The allowances can be bought or sold (traded) in a regional market, which establishes a price for emitting greenhouse gases and in essence creates a penalty for emitting.  This provides an incentive for each source to innovate in order to reduce emissions, thus lowering its expenses toward purchasing allowances each year.  Proceeds from the trades are delivered to the participating states, and are used at least partly to promote research and development of renewable energy enterprises.

Carbon Tax.  An alternative mechanism for limiting greenhouse gas emissions would be to impose a direct carbon excise tax on fossil fuels.  The tax rate is based on the amount of greenhouse gas emitted by the respective fuels.  The New York Times columnist Thomas Friedman has been advocating a carbon tax for several years, most recently on February 22, 2011.  Professor Daniel Esty of Yale University has also proposed a charge on burning fossil fuels that he calls a carbon charge, or a “harm charge”, on April 13, 2010. 

In each case, the authors propose imposing a low tax at the outset, then raising the tax according to a pre-established schedule, until it reaches a high enough level to have an effect on consumers’ energy habits.  Mr. Friedman suggests using the proceeds to reduce the U. S. national debt.  Prof. Esty, in contrast, suggests returning the proceeds to taxpayers by lowering the payroll tax (contribution to Social Security).  Overall, according to Prof. Esty, the higher cost associated with use of fossil fuels will lead businesses to change to measures and investments that increase conservation of fossil fuel use and produce a shift to renewable energy sources.

The Current U. S. Carbon Tax on Gasoline.  The United States imposes a modest tax on gasoline and diesel fuel at the federal level.  For gasoline currently it is US$ 0.184/gallon (US$ 0.049/liter).  (In contrast, as a result of high taxation, the representative price of gasoline in Europe in 2008 is about US$ 7.83/gallon, whereas in the U. S. it is about US$ 3.25-US$ 3.40/gallon.) As of April 2006 the federal tax is scheduled to fall to US$ 0.043/gallon on October 1, 2011.  This tax has been apportioned partly to the federal Highway Trust Fund, which is used mostly to support maintenance and expansion of the federal vehicle highway system, as shown in the graphic below:  

Collection and Distribution of Federal Gasoline Taxes, FY2001

It is to be noted that although the rectangles for the Highway Account and the Mass Transit Account appear the same size to the eye, the Highway Account is actually more than 5 times as large as the Mass Transit Account.

Source: U.S. Department of the Treasury, Internal Revenue Service, compilation of trust fund certifications dated June 18, 2001, Sept. 18, 2001, Dec. 28, 2001, and March 19, 2002; http://ncseonline.org/NLE/CRSreports/06May/RL30304.pdf.

The costs of cap-and-trade or a carbon tax would be higher than the current federal tax.

Opposition to the Present Carbon Tax.  Interest groups express differing opinions about the federal gasoline excise tax.  RedState.com feels that even the low present level of taxation on gasoline is too high. The group notes that combined federal and state gasoline taxes average about US$ 0.272/gallon.  It feels that with fuel prices rising, the taxes should be eliminated so that drivers don’t have to pay as much.  It also advocates eliminating federal support for highway construction projects.  On the other hand, the Public Policy & Sustainability Blog, which appears to be affiliated with Con-way freight, notes that the Highway Trust Fund is underfunded, requiring infusions from the Treasury to maintain its expenditures.  The blog suggests that the portion of the gasoline tax directed toward mass transit, such as high-speed passenger rail, be transferred into the Highway Account.

Conclusion.  The Libyan revolution in progress as this post is being written has critically affected its oil exports.  Even though only a small fraction of the world’s supply  is in question, the crisis has had a disproportionately large effect on the near-term price for oil, which results in higher prices of fuels for cars and trucks.  This has an adverse effect on our economic growth, and carries the disadvantage of transferring excessive wealth from the U. S. to the overseas producers of the oil.  Clearly, the instability and uncertainty of oil supplies from abroad should be a matter of serious concern to the American public, and to its government.

This occasion highlights the need for the U. S. to move away from its addictive dependence on fossil fuels for its transportation needs as soon as possible.  Renewable energy should be developed on an urgent basis to substitute for oil in our transportation.  Imposing a financial penalty on gasoline and diesel fuel, graduated over time, would help constrain our demand for these fuels, and would provide significant revenue for the federal treasury.  The penalty could come from a cap-and-trade system, or from a direct fuel tax, or from other mechanisms not yet identified.  The revenues could either be distributed as tax rebates to the driving public, or could contribute to paying down the national debt, or could be used to support research and development of alternative fuels and transportation modes as is currently done by the ARPA-E and other programs of the Department of Energy.  As many have said, “If not now, when?”

Note 1. Abstract available online free, or the full article for a fee or through personal or institutional subscription.  Many public libraries, and university libraries open to the public, receive the journal.

© 2011 Henry Auer