Clinton (well Gore) went to Kyoto. Obama went to Beijing.

Many of us carbon nerds remember President Clinton’s 1997 remarks announcing that an agreement had been reached at the climate negotiations in Kyoto, Japan. The speech was full of hope and happy economic words like “tools of the free market,” which referred to highly touted flexibility mechanisms like the Clean Development Mechanism and Joint Implementation. President Clinton pointed the finger at the Developing World as the main missing piece to tackle this major problem. What came next resembled my last three attempts at trying to lose 10 pounds: Nothing. The Clinton-signed treaty never even made it to the Senate for ratification. Since 2000, US emissions have grown by 4.7%, which fortunately is down from a peak of 17.5% in 2007. One major reason that there was little political support for US action was the fact that the fastest growing and now largest source of emissions – China – refused to be part of a deal that required reductions of total emissions for them.

Last week, President Obama and Premier Xi stood together announcing a deal on emissions reductions between these two great nations. The fact that such a bilateral agreement is possible and sealed with a handshake is a big deal. My twitter feed’s pulse rose to 200 tpm. Cheers from the left and jeers from the right. In my humble opinion there are three main positives from this pact:

  1. China is willing to start thinking about reductions in terms of total carbon emissions, not carbon per unit of GDP. Carbon per unit of GDP can go down (meeting Chinese targets) while total emissions continue to rise in a rapidly growing economy. This is a major policy change.
  2. Climate change has become the responsibility of the very top layers of the Chinese government. The Chinese Premier and State Council are currently in charge of this issue, which leads me to think that centralized action is possible and imminent.
  3. President Obama is not going to throw the issue of climate change under the bus during his last two years. This agreement plus his $3 billion commitment to a global climate fund give the impression that he has not given up on potentially making progress on this issue.

Now I am too tall and uncoordinated to be a cheerleader. Blame my excessive reading of French existentialists during my 20s, but I see more doom than gloom still. Let’s look at the New York Times’ excellent graphic of what this deal really means:

NYT graphicThe US pledged to cut emissions by at least 26% from 2005 level by 2025. By 2012 we already had cut emissions by 11%, so this leaves us with another 15%. While we could argue about the exact numbers for hours, the more stringent CAFE standards on the books and the Clean Power Plan (carbon dioxide standards for existing power generating sources) should get us there. Hence, if CAFE and the clean power plan get implemented and enforced, Obama will have kept his promise.

This leads me to my first source of concern. The GOP is already out for blood on this climate deal and is looking for ways to derail it. Some of my best friends are very good lawyers and they argue that derailing CAFE will be hard for the GOP; yet the CPP is vulnerable. It is a rule enforced by the EPA under the provisions of the Clean Air Act. Emissions reductions will come from individual states through State Implementation Plans (SIPs), which is the way we deal with criteria pollutants like PM10 and NOx.

I imagine a future where the EPA is severely defunded and a number of governors in high emitting states file SIPs which they have no intent to pursue. For example, in California we have violated the Clean Air Act every single year, yet as far as I can tell the stick, which is the withholding of federal highway funds, has never been exercised. The difference between carbon and local pollutants is that nobody likes local air pollution, which gave rise to efforts across the nation to clean up the air. When it comes to carbon, there are very few local benefits from its abatement (but significant health co-benefits due to the reductions in other pollutants from lower coal use), yet significant costs. This puts us in a world where there is regulation on the books that is not or weakly enforced and we miss the emission reduction goal. By a lot.

Now let’s turn to China. The only goal China has agreed to is that it would require its emissions to peak by “around 2030.” My three main concerns are:

  1. I hope “around” does not refer to a confidence interval measured in geological time scales.
  2. If you refer back to the New York Times graph above, growth of emissions from China until 2030 is literally off the chart. The graph stops at 8 billion metric tons roughly now.
  3. If we look at the forecast of the International Energy Agency’s World Energy Outlook for China, emissions in a status quo world are expected to peak “around” 2030 in the absence of any aggressive climate policy.

So where does this leave me? The amount of damage from carbon emissions that this highly applauded agreement would still leave on the books is likely significant. The informal consensus among my climate buddies is that this emission scenario, which represents a policy intervention on the part of the main two emitters, firmly puts us on a path beyond 2 degrees Celsius, which is the maximum some of us think we should strive for to prevent serious damages. To me this agreement represents the status quo baked into a shiny “agreement.” While I understand that reaching the goals embedded in this agreement represents the upper bound of what is politically feasible, I hope we can do more. James Inhofe’s latest comments make we want to have a stiff drink to drown my sorrows.

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Cross-state power flows complicate the Clean Power Plan

The release of the IPCC Synthesis Report earlier this month underscores the need for swift and aggressive action to combat climate change.  With the shifting control of Congress, answering that call becomes more of an uphill battle.

uphill-battle

Image source

One saving grace is that it will be hard for Congress to completely block the Clean Power Plan (CPP), which aims to reduce greenhouse gas (GHG) emissions from the power sector, while Obama is still in office. This is because the CPP regulates CO2 emissions from the power sector under the Clean Air Act.  The House and Senate can vote against the plan, but stopping the rule would require a full two-thirds majority vote to amend the Clean Air Act (or invoke the Congressional Review Act).

In this environment, the Clean Air Act has its advantages. In particular, it creates an opportunity to steer climate change regulation through a hostile Congress. But working within this statute to reduce GHG emissions from the power sector is posing some real challenges. One key complication is that the delegation of regulatory power under the Clean Air Act does not mesh so well with inter-state coordination of electric power systems.

The Clean Air Act meets modern day power markets

Under the Clean Air Act, the federal government has the authority to establish minimum standards that states must meet (both through statute and regulation). States are generally free to choose any regulatory approach so long as those goals are attained.

Under the proposed Clean Power Plan, the EPA has established state-specific CO2 emissions standards. The bottom of each bar in Figure 1 represents the standard. The top of each bar represents the state’s emissions rate in 2012. Colors denote the contributions of alternative emissions reduction options to targeted reductions: heat rate improvements (HRI), redispatch to natural gas combined cycle (NGCC), preserved generation from nuclear, renewables, and end-use energy efficiency. CPP_blocks.fw

Figure 1: State-specific reductions in CO2 emissions rates under the Clean Power Plan

 (Source: Data are reported in the EPA Goal Computation Technical Support Document- Appendix 1 and 2).

States have the freedom to choose how they actually meet these targets. This gives states the flexibility to pursue whatever strategies they can find to minimize compliance costs.

Back in the day when CAA emissions regulations were more prescriptive and electricity was distributed by vertically integrated monopolies (typically limited to a single state), state-level coordination of compliance with power sector regulations meshed well with the state-level scope of power sector operations. But things have changed. For one thing, the Federal Energy Regulatory Commission (FERC) has been successfully promoting the development of large scale (multi-state) integrated transmission systems. This has resulted in much more geographically integrated power networks.

The graph below provides some sense of the extent to which power flows from one state to another. This figure shows (total retail sales – total generation) as a share of total retail sales (all measured in MWh) by state in 2012 as reported by the EIA. Positive shares denote net importing states, negative shares denote net exporters. For example, exports in Wyoming (measured as net electricity generation less sales) are almost two times the electricity sold in the state.net_exports

Figure 2: Electricity sales (MWh) in excess of generation (MWh) as a share of sales (MWh) by state in 2012 (source: EIA)

FERC’s success in fostering regional integration of power markets has conferred important benefits including improved operating efficiency and electricity market performance. But one regulator’s triumph can be another regulator’s headache…

What’s the problem?

Interstate power flows have some problematic implications (from the perspective of the environmental regulator working within the Clean Air Act).  In a recent blog post, Jim Bushnell points to one important problem that arises when states in the same integrated power market face different emissions standards. Think California and Arizona. Figure 1 shows that California faces a relatively more stringent standard than neighboring Arizona. Increasing  the flow of power exports from Arizona to California could offer a means of bringing both states closer to compliance without delivering real emissions reductions.

There is another related but different complication. Interstate power flows give rise to a kind of “compliance externality” because investments in renewable energy and energy efficiency in one state can affect the compliance status of other states.

Consider, for example, a state that exports a lot of electricity (such as Wyoming). Wyoming has some of the highest wind power potential of any state. Suppose Wyoming expands investment in new renewable generation as part of its compliance strategy. To the extent that this increase in renewables generation crowds out fossil fuel production in neighboring states, Wyoming will incur the costs to deploy renewables whereas a neighboring state (or states) will enjoy some the compliance benefits that the associated emissions reductions confer.

Similar issues can arise with energy efficiency.  Consider, for example, a state that purchases a lot of power from out of state (such as Maryland) that converts to a mass-based standard. To the extent that demand reductions from efficiency programs in Maryland reduce demand for electricity imports, Maryland’s investments in efficiency programs will be reducing emissions elsewhere.

The economic solution

Economists have thought long and hard about externality problems and how to mitigate them.  One classic solution (highlighted in this blog post) involves defining and assigning property rights to the externality.  Along these lines, the EPA has proposed allowing a state to take credit for out-of-state emission reductions related to renewable energy generation. This would require tracking transfers of renewable electricity generation across state lines and measuring the associated avoided emissions – a non-trivial accounting exercise.

Going back to the economist’s bag of externality internalization tricks, an alternative approach combines or merges the externality-relevant activities into one firm or unit.  From a purely economic perspective, coordinating regulatory compliance at a regional market level makes a ton of sense:  the number of affected parties (i.e., states in a regional market) is small and costs of coordination should be relatively small given that regional entities have already been established to coordinate regional power system operations.

Implementing this elegant textbook solution is not so straightforward under the Clean Air Act; the EPA does not have the authority to require states to join together and form regional implementation programs. The only way to thread this needle is to make regional coalitions the most attractive compliance option for states.  This is a really important needle to thread. If the EPA can find ways to facilitate interstate coalitions under the proposed Plan, interstate power flows can be put to work for  - versus against - cost-effective and meaningful emissions reductions.

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What’s so Great about Fixed Charges?

There’s a lot of talk in California these days about imposing fixed monthly charges on residential electricity bills.  The large investor-owned utilities in California have small or no fixed charges,[1] instead collecting all of their revenue from households through usage-based charges, called volumetric pricing.  (And those volumetric prices increase steeply with your monthly usage, the “increasing-block pricing” approach that I discussed in September.)

Interestingly, one of the three natural gas distribution companies in California has a fixed charge, but the other two don’t  (SoCal Gas has a charge that is about $5/month.  Feel free to chime in if you know how this difference came to be.)  Most other electric utilities in the U.S. do charge some fixed monthly fee for being hooked up to the electric grid.

FixedChargesBarChartFixed monthly charges at regulated and muni utilities (randomly selected outside CA)

Fixed charges are often justified based on the utility having fixed costs.  The connection seems logical at first glance, but when you look closer it’s more complicated.

Fixed costs fall roughly into two types: customer-specific and systemwide.  When having one more customer on the system raises the utility’s costs regardless of how much the customer uses – for instance, for metering, billing, and maintaining the line from the distribution system to the house – then a fixed charge to reflect that additional fixed cost the customer imposes on the system makes perfect economic sense.  The idea that each household has to cover its customer-specific fixed cost also has obvious appeal on ground of fairness or equity.

CustSpecFixedCostsCustomer-specific fixed costs from things like metering, billing, electric drop to house

But much of the utility fixed costs that are being discussed are systemwide – such as maintaining the distribution networks in residential neighborhoods.  These costs wouldn’t change if one customer were to drop off the system.  In other words, running the system as a whole has certain unavoidable costs and someone has to pay them.  There isn’t much guidance, based on economics or equity, about who should pay, because there is no “cost causation” as it is termed in the utility world.   In particular, the statement I have heard a number of times recently that “the utility should cover fixed costs with fixed charges” has no basis in economics when it comes to system fixed costs.

Before we discuss how to pay for system fixed costs, let’s step back and remember where economics does provide a valuable guide, that is, in setting the price of an incremental or marginal kilowatt-hour.  The price for a marginal kilowatt-hour should reflect the full “societal” marginal cost of providing that electricity, meaning that it should include the industry’s marginal production costs plus the marginal externality costs imposed on others outside the production process, like the cost of greenhouse gases that are released.  The idea is that if you don’t place a value on the good that is at least as great as the full cost of producing it (including the pollution it creates), then society shouldn’t allocate resources to produce it for you.

If you don’t think about it too hard, you might conclude that if the marginal (or volumetric) price just covers marginal cost, then what is left over is fixed costs, so fixed charges “should” cover fixed costs.

But there are at least three good reasons to think harder about it.

First, the marginal cost that the utility faces is less than the full marginal cost it imposes on society when it produces electricity because the utility does not have to pay the full social cost of the pollution it produces — including NOx, particulates, and greenhouse gases.[2]

If the utility charges a price that covers the full marginal cost including all the externalities, but doesn’t itself actually have to pay for those externalities, then it generates extra revenue.  That revenue can go towards covering fixed costs.   That lowers the fixed charge necessary to cover costs while at the same time setting appropriate marginal prices.[3]

Second, as everyone who studies electricity markets knows (and even much of the energy media have grown to understand), the marginal cost of electricity generation goes up at higher-demand times, and all generation gets paid those high peak prices.  That means extra revenue for the baseload plants above their lower marginal cost, and that revenue that can go to pay the fixed costs of those plants, as I discussed in a paper back in 1999.

The same argument goes for transmission lines, where price differentials between locations mean that the transmission line generates revenue above its marginal cost (which is effectively zero), and can go to pay the fixed costs of transmission lines.  In fact, the fixed costs of generation and transmission should generally be covered without resorting to fixed monthly charges.

The same is not true, however, for distribution costs.  Retail prices don’t rise at peak times and create extra revenue that covers fixed costs of distribution.  That creates a revenue shortfall that has to be made up somewhere. Likewise, the cost of customer-specific fixed costs don’t get compensated in a system where the volumetric charge for electricity reflects its true marginal cost.

But unlike customer-specific fixed costs, there isn’t a strong fairness or economic efficiency argument for recovering fixed distribution costs – which are not customer-specific — through a fixed monthly charge.

Lots of potential?

Programs subsidizing high-efficiency light bulbs, refrigerators and washing machines may be a great idea, but they still create fixed costs that ratepayers have to cover

And then there are sunk losses from the mistakes of the past, such as expensive nuclear power plants and high-priced contracts signed during the California electricity crisis.   And don’t forget ongoing expenses that are not directly part of the electric utility function, like energy efficiency.  Someone has to pay for those subsidies on new refrigerators and clothes washers.[4]

That brings us to the third reason to think hard about fixed charges: fairness and distributional considerations.  If customer A uses 10 times more electricity than customer B, should they pay the same share of the system fixed costs?  And, by the way, customer A is on average wealthier than customer B.  My informal poll suggests most people think customer A should pay more.

But any approach that is based on usage amounts to raising the volumetric price further, after we have already raised it to reflect the real externalities.  Doing that encourages inefficient substitution away from electricity.  Yes, there can be such a thing as too much energy efficiency investment (take a look at the cost of retrofitting windows).  Nor does it really help society when high marginal prices incent households to install solar just to shift fixed costs to others.  And, of course, Max recently blogged about how high marginal electricity prices discourage EVs.

And that’s where it can make sense to resort to fixed monthly charges to cover at least part of the shortfall.   Fixed charges may be the least bad way for utilities to balance their books without setting volumetric electricity prices so high that they unreasonably distort behavior.

But the mere existence of systemwide fixed costs doesn’t justify fixed charges.  We should get marginal prices right, including the externalities associated with electricity production.  We should use fixed charges to cover customer-specific fixed costs.  Beyond that, we should think hard about balancing economic efficiency versus fairness when we use additional fixed charges to help address revenue shortfalls.

 

I tweet energy news articles, and the occasional research article, nearly daily @EnergyClippings

—————

[1] PG&E and SDG&E have no fixed charge, SCE’s is $0.99/month.  All three have a small minimum bill, less than $10,  which is binding on extremely few customers.

[2] What’s that you say? that California utilities already have to cover their GHG emissions in the state’s cap-and-trade market? Oh please.  First, the utilities are given free permits to cover most of their emissions.  Second, the regulatory agency (CPUC) has said publicly that it will not allow GHG costs to raise residential rates.  And, finally, do you really think the current price in the cap-and-trade market of $12/ton – an amount that will lead to virtually zero change in production or consumption behavior — covers anything like the full cost of the GHG emissions?  It’s less than one-third of the U.S. government’s estimate of the true externality cost  (which I think is likely still too low).

[3] Of course, if we ever get to actually charging polluters for their emissions, then this source of extra revenue to the utility will go away.  That will still be a happy day for me.

[4] Please, save the comments arguing that energy efficiency programs pay for themselves.  They may save society as much or more in energy resource costs as they cost the utility, but when it comes to rate making, the money for those programs comes from ratepayers, and energy efficiency programs don’t justify a volumetric rate increase on economic grounds.

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Better Yellow Labels

Information provision is a key element of energy-efficiency policy. Just think of the ubiquitous yellow EnergyGuide labels, which are required by law to be displayed on all major appliances sold in the United States. This information is supposed to help consumers make better decisions. However, current labels report only very coarse information based on national average energy prices and national average usage of the appliance.

The information can be particularly misleading with air conditioners. Within the continental United States annual cooling hours range from 310 in Maine to 2,771 in Florida, almost a 9:1 ratio. Residential electricity prices vary too, so the overall variation in operating cost for an air conditioner ranges across states by more than an 11:1 ratio. This means that the current labels are providing highly inaccurate information for many consumers.

coolingmap

Annual Cooling Hours by State

In a new EI@Haas Working Paper, available here, Gib Metcalf and I conduct an online experiment to measure the potential benefits from providing more accurate information. The control group was shown the current labels, while the treatment group was shown labels with state-specific information. For example, the label on the right below is for Iowa, a state with below average electricity prices and usage. Both groups were then asked to make hypothetical choices between air conditioners with different purchase prices and levels of energy-efficiency. 

Both Labels Smaller

             Current Label                                          State-Specific Label (Iowa)

We find that when presented with more accurate information, the average energy-efficiency of selected air conditioners stays about the same, but the allocation is much better. That is, consumers facing low expected operating costs invest less in energy-efficiency, while consumers facing high expected operating costs invest more. The figure below shows this graphically.  The circles show the mean for each group and the range indicates the 95th percentile confidence interval.

terciles

The implied aggregate savings are substantial. We find that state-specific labels decrease lifetime cost by an average of $10 per purchase. Last year 4.4 million room air conditioners were purchased in the United States, so this is $44 million in annual savings.

We argue that this exceeds any reasonable estimate of the cost of implementing better labels. The Federal Trade Commission (FTC) already maintains label templates that manufacturers can download. Instead of one template per appliance, the FTC would provide 50 different templates, one for each state, accessible through a drop-down menu. Perhaps at the same time the FTC could automate the simple calculation required to fill in estimated yearly energy cost. All of this could be done at low cost, and be done not only for room air conditioners but for other appliances too.

Our results are consistent with an emerging view of consumers as “rationally inattentive” when it comes to making energy-related decisions (Sallee, forthcoming). When we ask them at the end of the experiment simple questions about the labels they demonstrate a remarkably low level of comprehension. Most do not know whether the labels they just saw were based on national or state energy prices, nor do they know how their state’s energy prices compare to the national average.

Daniel Kahneman refers to this kind of decision making in his book as WYSIATI, “What you see is all there is.” The content of the labels changes decisions, so it is not that people are ignoring this information completely. But they are not exerting the additional effort that would be required to understand what this information means or to spontaneously transform the information to take local conditions into account.

You see this not only in our experiment, but in actual choices as well. If choices were being made efficiently, you would expect to see consumers throughout the South buying energy-efficient air conditioners.  Instead, the highest levels of adoption of Energy Star air conditioners are actually in the Northeast and Midwest.

energystarmap

Share of New Air Conditioners Sold that are Energy Star

This suggests that other factors like political ideology may be important. But it also provides further evidence that the current labels are not working as well as they could. It  is not enough to simply say, as the label does, that “Your cost will depend on your utility rates and use.”  We need to provide better information to help consumers connect the dots.

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Plug in Hybrid – Saving Carbon and Dollars?

I am in the market for a new car. At a recent visit to a Ford dealer I was confronted with the choice between the regular hybrid-electric version of the C-Max (think standard Prius but made in the USA!) and the plug-in hybrid electric version of the same model. The only difference between the two is the plug-in, well, plugs in. You get a 7.6kWh battery under your now largely non-existent trunk, which you can charge using a supplied cable from any standard electric outlet. This lets you drive an advertised 22 miles in all electric mode and after your battery is empty you drive a regular hybrid. That is right, 22 miles, without ever burning a molecule of evil climate changing, health destroying, liquid petroleum product. My pulse quickened. I felt like I was about to lease a halo. And then the dealer said: “This car is great. It saves me so much money. I never plug it in at home. I just charge it at work!” Cold sweat started forming. I thought to myself “I wonder if this guy used to siphon gasoline out of his boss’ gas tank before he got his new wheels?”

So let’s think about this for a second. 7.6 kWh for 22 miles comes out to 0.35 kWh per mile. What the heck are kWhs? They are the units that the electricity delivered to your outlet is measured in. What do they cost? Well, that depends on who your utility is. In my case, this utility is called PG&E and I pay for my electricity using block rate pricing. Here is what the price schedule I face looks like:

table rates
What this means for those of you living in the hotter parts of Contra Costa County is that if you use your air conditioner when it’s hot, you are probably paying 32.4 cents per kWh. This means a single battery charge of the C-Max hybrid energy would cost 7.2 * 0.32445 = $2.33. While I would be cruising down the road quietly like a puma, my card carrying economic soul is crying into its pillow. Why? If I would have not plugged in the C-Max and just used the hybrid feature using some evil gasoline, I would have gotten 44+ miles per gallon. At $3.35/gallon (best price on gasbuddy.com right now), the 22 miles would have cost me $1.68. A savings of 28%.

My greener than Al Gore mother would argue that if I were more saintly in my home electricity consumption and were on tier 1, the 22 miles would have cost me $1.09, which is 35% cheaper than the hybrid mode.

So I pulled my electricity consumption record using the green button and tried to figure out what getting the plug-in would do to my electricity consumption and how the cost would compare to the regular hybrid using our past 5 years of electricity consumption as data. I added a daily charge of the car to our electricity bill and calculated out bill totals with and without the plug-in. The plugin costs about 67 dollars a month to charge at home, which comes out to 10.25 cents per mile. If I had driven in hybrid mode I would have paid 7.39 cents per mile assuming the low gas price. But even at $4 a gallon, the hybrid mode wins. Now, since I am supposed to do what is socially optimal, I have to add in the damage carbon does. Assuming the less favorable $4 gas and a $40 Social Cost of Carbon, the hybrid still wins – just barely. I would save about $90 by going hybrid.

One thought that had occurred to me is to see whether my utility offers a tariff which accommodates my new usage pattern. And it does.

estimated rates

Their estimates suggest that I will be paying $260 more than I currently pay for existing uses and a back of the envelope calculation suggests that I lose compared to the current plan with my plug-in hybrid as well.

Now here comes the kicker. Because of the federal and state subsidies, the lease price of the plugin hybrid and the regular hybrid are almost exactly the same. And at my place of work there are outlets in the parking lot. So what is the privately optimal thing to do? Buy that American made electro stallion, plug it in at work and save some money. Which is roughly what the guy trying to sell me the car did.

But this is just plain wrong.

  • I would increase the university’s electricity bill and drive up my students’ tuition! (Severin has already written about why free charging is a bad idea.)
  • I would get a free ride in the car pool lane, because I bought myself a halo and increase congestion in these lanes.
  • I would rake in thousands of dollars in taxpayer-financed subsidies for the option to charge the car when it is cheaper for me to do so (at the movies and my mother-in-law’s house). These subsidies and stickers are pushing this technology and are hoping for it to become more efficient in the long run, which is sensible. But the gap is still several thousand dollars on the lot.
  • On the marginal cost side the plug-in is almost competitive with the existing hybrid technology even in my very expensive electricity neighborhood and after accounting for the external costs from carbon emissions. But my electricity is California oh so clean! Areas with cheaper electricity mostly rely on a higher mix of cheaper dirtier coal power, which will drive up the external costs per mile. A recent paper by some alumni and friends of EI suggest that electric vehicles aren’t greener — compared to a comparable hybrid if charged with coal fired power.

I might still get the plug-in, but I am charging it at home. Because my Dean reads this blog.

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The multibillion dollar question: How to spend carbon revenues?

Debates over carbon pricing policies tend to focus on the costs imposed on firms and households. When a carbon tax or cap and trade program is introduced, firms see energy-related operating costs rise, drivers pay (cents) more at the pump, households see the prices of energy – and energy-intensive goods – tick up.

On the flip side, in addition to reducing harmful emissions, these policies generate revenues.  Estimates of the total value of revenues from the auctioning of emissions allowances in the European Union’s Emission Trading Scheme are estimated to be around €10 billion annually. In California, lawmakers expect sales of greenhouse gas pollution permits to bring in $5 billion annually.

By now you may be wondering – where is all this money going?   The answer varies across the jurisdictions that are implementing carbon pricing policies. This week’s blog takes a look at how two very different revenue recycling policies are panning out.

How should we be spending carbon $$ (in theory)

Over the past decade, economists have been busy analyzing the implications of different uses of carbon revenues, paying particular attention to how carbon pricing policies interact with pre-existing taxes. The policy recommendations that emerge from these studies depend critically on what policy makers are trying to achieve.

Model 1: If minimizing the economic costs imposed by the carbon pricing policy is the primary concern, substituting carbon for distortionary taxes on capital produces the largest economic cost savings. Recent work by Dale Jorgensen and co-authors suggests that if carbon revenues are used to offset taxation of capital spending, the performance of the overall economy (in terms of GDP) could actually improve under a carbon tax.

Model 2: If policy makers are concerned about the equitable distribution of policy impacts across different income/demographic groups, there is a case to be made for reductions in payroll taxes, or even targeted transfers, to correct for the regressivity of a carbon tax (i.e. taking a larger percentage of a lower-income and a smaller percentage of a higher income) and/or meet re-distributional objectives.

Model 3: If policy makers are losing sleep over budget deficits, carbon revenues can be used to offset increases in capital, labor, or consumption taxes that would otherwise be needed to balance the budget.  Here again, offsets to capital tax increases provide the largest economic benefits, followed by labor taxes, consumption taxes, and lump-sum transfers.

Model 4: If concerns about global climate change are paramount, tax revenues can be used to support the research and development of clean energy research, development, and deployment that many see as essential inputs to meaningful climate change mitigation in the long run.

 How should we be spending carbon $$ (in public opinion)

Whereas economists see the costs and benefits of many options, public opinion on how revenues should be spent appears less equivocal.

A group of political scientists – including my former Michigan colleague Barry Rabe  – recently conducted a national survey to gauge public support for a carbon tax. The survey asked several questions about “support for a tax on carbon-based fuels such as coal, oil, and natural gas”.  They find that the level of support for the tax varies significantly with the choice of how to allocate revenues:

rabe

What is particularly striking about these results is the extent to which tying revenues to a particular use – renewable energy investment in particular – increases support for the carbon tax.

How are carbon $$ actually being spent  (in practice)

Carbon pricing is underway! Here on the west coast, between California and British Columbia, we are seeing some real live experimentation with hybrid-versions of the four models summarized above.

I was fortunate enough to spend some time recently in British Columbia, home to old growth forests, humpback whales, and a revenue neutral carbon tax.  I seized the opportunity to play carbon tax tourist and ask lots of questions.

The BC carbon tax is pegged at CDN $30/tonne  CO2e (approximately $27 US). To put this in some perspective, the tax adds about 25 cents per gallon. For a fascinating account of the mechanics and politics of the BC carbon tax, read this paper.

When the carbon tax was first introduced, the provincial government made a commitment to return carbon tax income to BC residents via tax reductions and lump-sum payments. The enacting legislation actually threatens to reduce the Finance Minister’s salary by 15% should he fail to deliver on this revenue neutrality promise.  To date, the finance minister is still getting paid; all tax revenues have been “recycled” through a number of tax channels. Initially two thirds of the tax cuts went to individuals (including a low income tax credit and reductions in personal income taxes) and one third to firms via corporate tax reductions. Over time, the share of tax cuts flowing to the business community has increased to more than half.

Of course, it is difficult to know for certain whether these tax cuts would have happened even without the carbon tax. What we do know is that distortionary taxes have been reduced as the carbon tax increased. A recent paper suggests these changes in the tax structure have been progressive. Moreover, my very unscientific polling of whoever would talk to me about carbon taxation suggests that the Canadian-on-the-street understands how carbon tax revenues are being spent and believes that this approach is working. Oh Canada!

Next stop, California

The politics of the California cap-and-trade-program, constraints imposed by the state’s constitution, and a host of other complicating factors have given rise to a very different allocation of carbon revenues in California as compared to BC. Currently, a majority of permits are allocated for free as a form of industrial assistance, allocated to utilities on behalf of ratepayers (Californians, look out for your lump sum climate credit this month) or set aside as a cost-containment reserve. The remainder are sold at auction to generate revenues.

By law, permit auction revenues are deposited into a Greenhouse Gas (GHG) Reduction Fund to be used to support projects and programs that reduce GHG emissions; 25 percent of all revenues must benefit disadvantaged communities.  Although this may sound straightforward in principle, implementing this in practice has been messy.  Facing major budgetary challenges , the 2013-14 Budget Act loaned $500 million in auction revenues to the General Fund.  In June, California passed a state budget that allocates a quarter of cap-and-trade revenues to help pay for a highly controversial high-speed rail project.

Critics of the carbon pricing policies look at this and see a gravy train… “a massive new scheme of general taxation to be used for the whims and wish lists of the politicians.”  The Legislative Analysts Office, in addition to several environmental groups,  have argued that it is very hard to justify devoting scarce climate funds toward a new high-speed rail system on the grounds that it’s the most effective way to reduce carbon emissions.

Regional experimentation with carbon pricing policies has the potential to successfully demonstrate proof of critical policy concepts, increasing the likelihood that other jurisdictions will follow suit.  Economists have demonstrated how the allocation of carbon revenues generated by carbon pricing can significantly affect the success of  the policy in theory. Political scientists are highlighting how the choice of how to allocate revenues significantly affects the political feasibility and durability of the policy. In sum, these spending choices are an important part of the larger policy picture.

British Columbia is successfully demonstrating a disciplined approach to ensuring that carbon tax revenues offset other tax distortions. In contrast, California is aiming to spend revenues on climate change mitigation programs and technologies. This approach resonates in principle with a majority of voters.  But in terms of demonstrating this model in practice, so far not so good.  California needs a more measured and less political system of allocating carbon revenues to meet important policy goals.

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A Common Energy-Saving Device that I’ve Never Seen in the US

I tend to think of the US as ahead of most of the rest of the world when it comes to energy efficiency. Maybe not in the Germany or Japan league, but at least above the median. After all, our utilities are spending billions of dollars per year encouraging energy efficiency and our policy makers talk about it a lot.

But, I’ve stayed in hotels in France, Singapore and Kenya over the past six months and seen an energy-saving device that I’ve never seen in the US. Maybe you’ve seen them. It’s a simple fixture, pictured below, where you insert your key to activate the electricity in the room.

2014-07-11 07.48.17This doesn’t mean that you get charged for the electricity you consume while at the hotel. The device is basically a master switch that turns everything off as you take your key out and leave the room. (In my Singapore hotel, this worked with a lag, giving me a couple seconds to get out with the lights still on.)

To me, the energy savings to the hotel are ancillary and the main benefit is that there’s a single, default spot to leave my key. No more hunting through my purse and looking on every flat surface in a room as I rush out the door. The key is right there, on the wall next to the door, ready to go. I would pay extra for a room that had such a pocket even if it had nothing to do with electricity.

This is a clear example of what the energy efficiency community labels a “non-energy benefit.”

So, why don’t we see these in US hotels? It’s not because I’m staying at fancy new hotels in city centers in the other countries. Both my recent hotels in Western Kenya had the devices – in Kisumu and overlooking the Ugandan border in the town of Busia (population 52,000), where I took the photograph above, and pictured below.

An aerial view of Busia, Kenya

An aerial view of downtown Busia, Kenya

But, maybe I stay at nicer hotels in the US than when I travel abroad? The device has a penny-pinching feel to it, and there are drawbacks. For example, you cannot leave your computer charging while you’re out of the room. I don’t think that’s the story, though, since at least the hotel in Singapore was quite nice, and I’ve stayed in some real dives in the US and still not seen a key pocket.

It’s also not the case that electricity is extraordinarily expensive in the countries where I’ve seen the key pockets. They all have commercial rates in the 14-20 cents per kWh range, which is higher than the US average, but no higher than California. So, the hotels outside the US are not facing larger monetary savings from installing the master switches. (See here for Singapore prices, and here for French prices. I got the Kenyan prices from a recent presentation I saw by a former regulator. Admittedly, the true costs in Kenya should average in the occasional cost of running the diesel generator when the grid goes out.)

We talk about an energy efficiency gap, meaning that consumers and firms may be failing to invest in energy efficient technologies even if the payback in terms of lower future energy bills clearly outweighs the upfront investment. The typical explanations for the energy efficiency gap are that there is a market failure at play, like a split-incentive problem or lack of information. Certainly, hotel guests do not think about the effects of their actions on the hotel owner’s energy bill, so there are elements of the split-incentive problem here. But, this device is explicitly designed to address that problem and force the guests to save energy for the owner.

I am also hard-pressed to see US hotels’ failure to adopt the key pockets as an example of the energy efficiency gap, since the devices have been adopted in other countries. I can’t see why market failures exist in the US that don’t in Singapore, France or Kenya.

So, is it possible that Hilton contemplated installing these in their US hotels, and decided that their guests would be turned off, meaning that lost business would outweigh any energy savings? I suspect that’s the case. Even Starwood’s new Element hotels, which are branded as green and use low-VOC paints and carpets made from recycled materials, opted not to use the “master switch.”

This article quotes an Element executive describing how they surveyed customers before deciding whether or not to use the switches.  “’Some,’ he recalled, `said they would suffer discomfort because they would get back to their room and it would be extremely hot.’”

hotel ac

Always on?

One lesson is that I am not a typical US hotel customer. I like having a place to keep my key, and I don’t like walking into what feels like a 65-degree hotel room, even if it’s 95 degrees outside. But, other US consumers apparently like a lot of AC.

This example highlights that saving energy can come at an economic cost. Sure, there may be energy-saving technologies – simple ones installed in remote Kenyan hotels – but if people like walking into 65-degree hotel rooms, businesses will be unwilling to adopt them. And, if a utility program or government standard pushed the hotels to adopt them, all those hotel guests with polar bear tastes would be less satisfied customers.

I am curious. Have you seen these devices in the US? If so, in which hotels? Where? If not, why is the US so different from other parts of the world? Do you agree that US consumers’ love of AC is part if the explanation? I, for one, would love to get to the bottom of this!

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