Californians Can Handle the Truth About Gas Prices

A few weeks ago, Jim blogged about the concerns that cap-and-trade will drive up gas prices in California.   In late June, those concerns resulted in a letter from Assemblymember Perea and 15 other Democrats asking the California Air Resources Board to delay this expansion of the cap-and-trade program to include transportation fuels from January 1, 2015 to January 1, 2018.  And a couple weeks ago, the ARB Chair, Mary Nichols, sent a reply explaining why ARB was not going to do that.

Meanwhile, the oil industry and some other groups opposed to fuels in the cap-and-trade program have been making inaccurate statements that the change will cause huge increases in gasoline prices.  The ARB and some other supporters of fuels under the cap have responded with their own inaccuracies, saying that including fuels in the program needn’t raise gas prices at all and suggesting that any increase is the fault of oil companies.

CarbonPieChart

There is a real policy debate here about how and when California should reduce its greenhouse gas emissions, 38% of which come from transportation.  I share Jim’s view that this is a moment of truth in which California needs to show it will really step up to reduce GHGs.  Unfortunately, that debate is being obscured by the battling spin over how much gas prices will go up when we expand cap-and-trade on January 1, 2015.

So here’s my attempt at de-spinning (I’m going to focus on gasoline, but the calculations are similar for diesel):

California’s gasoline blend sold at the pump is 90% gasoline and 10% ethanol, a ratio that is unlikely to change anytime soon.  Ethanol counts as zero carbon under cap-and-trade (long story, but not as silly as it sounds).  Pure gasoline emits about 0.009 tons of CO2e (the units of the cap-and-trade allowances) per gallon, so the gasoline blend you put in your car will make the seller responsible for about 0.008 (90% of 0.009) allowances per gallon.

The current price of an allowance is slightly less than $12/ton and the futures market predicts it will be about the same on January 1, 2015.  Our own analysis that I discussed a month ago also finds that the price of allowances will most likely remain in the $12-$15 range out to 2020.[1]  There is a small, but real, risk that allowance prices could go much higher a few years out, which we discuss in detail in our report. But if you want to know what gasoline price “shock” will hit consumers in January when gasoline comes under the cap and trade program, the relevant allowance price is about $12/ton.  That will increase the marginal cost of selling a gallon of gasoline by about 9-10 cents per gallon on January 1.

A large literature in economics has examined what happens to gasoline prices when the marginal cost of selling gas increases, looking at changes in the price of crude oil and changes in gas taxes.  The answer: those increases are passed through one-for-one to consumers, generally in a matter of days or maybe a week or two.

That’s why the almost certain outcome is that within a few days after January 1, 2015, the cap-and-trade program will cause the price of gasoline in California to increase by 9-10 cents, less than the drop in gas prices over the last few weeks.

GasPriceNonsenseSource: Energy Information Administration

 Average California gas price so far this year

(What’s that you say? You didn’t notice the drop? I’m not surprised.  With oil price fluctuations regularly pushing gasoline up or down 25 cents or more, an extra 10 cents one way or the other doesn’t catch the attention of most consumers.)

Before I move on to confront some of the spin, let’s consider that price increase in context.  A 10 cent increase will be about 2.5%.  Here are some things you could do to fully offset that additional cost:

  • Drive 70 mph instead of 72 mph on the freeway. That difference would improve your fuel economy by about 2.5%.  The savings are much larger if you actually drive the speed limit.
  • Buy a car that gets 31 MPG instead of 30 MPG. That will get you more than a 3% savings in fuel cost, more than offsetting the price increase.
  • Keep your tires properly inflated. The Department of Energy estimates that underinflated tires waste about 0.3% of gasoline for every 1 psi drop in pressure.

Instead of this simple reality, we are hearing misinformation coming from both sides:

 

wspa

What The Oil Industry is Claiming (and many others opposed to the program expansion are repeating):  The Western States Petroleum Association (WSPA) says at every opportunity that cap-and-trade will raise the price of gasoline by 16-76 (or 14-69) cents per gallon. Huh?  These ranges don’t even include the most likely effect of 10 cents.  The industry got to these much-scarier ranges in two ways, both of which are – to be charitable – not based on the current information.

First, they took a 2010 ARB study – from before the final details of the program were even set – that predicted a 4%-19% price increase back when gas prices were in the $3 range and just slapped it on the current price of $4.  That doesn’t make any sense because the cost of allowances doesn’t scale up and down with the price of gasoline.  But, in any case, the range was based on a range of possible allowance prices from 2010 analysis.  We know a lot more now than we knew in 2010.  For instance, we now know the current market price of allowances and the market’s prediction for the January price.  Those allowance prices imply gasoline prices will rise by 9-10 cents, below the bottom of the very wide range the oil industry asserts is possible.

Second, WSPA took a prediction from their own consultants’ 2012 report, which argued that allowances would cost $14-$70 and (doing the calculation slightly incorrectly) concluded that this would cause the emissions costs from gasoline to be 14-69 cents per gallon.[2]  More recent information suggests the best forecast for January is below this range, so the oil industry is just choosing to ignore more recent information.

On August 1, the oil industry doubled down on their assertions in a letter to ARB.  While making some valid points about ARB’s misguided claims (which I’ll discuss below), WSPA states that ARB’s 2010 numbers must be the best estimates out there because ARB hasn’t put out a new estimate. That seems less than genuine given that the oil industry is as familiar as anyone with the market price of allowances.  They can certainly do the calculation I’ve done above.[3]

The oil industry might respond that the high end of this range could conceivably happen years from now if no further changes to the program are made.  That’s true — as our report explains — but these figures are being used to argue for a 3-year delay in fuels under the cap, often using the WSPA range to discuss the price shock that might otherwise occur in January 2015.  The “shock’’ on January 1 will be about 10 cents.

The oil industry’s numbers are eye-catching — much more than the boringly realistic 10 cents a gallon impact — and they are getting traction. Media reports of expected increases include 15-40 cents, 17 cents or higher, 40 cents, 15 cents or more and 15 cents (surprisingly moderate for Fox News).  A few stories repeat claims that cap-and-trade could cause gas prices to spike by more than a dollar, though I haven’t seen that claim attributed or justified.  Even the letter from the Assemblymembers to ARB says of the immediate price jump at the pump on January 1, 2015: “an increase of about 15 cents is likely and a much larger jump is possible.”  Not true.

 

CARB

What the Air Resources Board is Claiming:  ARB officials and (others supporting the policy) seem to have decided that counterspin is a better strategy than straight talk.  They have repeatedly suggested that if gas prices rise in January, ARB policy would not be the cause:  Cap-and-trade just requires sellers to turn in allowances; whether they choose to pass along that cost to consumers is their decision, not ARB’s fault.  Really? Every economic analysis of cap and trade I have ever seen –left, right or center politically (and ARB’s own analysis) – recognizes that it will raise the cost of selling gasoline and that this increase will be passed along to consumers.  That isn’t due to some conspiracy.  It’s how markets work; when the marginal cost of selling a good goes up, firms raise their price.  The cap-and-trade program will cause gas prices to go up in January 2015 by about 10 cents per gallon.

An ARB spokesperson has also suggested that these costs somehow won’t or shouldn’t be passed along because oil companies have been buying allowances since 2012 and already have a lot of them.  What?!? That’s like saying you paid for your house long ago so now you should give it away for free when you move.  In reality, every allowance a fuel dealer uses to cover its compliance obligation from selling gasoline will be an allowance it can’t sell in the marketplace.  That’s a real cost.

In the letter to Assemblymember Perea and his colleagues and in other statements ARB argues that any impact from cap-and-trade should occur gradually, not a sudden jump on January 1.  But the cost effect of fuels under cap-and-trade will go from zero on December 31, 2014 to 10 cents on January 1, 2015.  Just like an increase in crude oil prices or raising a gas tax, the empirical evidence is that this will show up at the pump within days.

Bottom Line: Like Jim, I strongly support bringing fuels under cap-and-trade on January 1, 2015.  That’s been the plan for many years and the current arguments for delay contain no new information.  Robust debate is valuable, but that debate is undermined when the public is told either that this change won’t (or shouldn’t) cost them anything or that the cost will be many times higher than the most reasonable estimates.

One Final Note About Public Opinion: Many of the newspaper articles on the price increase and many of the advocates for delay are citing a poll by the Public Policy Institute of California.  They quote the PPIC report saying “A large majority of Californians (76%) favor this requirement [including transportation fuels in cap and trade], but support declines to 39 percent if the result is higher prices at the pump.”  Is that informative? When you look at the actual survey question (page 31, question 30), I’d say it’s pretty useless.  The question asks if you favor requiring oil companies to “produce transportation fuels with lower emissions?” and then “Do you still favor this state law if it means an increase in gasoline prices at the pump?”.  There is no specific increase mentioned; that’s left up to the imagination of the person answering.  I bet if they asked about a one cent increase, there would have been almost no change, and if it asked about a one dollar increase, support would plummet.  Too bad they didn’t ask about a 10 cent increase.  That would have been interesting.  But I have no idea how to interpret the results of the question that was actually asked.

 

 

[1] The California Legislative Analyst’s Office sent a letter to Assemblymember Perea last week that called our study the most credible of the studies they reviewed.  They used our estimates to say that gas prices would likely go up 13-20 cents by 2020.  They did not mention that the same reasoning implies the impact in 2015 will be about 9-10 cents per gallon, but that is what their analysis also implies.

[2] Actually, the report states this range for the year 2020, which is three years after the proposed delay of implementing fuels under the cap.

[3] Some in the oil industry continue to argue that transportation fuels under cap-and-trade will hurt sellers – it won’t because the cost will be fully passed through – and that sellers should receive some free allowances to cover this additional burden.  Free allowance allocation would just be equivalent to a cash gift to gasoline distributors; for the marginal cost reasons explained they would still raise gas prices. (In fact EU policy makers tried this and were “shocked’’ to see that the companies getting free EU-ETS allowances still raised their prices).

I tweet interesting energy news articles most days @EnergyClippings

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23 Responses to Californians Can Handle the Truth About Gas Prices

  1. Steven Kopits says:

    So let’s consider the cost-benefit of reducing your speed from 72 to 70 miles per hours. Let’s assume you have an income of $60,000 per year (no great shakes in California), which makes your time worth about $0.50 per minute. Let’s assume gasoline costs $5 / gallon in California.
    Further, let’s assume your car requires 3 gallons to go 72 miles (24 mpg). And further, assume that the efficiency gain is 2.5%, per Severin’s assertion above, for slowing down from 72 to 70 mph. Is it value-enhancing, or value destroying, to slow down?

    In such an event, one hour driving at 70 mph would take you 1.7 minutes longer, and a value in time of $0.83. You would be saving fuel with a value of $0.38. Clearly, slowing down is value-destroying, by more than a 2-to-1 ratio.

    Not that hard a calculation.

    • Joe Looney says:

      Ah, but if we also assume we care about our children’s and grand-children’s future environment, slowing down to offset the gasoline cost is life-enhancing if not monetary value-enhancing. Don’t necessarily disagree with your calculations, but we have a multitude of values, none of which should be looked at in isolation. I live in California and am willing to pay the price. Lots of ways to offset these costs. It will be interesting to see how accurate this forecast is in six months, and I agree with the comments below about available tools to assist low-income drivers.

    • Robert L. Borlick says:

      Really Steven,

      Do you actually believe your own analysis? Is your leisure time really worth 50 cents per minute? Can you actually earn 50 cents during the minutes you would save driving faster? Also, on an after-tax basis your time is worth even less. How about sleeping less. Think of how much money you would save.

    • Severin Borenstein says:

      Steven
      The main problem with your calculation is that the $60k/year earner is not the person Assm Perea is proposing to protect. The secondary problem with such value of drive time calculations is that they assume that all value of time is lost when in the car. Even before cellphones, there were many activities — such as listening to the radio or talking to passengers — that probably had some value. With cellphones, many people find driving time even more valuable.

      My point is not that people should or shouldn’t drive a certain speed, but that if this is really such a huge hardship here are some relatively low cost ways to offset it. Few people are arguing that the wealthy should be protected from the cost of the carbon emissions they produce. For those for whom Assm Perea and other argue this is a hardship, I think it is important to put in perspective the magnitude of this hardship.

      Severin

  2. mcubedecon says:

    As usual a nice insightful post. I have an observation that that has only been alluded to indirectly in the debate. The main point of the legislators’ letter calling for a delay in implementation is that low income groups may be particularly hit. The counter argument that we need the inclusion of transportation fuels under the cap to incent innovation seems to pit the plight of the poor against the investment risk of wealthy entrepreneurs.

    Our state legislators are rightfully concerned about the impacts on those among us who have the least. Nevertheless, that problem is easily addresses with the tools and resources that are already available to the state. Those families and households who now qualify for the CARE and FERA electric and natural gas utilities rate discounts can be made eligible for an annual rebate equal to the average annual gasoline consumption multiplied by the amount of the GHG allowance cost embedded in the gasoline price. This rebate could be funded out of the state’s allowance revenue fund. For example, if the price is increased by 15 cents per gallon and the average automobile uses 650 gallons per year, an eligible household could receive $97.50 for each car.

    About 30% of households are currently eligible for CARE or FERA. On a statewide basis, the program would cost about $650 million, which is comparable to the cost for CARE for a single utility like PG&E or Southern California Edison. Those legislators who are most concerned can coauthor legislation to put this program in place.

    • UglyHedgepiglet says:

      Yes, yes yes.

      It would be nice for *someone* to be the example of a Pigouvian carbon tax where the money is given back to taxpayers, with a bias toward those who can least bear the impacts, rather than another revenue source for a dubious transportation investment. I’m not dead-set against HSR (which will be funded out of cap-and-trade?), but subsidized comfortable electric buses or something seem like a better option. You could play around with HOV / bus lanes or something.

      • mcubedecon says:

        Rebating the carbon tax based on income has been proposed by several economists including Ian Parry, Dallas Burtraw and Larry Goulder. We at M.Cubed have proposed using CARE rate discounts to finance energy efficiency programs rather than just providing lower bills, essentially having the utilities act as banks to a community that doesn’t have a good relationship with the banking industry.

  3. mcubedecon says:

    Reblogged this on M.Cubed: Outside the Box and commented:
    Sev Borenstein writes about the two sides of the argument on whether transportation fuels should be rolled into the cap-and-trade program in January 2015. (BTW, I think the DOE fuel use calculator is outdated–on my many trips to LA I haven’t seen these types of fuel economy changes.)

    I have an observation that that has only been alluded to indirectly in the debate. The main point of the legislators’ letter calling for a delay in implementation is that low income groups may be particularly hit. The counter argument that we need the inclusion of transportation fuels under the cap to incent innovation seems to pit the plight of the poor against the investment risk of wealthy entrepreneurs. We haven’t really done a good job of addressing affordability of the transformative policies that can change GHG emissions. The proposal to use carbon tax revenues to rebate to low income taxpayers has been floated at the national level, but of course that died with the rest of the national cap and trade proposal.

    Our state legislators are rightfully concerned about the impacts on those among us who have the least. Nevertheless, that problem is easily addresses with the tools and resources that are already available to the state. Those families and households who now qualify for the CARE and FERA electric and natural gas utilities rate discounts can be made eligible for an annual rebate equal to the average annual gasoline consumption multiplied by the amount of the GHG allowance cost embedded in the gasoline price. This rebate could be funded out of the state’s allowance revenue fund. For example, if the price is increased by 15 cents per gallon and the average automobile uses 650 gallons per year, an eligible household could receive $97.50 for each car.

    About 30% of households are currently eligible for CARE or FERA. On a statewide basis, the program would cost about $650 million, which is comparable to the cost for CARE for a single utility like PG&E or Southern California Edison. Those legislators who are most concerned can coauthor legislation to put this program in place.

  4. policywonk says:

    On the general issue of how much to discount industry predictions of the consequences of a new regulation, it’s always useful to recall:
    1. automobile industry executives and engineers predicted the most dire effects (undrivable cars that no-one could afford) from smog controls;
    2.coal-burning utilities were apocalyptic about the lights going out all over the midwest if we enacted sulfur limits;
    3. tobacco merchants (and a lot of smokers) forecast the complete collapse of entertainment, dining, and drinking commerce in NewYorkParisBerlinRomeEtc. if we did anything so reckless as to outlaw smoking in bars and restaurants.
    It’s possible that these advocates actually believed what they were saying; it was naïve for anyone else to.

  5. Pingback: Repost: Californians Can Handle the Truth About Gas Prices | M.Cubed: Outside the Box

  6. I would tend to believe those who actually will retail the product. The refiners are positioning consumers for the price spike. That way, when the finger wagging begins, they can say, “we told you so.” I hope the author will revisit this very post, in about 18 months when we know what the prices are.

  7. Jack Ellis, Tahoe City, CA says:

    Assuming the California legislature was serious about reducing CO2 emissions in the first place, Severin makes a pretty compelling argument that both the oil refiners and distributors, and the ARB are behaving irresponsibly (though not necessarily irrationally).

    What I find most annoying about the legislature’s antics is how they once again pass a law without thinking through the consequences and then become upset when easily foreseen outcomes materialize. If CO2 reduction is a state policy priority, then transportation fuels have to be included.

    If Perea and others are really concerned about the economic welfare of the less well off and still want to pursue CO2 emissions reductions, then they should replace the renewables mandate with a carbon tax (actually should have been done ten years ago). Estimates back in 2008 put the price per ton of carbon reduction associated with the mandate at between $160 and $200, compared with the forecast cap-and trade price of $12.

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  14. Rob Dekker says:

    Severin, thank you for your post.
    Your 10 cts/gallon makes sense if the FULL carbon content of gasoline would have to be purchased.
    But isn’t that unrealistic under the California cap-and-trade system ?

    The way I understood the basic concept, is that the state of California would issue carbon “allowances” to industry based on the amount of ‘energy’ (kWh) or ‘product’ (gasoline or diesel) to the amount of that carbon “cap” that the State of California wants to achieve that year.
    The industry can “trade” these carbon allowances, based on their individual carbon emissions, and at the end of the year they have to show as many carbon allowances as the emitted.

    If so, there should be no direct NET cost to the customer. Coal fired power plants will simply have to buy allowances from solar power companies, and, for the liquid fuel industry, refiners of Canadian tar sand bitumen would need to buy allowances from refiners that purchased domestic light sweet crude.

    As far as I understand the regulations, the State of California (CARB) was supposed to issue 90% of the cap ‘free of charge’ to the industry, and keep 10% in reserve and up for auction if the allowance price shows too much volatility.

    If AB32 does work that way, then the real impact at the pump should be at most 10 % of the allowance price, and thus only about 1 cts/gallon.

    And, if I understand the law correctly, regardless of the cost that polluting companies pay for these allowances, the proceeds of the allowances (paid to companies that produce less carbon per unit of product) would HAVE TO BE credited to the rate payer under AB32.

    So either way the consumer gets the money back.

    Wasn’t it supposed to work that way ?
    And has it not already been working that way since 2012 ?

    And if it does NOT work that way, then where is the 10 cts/gallon that you assess actually going ?
    Who gets that money ?

    • Severin Borenstein says:

      Hello Rob:

      Your understanding of gasoline under the cap is simply incorrect. None of the allowances for this use are being given away for free. They are all being sold, and the money is going to the state of California.

      In other industries, such as cement and oil refining, firms are given free permits as a function of the amount of output they produce. We discuss in our report the incentives this creates. But in any case, that does not apply to fuels under the cap.

      Severin

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