Looking for warmer weather? Be careful what you wish for.

Here in Ann Arbor, Michigan, this past March has been anything but spring-like. Even by our standards, we’ve had more than our fair share of cold, wind, and snow. And now winter seems to be extending itself into April…after a tease of spring with a warm and sunny Easter Sunday, this Monday brought us a high of 39F with scattered snow flurries. To which I say boo.

So, yes, warmer winter weather would be nice. And as it so happens, warmer winters are something we should expect to happen with climate change, so that’s good news. The bad news is that (as economists like to say) there is no free lunch, so climate change will bring us hotter summers too. And as anyone who lived through last summer in Ann Arbor will attest, three months of scorching weather can be pretty unpleasant too.

But does the discomfort associated with a hotter summer actually outweigh the increase in comfort that will come with a warmer winter here in Ann Arbor? And what about the rest of the U.S., some parts of which currently experience very little winter cold (Florida), while others experience very little summer heat (North Dakota)? In a new paper (Climate Amenities, Climate Change, and American Quality of Life), David Albouy, Walter Graf, Hendrik Wolff, and I try to answer these questions by assessing U.S. households’ willingness to pay to avoid hot and cold weather.

How do we come up with an estimate of households’ willingness to pay for climate, in dollars? We take advantage of the fact that local climate is a factor that potentially affects households’ choice of where to live. Compare Berkeley to Ann Arbor, for example. I’ll conjecture that most people think that the climate in Berkeley is superior to that in Ann Arbor–Berkeley has lots of days with warm afternoons and cool, comfortable evenings, while in Ann Arbor such days tend to occur only in the spring and fall. So why don’t people move from Ann Arbor to Berkeley as soon as they have a chance? Well, it costs a lot more to live in Berkeley than it does in Ann Arbor. For the cost of a studio in Berkeley, you can get a pretty nice two bedroom apartment in downtown Ann Arbor. So there’s a tradeoff here–if you live in Berkeley you get beautiful weather, but you have to pay a pile of money in rent (or mortgage payments if you own) to get decent housing, leaving you with less money to spend on other things you want. Thus, the cost of living difference between Berkeley and Ann Arbor reveals something about their residents’ willingness to pay for a comfortable climate.

In the paper, we extend this idea across the U.S. to get at households’ willingness to pay to avoid hot and cold weather. There are, of course, a number of important details that are important to get right along the way–for instance, differences in wages across cities matter too, as do differences in other amenities such as coastlines, mountains, and population density. Our main result is that, on average, households’ willingness to pay to avoid an excessively hot day is greater than the willingness to pay to avoid an excessively cold day. This result comes from the fact that in hot places like the South, the cost of living is quite low relative to wages, indicating that households are willing to pay very little to endure the South’s hot, humid summers. The result also makes (at least to us) a lot of intuitive sense. On a cold day, you can protect yourself outside by layering up with coats, hats, and mittens. On a hot day though, there is unfortunately a limit to how many clothes you can take off (most jurisdictions won’t even legally let you get down to zero), so you’re uncomfortable outside no matter what you do. Sure, you can go inside to your air conditioning, but if you’d rather be outside in the afternoon, there’s a cost to doing so.

What does all this mean for the potential effect of climate change on comfort? If heat is worse than cold on the margin, then the extra discomfort from hotter summers will outweigh the benefits of warmer winters. When we use “business as usual” climate projections for 2100, we find that unless technology or preferences change, the annual net loss of comfort from climate change will be worth between one to three percent of U.S. income. Those numbers might seem big or small to you depending on your perspective, but for reference they’re in the same range as forecasted losses in GDP from damages to market goods such as agricultural products that come from the Nordhaus DICE model and the Stern report.

Perhaps even more interesting than the average welfare loss is the distribution of this welfare loss across the U.S., which we depict in the map above (losses expressed as a percent of 2100 income). As you might expect, the South gets hit fairly hard, since their summers are already hot and their winters are fairly mild–there’s not a lot of scope for climate change to give southern residents benefits in the winter. But most of the North fares quite poorly as well, even in places like North Dakota that currently have harsh winters but mild summers (though they do already experience some pretty hot days). What’s going on there? This is where it’s important to note that not everybody has the same preferences for climate. Some people aren’t bothered that much by cold weather, while others can’t stand it. It turns out that people sort themselves according to these preferences, so that North Dakota is largely populated by people who don’t mind the cold so much, while Florida gets populated by people who strongly dislike the idea of winter. So if you live in North Dakota, the fact that climate change will result in a warmer winter won’t be worth that much to you, but the fact that your relatively mild summer will turn into an extremely hot one will be worth a lot. The take-away message here is that if we want to forecast who will gain and who will lose from climate change, taking regional preferences into account can matter a lot, and it may be that southerners won’t be the only ones to suffer if the latest climate projections are realized.

Marketing Solar, Part Two

Several weeks ago I blogged about a solar quote my family received. The quote suggested that we could spend $12,400 to save $39,500 on our future electricity bills. My post raised two issues about the quote, including that the savings summed over the next twenty-five years were not discounted and that the company was projecting that our electricity payments without solar would rise at over 5% a year.

In this post, I provide some promised extensions, and address several issues and suggestions that were raised in the (generous and voluminous!) comments.

Recall that the company is trying to forecast what my family’s savings will be in the future if we spend $12,400 for their panels. Forecasting is a tricky business, but we do it when we make many investments, whether it’s buying stock in the hopes of reaping future dividends and capital gains or buying a house in the hopes of avoiding rent and possibly realizing capital gains when we move out. In the case of solar panels, the expected future returns are lower electricity bills. Calculating those returns requires forecasting what you would have paid for electricity had you not installed solar panels.

Electricity bills reflect the price we are charged for power multiplied by the amount of power we consume. In California, and many other states, the price we are charged varies as a function of how much power we consume. For instance, my family pays PG&E 13 cents per kilowatt-hour (kWh) for about the first third of our power, 15 cents for the next third and, in most months, 30 cents for the last couple kWh of electricity. People who consume more than us in Berkeley can pay as much as 34 cents per kWh. (The kWh thresholds, where the rates change, vary as a function of climate zones – they’re higher inland. They also differ between summer and winter.)

PG&E is using what are called “increasing block rates”: the price per kWh is increasing in the number of kWh we buy – the opposite of a volume discount. Here’s the thing: California regulators are currently considering flattening the increasing block rate structure. This could have a large impact on the savings from solar panels.

Keep in mind that the solar panels proposed for our family would not offset all of our power consumption. We’d still be buying about a third of our electricity from PG&E.  It would offset the most expensive 30 cent power, and leave us paying 13 cents for most of the remainder. But, if regulators flatten the rate structure, the savings from offsetting the high cost power will be lower, and our remaining charges will be higher.

One suggestion on my last post was to be more concrete: how much lower would the savings be if we discounted them, for instance? To get some sense for specifics and to devise some rough estimates of the impact of bill restructuring, I have devised a very crude spreadsheet.

To calculate discounted savings, I have to take a stand on the appropriate discount rate. One way to think about this is to compare the returns my family would earn if instead of buying the solar panels we made another investment, such as in the stock market. Historical stock returns, say over the past twenty-five years, have been around 10 percent, and given that we are making an estimate over the next 25 years, that’s probably a reasonable prediction. But, to allow for the fact that solar panels are probably less risky than an investment in the stock market, and returns from solar are most likely uncorrelated with the stock market (low beta), I used a 5 percent discount rate. If your alternative investment is something like a Treasury Bill, you might want to use a lower rate. At 5 percent, discounted cumulative savings, net of the panel costs, are negative through the first 12 years and only $13,500 cumulatively, compared to the $39,500 we were quoted.

Rate restructuring could have a big impact as well. I am not aware of specific proposals, so I considered a couple different options. If instead of 13 cents, 15 cents, 30 cents, the rates were changed to 15 cents, 16 cents and 24 cents, our discounted cumulative savings would be over 20 percent lower:  $10,500 instead of $13,500. To me, this seems like a big impact from a relatively small adjustment to rates.

If the restructuring is more dramatic, say a flat rate at 16 cents, the savings are reduced by more than half: less than $5,200 instead of $13,500. Note that I am assuming the rate restructuring is effective the first year we own the panels and then kept at the same relative levels into the future, but still escalating at over 5 percent a year. If these new rates only go up at 2.5 percent a year, our solar panels would never pay off.

It’s important to note that I am making pure guesses about rate restructuring. Regulators will have to consider many factors, such as whether the new rates provide PG&E the correct revenue. For most utilities, but not PG&E, households pay a fixed charge no matter how much power they consume. If this is on the table for PG&E in the future, the savings would be lower still.

A team of researchers at Lawrence Berkeley National Labs have put together a comprehensive analysis of the impact of different rate restructuring scenarios on bill savings for solar customers. They conclude that future regulations place substantial uncertainty on future bills, so that, “simple assumptions that project a flat or increasing value of bill savings over time (in real terms) may not be accurate.”

My own hope is that regulators will address this issue and, for instance, devise a more sophisticated version of my spreadsheet, both for potential consumers to use and to constrain how solar marketers display information.

One of my colleagues took pity on the solicitor noting, “Wow, did that company ever knock on the wrong door!” It could be, but everyone will eventually benefit if consumers are making well-informed choices.

From Big Energy Consumption (E) to Lower Energy Consumption (e)

Very little shocks me anymore. But I was shocked – SHOCKED! – to discover that one space in our house which takes up only about 5% of the floor space draws more than 20% of the KWH our house consumes in a day.

Can you guess which room this is? It is the space my family calls the “home office.”

Misery loves company and, it turns out, I am in good company. According to a 2009 Energy Information Administration survey, 30% of the energy an average U.S. home consumes goes to powering electronic gadgets, small appliances, and lighting.  That figure is up nearly 10 percentage points from 1993, when it was roughly 20%. As the Wall Street Journal recently reported, much of this trend is attributable to the increase in energy-consuming gadgets in the home.

In our home office, I knew something was powering the blue, green, and red glowing lights when the house is dark, but I was once again shocked to discover that a large chunk of the KWH these electronic gadgets use are consumed when we’re not there.

When I shared my misery with friends and colleagues, several gloated that their entire home consumed just slightly more KWH a day than my home office. I was shocked again!

How do they do it? In addition to replacing dated refrigerators with brand-new Energy Star refrigerators and making capital investments in whole house weatherization strategies like window replacement, insulation, and caulking, their advice echoed the advice of other experts: unplug electronic gadgets such as televisions, cable boxes, computer monitors, printers, and chargers when not in use.

Crawling behind sofas and under tables to plug and unplug the television and various other gadgets reeks of serious inconvenience to me, but attaching gadgets to an easy-to-reach power strip with an on-off switch serves the same purpose with much less hassle (though still not hassle-free).

A colleague of mine, David Levine, recently wrote in an op-ed in the Los Angeles Times about phantom power, the power that appliances continue to draw even when they are not in use. In his op-ed, he proposes manufacturers be required to list how much phantom power a device consumes in order to provide consumers more information about energy use. He also points out that European regulations require new appliances to draw no more than 1 watt of power in standby mode.

Despite decades of efforts and billions of dollars directed at energy efficiency, we know (shockingly) little about which investments and/or behavioral nudges will give us the biggest bang for the energy efficiency buck. We also know (shockingly) little about how well current energy efficiency regulations and programs work.

To answer those questions, The Alfred P. Sloan Foundation recently funded The E2e Project, which I and my colleagues at the University of California at Berkeley – Catherine Wolfram – and the Massachusetts Institute of Technology – Michael Greenstone and Chris Knittel – founded, to bring rigorous, state-of-the-art evaluation techniques to energy efficiency programs.

The mission of E2e is to unite top researchers in order to create a cheaper and greener future.

And at the same time, the mission is a personal one as I continue to learn how to get the biggest bang for my energy efficient buck at home.

EMB

Forecasting Supply and Demand in California’s Cap and Trade Market

Today we are taking the unusual step of posting in advance a draft paper that will be presented at the Energy Institute’s POWER research conference on March 22.

The paper is “Forecasting Demand and Supply in California’s Cap and Trade Market” by Elizabeth M. Bailey (University of California, Berkeley), Severin Borenstein (University of California, Berkeley), James Bushnell (University of California, Davis), Frank Wolak (Stanford University), and Matthew Zaragoza (University of California, Berkeley).  Because the paper presents estimates of possible future prices in the market, we felt it was important to make sure that all potential market participants had equal access to it.

The paper will be posted at noon PDT at the website for the POWER conference, http://ei.haas.berkeley.edu/power.html

With cross-state cap-and-trade, challenges await the next EPA administrator

Last week, President Obama nominated Gina McCarthy to be the new EPA administrator. If confirmed, McCarthy will be looking to break ground with new carbon dioxide regulations for power plants and rules of the road for hydraulic fracturing. But she will also be dogged by old regulatory challenges, including the current stalemate over cross-state air-pollution regulations.

Historically, cap-and-trade has featured very prominently in domestic efforts to control the emissions of so-called cross-state pollutants (namely, sulfur dioxide and nitrogen oxides). Pioneering efforts delivered laudable successes in both the Acid Rain Program and the NOx Budget Program, respectively. Emissions targets have been met or exceeded. Program benefits have exceeded costs by a significant margin. That was then.

Now, these cap-and-trade programs are shadows of their former selves. Repeated attempts to extend cross-state emissions trading programs have generated thousands of pages of court remands, dissenting opinions, en banc petitions – but no substantive progress.

This week’s blog post looks at two key factors that complicate policy making in this arena. And anticipates the daunting challenges ahead.

Location matters

A defining feature of so-called “cross-state” air pollution is heterogeneity. The health and environmental damages it causes vary significantly with the location and dispersion characteristics of the emissions sources. In principle, efficient emissions regulation should account for this variation. In other words, if my pollution causes twice as much damage as yours, I should be required to pay twice as much to offset my emissions.

This is not what we see when we peer into existing emissions trading programs. For the sake of simplicity, emissions permits for a given pollutant trade at a single price. This begs the question, should future policies be designed to better reflect spatial and temporal variation in emissions damages?

Nick Muller and I consider this question in a recent working paper. We demonstrate how integrated assessment modeling of pollution damages could be used to define the terms of “differentiated” emissions permit trading. If regulators are well informed about firms’ abatement costs, differentiated trading programs deliver efficiency gains over and above existing program designs.

But here’s the catch. Emissions abatement costs rarely – if ever- manifest as policy makers expect. Once this wrinkle is accounted for, the case for differentiated emissions trading gets far more nuanced. More generally, our paper underscores the importance of implementing market-based policy designs that can nimbly and flexibly respond to market conditions as they unfold. Unfortunately, this policy prescription is getting harder to fill in the current regulatory environment. This brings us to our second complication…

The legal dimension

The Clean Air Act gives the EPA has the authority to set air quality standards. Once standards are set, it is up to the states to meet these standards within their borders.  Things get complicated when emissions cross state borders, such that one state’s ability to meet a standard is impacted by pollution blowing in from an upwind state.

Enter the “Good Neighbor” provision of the Clean Air Act. This requires upwind States to take responsibility for the pollution they are sending to their downwind neighbors.

Initially, the courts did not interpret this provision to mean that emissions reductions achieved within a state had to correlate directly with the state’s relative contribution to a specific downwind nonattainment area. This was important, because it allowed for unrestricted emissions trading across state lines.

This all changed in 2008.  In a decision that overturned the Bush administration’s Clean Air Interstate Rule (CAIR), the D.C. circuit of the U.S. Court of Appeals ruled that:

“Each state must eliminate its own significant contribution to downwind pollution.”

This ruling was surprising. It seemed to disregard completely over a decade of progress with market-based emissions regulations. And ignore key economic insights regarding the reciprocal nature of emissions externalities.

Perhaps most importantly, this ruling introduced additional constraints into an already complicated policy arena. In an effort to comply with the court remand, the Cross-State Air Pollution Rule (CSAPR) was promulgated. Rather than allowing unlimited trading across state lines as previous rules had done, CSAPR prohibits interstate trading if a state exceeds its pre-prescribed emissions limit.

Last year, the D.C. Circuit invalidated CSAPR. In doing so, the court elaborated upon the ways in which the good neighbor provision should dictate state-level emissions abatement responsibilities. This latest ruling makes it even harder to imagine how the EPA can design a cost-effective, market-based emissions trading program for cross-state pollution that will pass muster with the court.

What next?

In her capacity as assistant EPA administrator, McCarthy followed the court directive to revert to the Clean Air Interstate Rule which will serve as a place holder until a new rule can be promulgated.

The good news is that, in the very near term, the need for a new cross-state rule is not immediate. Relatively low natural gas prices and the new mercury and air toxics standards are working to reduce the role of coal-fired generation. The first phase of CSAPR emissions reductions may well be achieved without a new rule.

But in the not-too-distant future, a new rule will be needed. The court will not allow CAIR to remain in effect indefinitely. And a number of states will need a more stringent cross-state rule to comply with ozone and particulate matter standards.  The new EPA administrator will almost certainly oversee a re-redesign of the cross-state air pollution rule.

The constraints that have been imposed in the name of “Good Neighbors” offer, at best, a crude means of accounting for spatial variation in pollution damages. And in limiting the market’s ability to exploit gains from trade across state lines, they increase the cost of cleaning the air. When the agency does return to the proverbial drawing board, we can only hope that the courts have become more amenable to building on – versus dismantling- past successes with market-based regulation.

Marketing Solar: Bring in Elizabeth Warren?

Last month, my husband opened the door to a solicitor from a solar company and eventually agreed to let the polite young gentleman on our porch order a quote for our family to go solar. The three-page form that the company sent had several very misleading figures. I was appalled.

Let me be clear – I am no foe of solar. At some fundamental level, I can see the appeal. If we really want to reduce carbon emissions dramatically and address global warming, solar power of some form likely has to be part of the global solution.

But, I do not think companies should be allowed to misrepresent information.

Here’s half of the first page of our quote:

(I am not revealing the company’s name because I don’t want to out any one person or company. I will say that this is no fly-by-night outfit.) From the first two numbers under “YOUR FINANCIAL BENEFITS,” it looks like we will spend approximately $12,400 and save $39,500. And, if you look more closely at the savings, they are net of the upfront cost. How could we not sign up right away? Seems like we would be ripping up a check for $39,500, right?

Go to the second page, and you see how the company calculated the $39,500. They’re adding up savings over the next twenty five years without discounting savings in the future. This company would fail my colleagues’ introductory finance course.

We would pay the costs of $12,400 in today’s dollars, in order to save $3,576 in the year 2038, assuming we’re lucky enough to be alive and buying $100 cheese pizza for our grandchildren.

There’s another part of the quote that’s potentially misleading. The savings the company projects reflect their estimates about our electricity bills in the future. The first two columns on the second page of our quote titled “Utility Without Solar” and “Utility With Solar” are their guesses about what our electricity bills will be with and without solar. The difference between these columns yields their “Annual Savings” estimate. The columns embed assumptions about how our usage and electricity prices will change over the next 25 years.

The company estimates that our utility bills without solar will go up by more than 5 percent a year. The escalation in electricity payments is also reflected in the upwards slope of the red and blue lines on the first page of our quote.

It’s not clear from our quote which part of this is the growth in electricity prices and which part is the growth in our usage, but apparently other solar companies break out the components. Greentech Media reports that a gentleman in California has sued Sunrun, the company that convinced him to lease a solar system, for deceptive marketing. The company’s promotional material suggested that utility prices would go up by 5 to 6 percent, while his have leveled off since he bought his system in 2011.

There are at least two more components of the quote that are misleading, but this post is already long, so I will continue with another installment.

Certainly, some people want to go solar for reasons other than saving money on their utility bills, and for them, the numbers aren’t important. But, for the rest of us, who want reliable guidance on how much money we will save with a large financial decision, companies like the one on our porch are doing a disservice. It’s time to impose better oversight on the way these companies present information.

California Holds Its Second Cap and Trade Auction: Signs of a Maturing Market

The California Air Resources Board (ARB) held its second auction for greenhouse gas allowances this past Tuesday (Feb 19^th).  Severin blogged about his reactions to the first auction held back in November 2012 here.

As a quick refresher, in the first auction, the market clearing price for a “current” vintage 2013 allowance was 9 cents above the auction reserve price of $10 per ton and all allowances available for sale – roughly 23 million – were sold.  The first auction had its share of excitement and controversy, which you can read about here.

The results of the second auction were released on Friday.

The market clearing price for a “current” vintage 2013 allowance was $13.62, nearly $3 above the auction reserve price of $10.71.  All the “current” vintage allowances available for sale were sold.

To me, the evidence suggests the market is maturing.

It is important to be clear:  On its own, higher spot prices are not a sign of a maturing market.  Similarly, a sold-out and/or over-subscribed auction is not a sign of a maturing market.

On the other hand, pricing evidence which is consistent with resolution of some of the uncertainty surrounding the future of the California cap and trade program is suggestive of a maturing market.

The relationship between the clearing price of a “current” vintage allowance in the November 2012 coupled with the corresponding “future with a floor” product being priced on the Intercontinental Exchange (ICE) suggests that there was a substantial implied belief by the market back in November 2012 that the cap-and-trade program may not persist in the near term.

The current relationship, however, between the auction clearing price for a “current” vintage allowance and the corresponding ICE product suggests a sizable reduction in uncertainty about the likelihood of the program persisting.   The results of these calculations are consistent with a maturing market.

For those who follow this market closely, this insight will not come as a surprise.  For one thing, in late January, a San Francisco Superior Court judge resolved on-going litigation over the use of offsets in the cap-and-trade program in ARB’s favor.

To be sure, there is still uncertainty to be resolved.  For now, however, the evidence suggests that market participants believe the market is maturing.

EMB