Coal is too Cheap
Two weeks ago on this blog, Max drew our attention to the fact that gas is too darn cheap. To underscore this point, he noted that the average American is purchasing gasoline at half of its true social cost. Well, by that measure, coal is even cheaper! The average coal plant is paying around a quarter of the estimated social cost of coal (more on this below).
Coal delivery (source)
The economist’s prescription for this coal-is-too-cheap problem is simple and elegant: raise coal prices to reflect the true cost of extracting and burning coal. But it’s proving extremely difficult to fill this prescription in practice. Last week’s SCOTUS decision reminds us just how hard it’s going to be to implement domestic policies that significantly reduce coal consumption.
First, some good news
Last year, the U.S. passed a milestone. As of July 2015, domestic electricity generators have been burning more natural gas than coal. This is kind of a big deal, given that coal has been the leading source of electricity generation in the US for as long as anyone can remember.
EIA Data released earlier this month show coal’s share of annual electricity generation in 2015 hit record lows (this is jumping the gun a bit, official December numbers not released yet. 2015 estimated using December 2014 as a proxy for December 2015).
Tweets from Donald Trump might lead you to believe that the decline of domestic coal is the result of Obama’s personal “war on coal”. Economists looking closely at the historic decline in coal-fired electricity generation paint a different picture.
In a recent working paper, Harrison Fell and Dan Kaffine argue that the two most important drivers have been the dramatic decrease in natural gas prices (largely due to the supply shock that is the shale gas boom) and the policy-induced increase in renewable energy supply. These two factors working together have pushed coal plants closer to the margin- and to some extent out of the market entirely.
Joseph Cullen and Erin Mansur look at how the drop in natural gas prices – and the associated increase in the coal price:gas price ratio- has affected CO2 emissions in the power sector. The graph below maps out the historical relationship they estimate between power sector emissions and natural gas prices, holding other factors (such as renewable energy capacity and coal prices) constant.
The graph shows that a decrease in the natural gas spot price from $12/mmbtu to $2/mmbtu, roughly what we saw over the period 2008-present, is associated with more than a ten percent drop in domestic power sector CO2 emissions.
Coal consumption has dropped – but not far enough
While we’ve seen a significant increase in relative coal prices since 2008, actual coal prices have been – and continue to be- astonishingly low.
The delivered coal price averaged $2.23/MMBtu in 2015. A study commissioned by the National Academy pegs damages unrelated to climate change at approximately $0.03/kWh (or more than $3.00 per mmbtu assuming average heat rates) . Using current Social Cost of Carbon estimates, greenhouse gas related damages work out to about $3.60/mmbtu (this assumes $38/ metric ton and 210.2 lbs CO2/mmbtu) . Taking these numbers at face value, the market price for coal amounts to approximately a quarter of the social cost.
At this point, the economist has to re-enforce the point that an across-the-board, across-the-globe tax that properly internalizes the health and environmental damages caused by fossil fuels would constitute an efficient policy response to the coal-is-too-cheap problem.
But the pragmatist has to point out that the theoretically preferred approach seems far out of reach when you consider the current state of affairs (recall that the much celebrated climate agreement coming out of Paris features voluntary actions with no enforcement provisions). So we are left to find the best possible policy within a politically constrained set of options – or do nothing.
Coal is too cheap– What are we going to do about it?
The Clean Power Plan(CPP) sits at the core of the Obama administration’s efforts to do something in the sector that matters most– electricity. Last week, the Supreme Court made a surprising and disheartening decision to put a stay on the implementation of the plan. Proponents of the rule – including Obama himself- are determined to see the rule through to implementation. But at the very least, this is a frustrating bump on the road to a domestic climate change policy that would significantly reduce coal-fired electricity generation in the US.
Given the uncertainty and upheaval surrounding the CPP, now seems like a good time to consider other (possibly complimentary) policy alternatives that are gaining momentum.
The U.S. government owns approximately one third of total domestic coal reserves. For some time, there have been calls to modernize the outdated Federal coal program to ensure taxpayers get paid a fair market price. More recently, environmental economists and other stakeholders have argued that reforms should go further to account for the environmental costs of coal.
Last month, the Obama administration announced that it was suspending new coal leasing on federal lands until a thorough review of how to overhaul the program to better reflect environmental costs can be conducted .
On the face of it, imposing a tax that reflects the social cost of coal at the point of extraction has clear appeal. Charging the full social cost would mean that federal coal will only be extracted if the coal will generate benefits in excess of these costs. Revenues could be used to fund investments in climate change mitigation and to help coal-dependent communities transition.
But there are complications. The big one, of course, is that the Federal Government controls a relatively small share of global coal reserves. A significant increase in the cost of federal coal would likely lead to substitution of other sources. If taxing federal coal simply shifts production to other coal mines outside the reach of the BLM, leaving federal coal in the ground will have limited impact on coal consumption or associated emissions. This report provides a more detailed look at these (and other) challenges.
Eliminating inefficient federal coal program subsidies is a clear-cut no-brainer. Economic arguments for taxing the carbon in federal coal are more nuanced. That said, a reform of the federal coal program that takes into account the substitution of un-taxed sources for taxed sources, in addition to other real-world complications (such as interactions between overlapping policies), would be a step in the right direction. Policies that raise domestic coal prices would reduce coal-related emissions, and lay some foundations for the more comprehensive, across-the-board climate change policies that the economist in me still dreams of.
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$38/tCO2 seems a little on the high side for the “global” cost of carbon, even before allowing for the Berkeley-documented publication bias (Zilberman and coauthors) or the lack of EPA disinterest. More importantly, said global cost is not relevant to the U.S. absent a strong and binding global agreement (Paris is neither). First, standard benefit-cost practice ala OMB prescribes using DOMESTIC benefits/damages (Gayer-Viscusi). Second, domestic benefits of climate mitigation are further reduced by leakage in the Nash equilibrium (Nordhaus’s AER paper w/ Xili Yang). We still need a corrective tax, but not as high as indicated.
See Weitzman’s paper about how “standard” B/C analysis may not be appropriate: http://scholar.harvard.edu/weitzman/publications/some-basic-economics-climate-change
Also, note that the US EPA is using $61/tonne for the social cost.
Richard,
The Gayer-Viscusi (2014) discussion about domestic vs. global mitigation is online: “Determining the Proper Scope of Climate Change Benefits.” I always thought Nordhaus and Zili Yang’s 1996 AER paper was unappreciated at the time, but they anticipated both the Gayer-Viscusi and leakage arguments.
Cheers,
Jim
P.S. Norhaus’s critique of Weitzman’s “dismal theorem” is also online.
Clean Coal is possible and it does not have to rely on the expensive technology of Carbon Capture Sequestration.
Carbon Capture Utilization converts the CO2 into useful – saleable products. Waste is not a waste if it has a purpose. Sidel CCU gives combusted coal exhaust a purpose. It will provide a lot of full time jobs. It will benefit many sub industries.
Coal can be combusted with less CO2 going into the atmosphere than combusted natural gas.
sidabma – How much does this technology cost on net? What’s the demand for coal exhaust? Since power plants are often in remote locations (and always the case in the West), does this require constructing new industrial facilities and communities at the existing coal plants?
And this doesn’t address the other issue–the significant environmental consequences of coal mining.
mcubedecon – The demand by the EPA’s Clean Power Plan is for cleaner coal exhaust. Carbon Capture Utilization will help these utilities to comply with the EPA’s CPP.
The combusted coal exhaust is diverted before entering the power plants big chimney into a single reactor where the CO2 is removed / transformed into other products. The heat energy is removed from the exhaust, and that heat energy can be used in a number of different ways. Some of these ways can create jobs for a lot of people. The power plant employees people, so there must be a local community.
We are here to help the power plants. Someone else can work at assisting the mining industry in their needs, and the transportation industry in their needs.
sidabma: The workforces at these plants are relatively small and the surrounding communities also are quite small and isolated. While some have rail lines to supply coal, most in the West are located at minemouths so they don’t have the same transportation connections. I presume that other material would have to be transported to the sites to use the exhaust. We’ve seen other proposals to use CO2 byproducts but the combination of unprofitable costs and limited market uses appears to make this option not very promising, at least not for the vast majority of the coal plant fleet. Do you have a market study that shows the projected net profitability (revenues and costs) and the expected total market for these products?
The argument for taxing the carbon content of federal coal in the ground is compelling — and one shared by my RFF colleagues.. (www.rff.org – go to Discussion Paper 15-13, March 2015.) But even apart from leakage issues recognized by the author, there are impediments that such a carbon-taxing regime needs to confront and manage. Coal so taxed may be exported to an environmentally-conscious country (say, Netherlands) that both uses, but also limits reliance on, coal ;or it may enjoy unrestricted use in some other export market.. In the former case, a double-taxation dilemma needs to be resolved. Overcoming the double-taxation problem in a tractable fashion may be much more demanding in the US to the extent that federally-taxed coal production is to coexist with the prospective centerpiece of the country’s climate policy — i.e., the coal constraints under the Clean Power Plan. Wanted: some anticipatory and creative thinking..
If coal and gas are ‘cheap’ relative to the ‘true social cost’ then meat, specially beef, and probably pork, too is really cheap. The social cost of cow flatulence methane must be factored in to the price of meat.
That’s probably true. Using USDA data, I found that producing beef emits four times as much carbon per calorie and twice as much per gram of protein than wheat or soy. We will probably have to move to plant-based diets to lower GHG emissions. I already made that choice.
This post reminds us that political correctness is alive and well—and more than willing to spend other people’s money to support a winners and losers strategy. Coal is “cheap” because the government’s economic policies are both starving the market of growth and conducting a war against “loser” technologies in this country.