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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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