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What Can Carbon Pricing Do?

It won’t reduce energy use much, but it can fundamentally alter where that energy comes from.

A decade ago, there seemed to be a Kumbaya trend in climate policy. Politicians of many stripes were saying that pricing CO2 and other greenhouse gases should be the first-line policy of choice against climate change. Then a few years later many on the political right disappeared behind the “we aren’t certain it’s a problem so let’s not do anything” rock. And more recently, many on the left seem to have decided that because carbon pricing won’t completely address the climate crisis and environmental justice at the same time, it should just be jettisoned.

Earlier this year, I blogged about the need to do more than just put a price on GHGs in order to incentivize efficient technological progress. But I also argued that carbon pricing is critical to the fight, because it helps communicate the full societal cost of using different energy sources, and thus to bend the economy away from carbon-intensive fuels.WhatCanCarbonPricingDoFig1

Today, I want to drill down a bit on where that bending is likely to come from. A bit of simple arithmetic suggests that it probably isn’t going to be from a reduction in the consumption of energy services. Rather, carbon pricing will help to decarbonize economies by driving substitution among energy sources.

Small Effects on Energy Demand

Let’s consider a price of $50 per metric tonne of CO2, which I pick both because it is around the latest estimate of the Social Cost of Carbon, and because it is higher than the price that any state or country imposes on most of its GHG emissions, so it’s probably pushing the envelope on political feasibility.

Fully passed through to end-use consumers, that $50 price would raise the price of gasoline by about 40 cents per gallon. That is about the same change we see when the price of crude oil moves up or down by $16 per barrel, which has happened numerous times in the last decade. Many analyses of gasoline demand — and just looking at traffic congestion and vehicle sizes in developed countries — demonstrate that 40 cents per gallon does little to change driving behavior. (The data and research on which I base these conclusions about the long-run impact on energy consumption are presented in Borenstein, Bushnell, Wolak and Zaragoza-Watkins, “Expecting the Unexpected: Emissions Uncertainty and Environmental Market Design”, forthcoming in American Economic Review, and the paper’s online appendix.)WhatCanCarbonPricingDoFig2

Similarly, $50 per tonne raises the cost of producing electricity in an efficient gas-fired generator by about two cents per kilowatt-hour, or about 18% of the average retail electricity price in the U.S. (a much lower percentage in California). Electricity demand is also pretty price-insensitive, and such a change would almost surely have a small effect – less than 10% — on consumption.

When it comes to natural gas, that $50 carbon price would add more to the average residential and commercial price in the U.S., about 30%. But studies show that even that would have only a modest impact on thermostat settings, building insulation levels, or hot water use.

Tilting Markets for Energy Supply

So, if pricing carbon isn’t going to do much to change the miles we drive, the amount of lighting we use, or the temperatures of our homes and commercial buildings, why do I still think it is critical to the fight against climate change? Because it can change the technologies we use to do all of those things. Pricing carbon won’t change consumption of energy services by much, but it can get us to lower carbon emissions from that consumption.

And, importantly, it will give firms and consumers incentives to find the areas where lower-carbon technologies can substitute most easily today without disrupting the uses where low-carbon alternatives aren’t yet close to cost competitive, such as air transportation and some industrial processes. We need to keep working on innovation where the alternatives are expensive, while picking the low-hanging fruit today in the many places they already exist.

Note: Union Pacific coal train near Douglas, Wyoming. Creative Commons.

$50 per tonne raises the cost of electricity from coal-fired generation by about 5 cents per kWh. In most markets, that alone would be enough to price it out of the generation market — compared to gas-fired generation, wind, solar, and hydro — even if we didn’t count the damage from sulfur, mercury, and fine particulates. cars turbines

And while the $0.02/kWh cost that such a carbon price imposes on gas-fired generation wouldn’t lower electricity consumption by much, it would greatly boost the competitiveness of wind, solar, and other near-zero carbon generation alternatives. It would also slow or stop the shuttering of existing nuclear power plants, which produce nearly 20% of U.S. electricity carbon free. (It wouldn’t do much to make new nukes competitive, as recent experience again suggests they are massively expensive.)

Even with recent progress in storage technologies, we aren’t at the point today that most grids can operate cost competitively without some natural gas generation, but a carbon price would push generators and grid operators to explore all alternatives.

The same goes for driving natural gas combustion out of buildings and many industrial uses. Even as the electrical grid gets cleaner, displacing gas in these uses will be slower if we don’t price it to reflect the damaging externalities from such end-use combustion. (It would also help if we more accurately priced electricity to reflect its true societal cost, as I discussed last year and last month.)

Electric vehicles, powered by a low-carbon grid, seem to be the most feasible route to decarbonizing transportation. Adding $0.40 per gallon to the price of gasoline won’t make the difference today, but as battery and EV technologies improve, such a carbon price could accelerate their pathway to cost parity. Ditto for biofuels if those technologies happen to make faster progress than EVs.

So, a serious price on GHGs would already be pushing down the carbon intensity of electricity generation, and could make a substantial difference in substituting away from natural gas in end-use combustion and petroleum in transportation.

Not the Only Tool, But an Important One

But can we say with certainty that $50/tonne, or even $100/tonne, would reverse the destructive trend in GHG emissions and solve climate change? The only honest answer is no. We don’t know the price that will get us to where we need to go on emissions, because we don’t know how technologies and costs — of both alternative energy and fossil fuels — will evolve (which I blogged about last year). And if we are being completely honest, we don’t even know exactly where we need to get to on emissions.

What we do know is that the impacts of climate change are appearing faster than most predictions from even a few years ago. And we know that rapid reductions in GHGs are what scientists prescribe. Pricing carbon isn’t the only tool we have, but it is key to finding the areas where we can substitute among energy sources most cost effectively. And that is key to finding a climate change strategy that all (reasonable) policy makers can agree on.

I am still tweeting interesting energy news articles, research papers and blogs (and occasionally my political views) @BorensteinS

Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.

Suggested citation: Borenstein, Severin. “What Can Carbon Pricing Do?”, Energy Institute Blog, UC Berkeley, September 30, 2019,



Severin Borenstein View All

Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.

6 thoughts on “What Can Carbon Pricing Do? Leave a comment

  1. Severin , I really enjoy this post but must observe 2 things:

    1. Do you think it is reasonable to come up with a price that reaches the intended outcome and timeline, while giving enough flexibility to adjust the price over time while goals change?

    2. In theory, this could result in significantly improved outcomes in the energy sector. However, as I know you are well aware, there are significant emissions of greenhouse gases from other sectors. Do you think this approach can be applied to those sectors?

  2. Natural gas at a lot of larger commercial buildings and by industry can be used much more efficiently. Too much combusted heat energy is still allowed to be vented into the atmosphere. The technology of Condensing Flue Gas Heat Recovery can have the buildings space heating or industries steam producing boilers operate between 90 to 95% efficiency.
    For every 1 million Btu’s of heat energy that is recovered from the combusted exhaust and is then utilized back in the building or facility, 117 lbs of CO2 will not be put into the atmosphere.
    Water is also becoming a precious commodity. In every 1 million Btu’s of combusted natural gas are 5 gallons of recoverable distilled water.
    Yes, we can become much more efficient, and increased efficiency does reduce carbon emissions.

  3. The problem with your analysis is that you chose too-low of a carbon price. The power of carbon pricing is all in the price. Writing about what a static $50/ton CO2 is not starting from what we know about carbon pricing from the World Bank, UN, and other expert economists (e.g. the High Commission on Carbon Pricing). According to them, we need a $40-$80 per ton CO2e price on greenhouse gas emissions in 2020, and $50-100 in 2030, and rising after, to send a price signal to get the emissions reductions necessary to meet IPCC temperature targets (see Figure 9: ).

    How can we charge that much for GHG emissions? Simply by rebating all the money collected from the carbon fee back to all households on an equal basis each month.

    The Carbon Fee and Dividend policy proposal uses that approach and puts a high-enough price on carbon: It starts at $15/tCO2e the first year, and rises by $10 more each year, for about 30 years.

    Try doing your analysis of energy production, transportation, building use, etc. with that pricing. The Regional Economics Modeling Inc. did so, and found a 40% reduction in twelve years and 90% reduction in thirty: See here for a graph that shows how the impact of that pricing signal compares to Paris Accord targets:

    Climate Justice is also covered by a fully-rebated fee. The low-income households come out with more money each month (and more spending power) with this policy than without it.

  4. Some oil companies even embrace the carbon tax. However they are likely to drop this support when they realize that a bump in gasoline prices are likely to drive up the price of gasoline and cause more people to buy EVs than ICE cars. If EVs drop a little more in price and solar panels can be made a bit lower cost on homes the switch to EVs and home solar panels to power those EVs will happen quickly. Once the oil companies figure this out they are not likely to support the EV+solar revolution since it will mean the end of fossil fuel transportation. The EV threat to oil companies is greater than to fossil fuels used for power production. We used to think nuclear was a threat to oil companies on the grid but it seems that nuclear is pretty much dead in the US at this time. Good luck to other countries trying to build new nuclear plant.

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