Sean Casten writes, “The Waxman-Markey proposal to reduce CO2 emissions by 17 percent over ten years is constrained only by its ambition.”

Cutting CO2 emissions by 20 percent could be realized with our existing assets — by ramping up our nation’s gas-powered electricity generators and ramping down our coal-fired generators.

Read more about how we can shift our electricity production away from a dirty resource to a clean one.

According to RED chairman Tom Casten, “Recycling waste heat from manufacturing facilities could do more to fight global warming than taking every passenger car in America off the road, and it reduces energy costs.”

The video series was created to show manufacturers and policymakers how they can reduce energy costs, slash greenhouse gases, and create jobs — all at the same time.

1. 50% of U.S. power generation (in MWh) comes from coal, while only 20% comes from natural gas.
2. 32% of total U.S. power generation capacity (in MW) is coal-fired, while 42% is gas-fired.

When it runs, the natural gas fleet emits just 50% of the CO2 of the coal fleet, which raises a rather interesting question: what would we have to do to make it run harder? And how big a difference would that make in our national CO2 footprint?

MW vs. MWh

So why, if we have more natural gas generation capacity, do we get more of our power from coal?

Simple: we have a lot of gas-fired generation (449 GW, as of 2007), it doesn’t run very often. The coal fleet is comparatively smaller (336 GW), but runs a lot more frequently. It is as if our vehicle fleet were dominated by Priuses, but they stayed parked while we drove our Escalades to work.

We have a huge resource that is already built that could massively lower CO2 emissions. Taking a page from the NRA, what if the problem isn’t that we need to build more low-carbon generation, but that we just need to make better use of what we have?

Environmental potential

To understand the opportunity, let’s look at a bit of simple math.

In 2006, the gas fleet generated 816,441,000 MWh, or 20% of what it could have produced if it had run 24/7/365.

The coal fleet, by contrast, generated 1,990,551,000 MWh, or 68% of what it could have generated if it had run 24/7/365.

If we never built another gas-fired power plant, but simply increased the annual capacity factor of the gas fleet up to the coal fleet’s 68% capacity factor, it would generate an additional 1,845,485,000 MWh, effectively displacing 93% of our coal fleet without the construction of a single new power plant.

Looking at the comparative CO2-signatures of those two fleets, that would reduce total power sector CO2 emissions by 37%. Since the power sector is responsible for 42% of U.S. CO2 emissions, that implies a 16% reduction in total U.S. CO2 emissions, just from changing generator dispatch order.

That’s a massive opportunity. What would it take to get there?

Economic considerations

There is an obvious limitation to the Prius/Escalade analogy: it’s cheaper to drive a Prius per mile, but it’s more expensive to generate a MWh of power from a gas plant than a coal plant. That, after all, is why the gas fleet doesn’t run as often.

But historic dispatch choices were made in a world in which the costs of CO2 pollution were not monetized. So the real question becomes: how big a CO2 price would be required to change dispatch order?

Intriguingly, while the environmental potential is huge, the economic cost to realize that potential turns out to be quite small.

The great economic disadvantage of gas-fired generation relative to coal is that gas is more expensive per unit of energy. The great economic advantage of gas-fired generation relative to coal is that it is more fuel efficient: while the U.S. coal fleet has an average generation efficiency of about 27%, the gas fleet has an average efficiency of about 38%.

The gas fleet also tends to have much lower non-fuel operating costs (less $ for fuel handling, fewer moving parts, etc.). Taking these factors into consideration—and assuming $2.50/MMBtu coal vs. $6/MMBtu natural gas—the variable costs (e.g., exclusive of capital recovery) of a coal plant are about $18/MWh lower than a gas plant (1.8 cents/kWh). Obviously, that is very sensitive to fuel price assumptions, but this range is hardly unreasonable for current markets.

But remember, the gas fleet has a much lower CO2 signature than the coal fleet. On a fleet average basis, every MWh shifted from coal to gas reduces CO2 emissions by 0.56 tons. So if we look at a $18/MWh cost differential to achieve 0.56 tons/MWh of CO2 reduction, that implies a (18/.56) = $32/ton CO2 price would be sufficient to tip the scales. That’s not insignificant—but not implausible either. And—here’s the key point—massively less than what any reasonable person might think it would take to shutter most of the coal industry.

Finally, note that this doesn’t require a carbon price of $32/ton to happen; it simply requires a net change in the relative costs of coal and gas-fired generation equal to $32/ton. You could get there by giving the gas guys nothing and hitting the coal plants with a $32 fine, but you could also get there by giving the gas guys $10 and hitting the coal guys with a $22 fine. A functioning cap-and-trade with bilateral rights will allow some sort of transaction between those two parties and—without speculating on those specific rules—one can assert with confidence that a $32 delta between coal and gas does not need anyone to buy or sell carbon credits at a $32/ton price.

Practical constraints

To be sure, we’re never going to shut down 93% of the coal fleet just by running gas harder. There are parts of the grid (like West Virginia) so devoid of gas assets that there’s no way to maintain voltage stability if you rely on far-away gas. And of course, there is the supply and demand issue (booming gas demand + slumping coal demand is almost certainly incompatible with $6 gas and $2.50 coal).

On the other hand, the gas fleet is hardly capped out at 68% capacity factor. Moreover, if we started the switch, we’d start by running the most efficient gas plants harder and the least efficient coal plants less so the first 20% is much cheaper, per ton of CO2 reduction, than the last 20%.

Of course this isn’t a panacea. You can’t get to the end game only with gas any more than you can get to the end game only with solar. It’ll take a lot of steps. But what’s fascinating about this analysis is that the gas fleet is uniquely able to quickly and—at least initially—quite cheaply make a huge dent in our CO2 emissions. It’s a tool we ought to use, and we ought to examine our proposed CO2 regulations carefully to make sure it gets put to use. Free allowances to coal plants don’t get you there …

Note: This first appeared on Grist.

E&E Daily reports ($ub. req’d) today on efforts in the House to try and determine how to minimize the economic pain of CO2 pricing.

They note:

Government studies conclude that for a new U.S. climate law to work, it must stem the demand for carbon-based energy by increasing prices — not exactly the most politically popular thing to do during an economic crisis that is being compared to the Great Depression.

All the logical failing of our CO2 policy discussion is nested in this paragraph.

For climate law to work, it must put a price on CO2 emissions. But there is no logical reason why that must imply an increase in energy costs, for the simple reason that energy is not CO2.

A price on CO2 emissions, done right, will facilitate a wealth transfer away from CO2-intensive forms of energy, but to assume that this must lead to higher energy costs is to assume that low costs and high carbon go hand in hand. And no matter how many hearings we hold and policies we develop that implicitly or explicitly make this linkage, it ain’t there. Coal is freakin’ expensive. Efficiency is cheap. Even solar PV is cheap if you ignore the capital costs (just like coal!).

The idea that charging for CO2 will increase energy costs makes as much sense as assuming that charging for mercury will increase tuna costs.

This persistent idea is both inane and dangerous. Inane because it’s wrong. Dangerous because it leads to one of two places:

1. Do nothing. For the last decade, we’ve spent so much time talking about the bogeyman under our bed that we’ve actually come to believe it. And so we stay in bed, per legislative mandate.
2. Do something economically dangerous. As I’ve noted before, this framing biases us towards economically disastrous CO2 policies, effectively giving us what we fear.

In other words, we have the power to make that economic bogeyman real. It is entirely within our power to pass economically disastrous CO2 policies that will drive up the cost of energy. But that is a policy failure, and in no way innate to good climate policy.

We need to send a clear message to D.C.: Grow up. Get over your bogeyman fears. We can’t afford to wait for you any longer.

Note: This first appeared on Grist.

We are rapidly approaching national greenhouse gas legislation, either through a congressionally-led cap-and-trade bill or an EPA-led amendment to the Clean Air Act. However passed, these regulations will then immediately face a practical problem: how do you enforce a law that is in conflict with itself?

This problem arises because of the Clean Air Act’s core failing: It compels businesses to increase their CO2 emissions. The moment we compel businesses to reduce those same emissions is the moment we expose this flaw and invite waves of litigation that will not only delay the implementation of CO2 policy, but also invite compromise and negotiation that will likely be forced to sacrifice some of the Act’s environmental intent. How on earth did we get here? And what are we to do about it?

The clean air act mandates greenhouse gas pollution

Broadly characterized, the Clean Air Act does three things:

1. It sets limits on the concentration of regulated pollutants at regulated point sources;
2. It steadily tightens those limits over time, and;
3. It requires any new pollution sources to meet the most current (stringent) pollution standards.

By any measure, the act has done a commendable job of reducing non-CO2 air pollution. But it has unwittingly increased CO2 pollution as well.

The first reason is the political tension in the act’s structure, which led to the concept of “grandfathering.” In essence, grandfathering says that if you get an air permit, you can always operate under that permit, regardless of future environmental rules. Many of us have direct experience with this concept in practice: when cars were forced to no longer burn leaded gasoline, we didn’t have to scrap our old Dodge Darts and buy new cars; we simply had to come into compliance once we bought a new car. Similarly, a coal plant permitted to release 200 parts-per-million of nitrogen oxide pollution can emit at those levels in perpetuity, even though new plants must comply with standards that are 10-times more stringent.

Seen from the perspective of the polluter, this makes a lot of sense. It would be hard to contemplate buying a car if you might be forced to buy a new one a year later because of tightening environmental regulations. However, for power plants and industrial facilities that generate pollution as a byproduct of selling a product (power, steel, etc.) grandfathering serves to give a decided economic advantage to the dirtiest and oldest sources, since they compete in a market that is set by the costs of pollution controls which they do not have to bear.

The perverse result is that rules designed to clean the air provide direct economic incentives to the dirtiest sources. Recognizing this potential, the Act has a built in trap-door in the form of “New Source Review.” NSR says, in essence, that your permit is revoked the moment you do a “major modification.” This line is not nearly as sharp as one might hope, but it has generally been interpreted to mean that while regular maintenance won’t jeopardize your permit, plant upgrades will.

That sounds reasonable, except for this awkward fact: the cheapest and most environmentally beneficial way to increase plant capacity is to increase fuel efficiency. Generate more power with the same amount of fuel combustion and associated pollution and the world is a better place, right? Wrong. Because that upgrade would constitute a major modification, revoking your air permit and taking away the economic advantage that your old, dirty plant has. The result is that our electric and industrial sector has, since the passage of the Clean Air Act, been incentivized to keep old, dirty facilities running rather than build new, clean ones. In the transportation sector, this largely hasn’t mattered: Dodge Darts weren’t built to last. But for the rest of the economy, we are intentionally driving 12-mpg, 1960s-vintage power plants, furnaces, and boilers, spewing needlessly high levels of CO2 into the atmosphere.

There are laws in process that would fix some parts of these problems and cause some of the dirtiest of the grandfathered coal facilities to be shut down. But even if the problems innate to grandfathering were fixed, the Act would still mandate increased CO2 emissions. This reason is mathematical.

Suppose you want your kids to eat healthier. Which is the more effective approach? (a) Tell them they can only have one scoop of ice cream with dinner, or; (b) Tell them their meal cannot exceed 10 percent ice cream?

Option A clearly limits their ice cream consumption. Option B most likely leads to fat kids, who quickly figure out that if they can scarf down a few more bites of spaghetti, they’ll get a pro rata increase in their ice cream allowance. The Clean Air Act takes the fat kid approach.

The overwhelming majority of the exhaust gas in a stack is CO2 and combustion air. Both of these are a direct function of the volume of fuel burned. The Clean Air Act sets pollution limits not based on total pollution release, but based on the concentration of pollutants in the stack exhaust. The perverse result is that if you increase the efficiency of your combustion process — e.g., you burn less fuel — you will very likely violate your air permit, even if your actual air pollution is unchanged. Thus, like the kid who tempers his desire to eat less pasta with the pain of less ice cream, our power plants and industrials are forced to temper their desire to save money on fuel purchases with the pain of losing their operating permit. The result is massive, needlessly inefficient combustion of fossil fuels, raising the cost and pollution of US goods and services.

To date, this has been an egregious environmental failure, but it is about to become a legal issue as well. Stealing from Peter to pay Paul may be short-sighted, but only presents a legal problem at the point when both Peter and Paul have equal rights under the law. The moment CO2 becomes a regulated pollutant is the moment when Peter files his first lawsuit.

The easy fix

The solution is surprisingly simple. We ought not compromise our environmental principles — we simply need to fix the math. But EPA needs to make the fix now, before CO2 regulation is passed, when the changes can be made administratively, and on the the agency’s terms. If we instead wait until the inevitable litigation starts, those changes will be directed by the courts, the Congress, and any number of self-interested parties — not all of which will have the long-term health of the environment in mind.

Fixing the math requires only that we shift existing pollution standards to an output-basis. (Note that this need not initially address CO2 — but it must address currently-regulated pollutants to avoid conflict.) Replace parts-per-million permits with parts-per-kilowatt-hour permits (or parts-per-Btu, in the case of many industrial processes. As is often the case, the states have led the way in this effort (See here [PPT] for an overview of Connecticut’s efforts, to pick just one example.) Moreover, the EPA already has a deep internal understanding of the issue and how to best implement.

This simple change would immediately convert energy efficiency from a permit-killer to a pollution control device on its own merits. Perhaps more significantly, it immediately would allow businesses to profitably meet their environmental requirements (after all, burning less fuel saves money). A world facing economic and environmental challenges inevitably asks which of those goals must be sacrificed in the name of the other. Output-based standards is that rare policy tool that succeeds on both fronts. But the moment for reform is now, before litigation forces us down a path that is only indirectly shaped by the broader public interest.

Note: This first appeared on Grist.

Kevin Drum over at Mother Jones blogged on my recent Grist post, joining my mom in the list of people who publicly praise my math skills. Thanks!

Much more interestingly, he raises this question:

Are we willing to charge [a price for CO2 emissions] openly, with the carbon charges going to the public, [or] inside a complex giveaway to a favored corporation?

(The question is in response to my estimate here that the recently passed Illinois Clean Coal Portfolio Standards Act represents an implicit $300-$500-per-ton payment in the name of CO2 reduction.)

It’s a great question because the truth is that under current federal and state policy, we do pay people for their actions to reduce CO2. But we do so in a horribly inconsistent way, providing not only inconsistency between technologies and “favored corporations,” but also wild disparities in price.

For instance, suppose you’re getting $0.03 per kWh from your state renewable portfolio standard. Those kWh displace — on average — 1,300 lb per MWh of U.S. power, and you are therefore being paid $46 per ton of CO2 you reduce. CO2 reduction is not the only justification for RPS policies, but would we ever have an RPS if we didn’t care about CO2? I doubt it.

The good news there is that people are, today, being paid in the U.S. for reducing CO2. But is there any rhyme or reason to their price? And is it at all consistent with what others are getting for the same environmental service?

More math below the fold.

1. Wind, geothermal, and closed-loop biomass are eligible for a $0.021 per kWh production tax credit. That works out to $32 per ton of CO2 reduction.
2. Open-loop biomass, landfill gas, municipal solid waste, and qualifying hydro are eligible for $0.01 per kWh production tax credits. That works out to $15 per ton of CO2 reduction.
3. The investment tax credit for solar PV at 30 percent of project capital costs works out to $253 per ton of CO2 reduction. (I assume $8,000 per kW, a 20 percent capacity factor, and a 12 percent annual cost of capital.)
4. The investment tax credit for fuel cells is also 30 percent. If we assume a typical fuel cell is $6,000 per kW, natural gas-fueled, and 45 percent efficient with a 60 percent annual capacity factor, that’s a $262-per-ton credit for CO2 reduction.
5. Nuclear plant loan guarantees have a massive impact on the ability of those plants to finance themselves. If I make the conservative assumption that this federal backstop to 80 percent of the capital costs of the plant lowers the borrowing costs of those plants by 10 percent (e.g., money they can borrow at 12 percent interest would have cost them 22 percent without the loan guarantee), that program alone is paying them $165 per ton of CO2 reduction. (This value may well be infinite, because it’s not clear to me that anyone would loan money at any price to a nuclear plant developer without those loan guarantees.)
6. The ethanol blender’s credit at $0.51 per gallon yields a net well-to-wheels CO2 advantage relative to gasoline of about 20 percent. At that level, this works out to a $52-per-ton payment for their CO2 reduction.

One can quibble with an assumption here or there, but here’s the larger point: The absence of a coherent policy on CO2 emissions has not stopped well-meaning legislators from crafting incentives that encourage actions to lower CO2 emissions. But those actions are wildly incoherent, providing radically different incentives to different technologies for no obvious reason.

This suggests the following:

First, it is a certainty that we are not making rational investments in response to the climate challenges we face. OK, that’s no great insight, but it does bear keeping in mind as we think about future CO2 policies. When two otherwise environmentally-identical technologies are subject to ten-fold differences in their public subsides, markets will allocate capital in ways that have nothing to do with fundamental value (economic, environmental, or otherwise).

This raises the question: What might a world look like that did provide a consistent policy signal on CO2? One, we would deploy a host of technologies that are cheaper and more diverse than those we currently deploy in the name of CO2 reduction. Two, we would deploy a host of technologies that cannot possibly be contemplated by those who’s knowledge of possibilities is limited to those possibilities we are currently deploying. In other words, all of us.

Taken in combination, this means that a consistent and coherent plan to reduce CO2 emissions will be cheaper and engender a more diverse suite of technologies, companies, and solutions than we can possibly contemplate based on current experience. All we have to do is start.

Note: Here and throughout, I have insisted, erroneously, on using 2,000 lb tons rather than the metric 1,000 kg tonnes in which CO2 prices are commonly denoted. Adjust the math if you like, but it doesn’t affect my larger point about the massive variability in CO2 pricing.

Note: This first appeared on Grist.

It’s worth reviewing this great presentation from the folks at @Ventures.

If they’re right — as I believe they are — we are soon going to see lots of greentech venture capital funds lose money. Given the potential for that loss to be skewed as “green technologies aren’t profitable” rather than “greentech VCs don’t have their models right,” and for politics and business to respond to the conventional wisdom rather than the facts on the ground … you see where I’m going.

What I particularly like about the presentation is that it articulates concerns those of us in the space have had for a while, but does so from the view of the investor rather than the investee. Click the link to see their vantage point. In the meantime, my theories are below the fold.

The late ’90s saw an explosion in venture capital firms that specialized in tech investments, primarily IT and biotech. (Indeed, if you’ve read The New New Thing, you’ll recall that IT investors very quickly transitioned into healthcare investors, with very little rigor connecting those two industries. Many of those same firms are now in the energy space.)

Broadly speaking, those investors made a lot of money — which means that they had to find a new place to invest. Along came greentech, which was never clearly defined, but seemed awfully sexy, needed cash, and had the potential to be massively socially transformative. (In the VC world, green tech is a big bucket, ranging from hydrogen to ethanol to fuel cells to demand-side management.)

Superficially, greentech looked a lot like things the VC world had proven itself good at. But — to misquote Rick James — hubris is a hell of a drug. And the skills it takes to find value in IT and biotech are different than those necessary in the greentech space. Specifically:

1. IT and biotech are largely technology plays. Find the company with the strongest patent position and then worry about business model.
2. IT and biotech are, to a significant degree, about market saturation. Build the company so that they have 70 percent of the market space (be it the market for e-books or the market for type-1 diabetes drugs), and then worry about the business model.
3. IT — and to a much lesser degree, biotech — is only minimally dependent upon regulation. (Indeed, for every IT firm nervous their model won’t succeed unless the anti-trust regulators damp down Microsoft’s ambitions, there are probably 10 counting on Microsoft to leverage their dominance to buy them out once they succeed.)
4. Finally, neither IT nor biotech depend to any significant degree on unrelated infrastructure investments.

Now compare these to greentech:

1. Green technologies compete in one way or another against a massively regulated and subsidized energy sector. On the one hand, this means that if your management team doesn’t have the savvy to negotiate those regulations, you won’t make any money. On the other hand, it means that there are a ton of profitable technologies out there that haven’t been deployed because of the subsidies to status quo industries. This is a sector who’s success is based not on the development of new technologies, but on the reform of old laws.
2. Green technologies are all, ultimately, about selling commodities (electricity, fuel, etc.). The guy who sells 1 percent of the electricity in a given market has no particular pricing advantage against the guy who sells 10 percent. And the market is so enormous that it’s not possible to get the 50+ percent market shares targeted in the IT space. This means you need a totally different ramp strategy.
3. Many green technologies are highly dependent on massive infrastructure changes. Want to make money in wind? Better hope someone drops a couple billion dollars on transmission lines. Want to get into the hydrogen business? Better hope we build a network of hydrogen fueling stations and hydrogen cars. The cost and time required to make these changes are massive, and these infrastructure investments have no direct parallels in the IT and biotech spaces.

My predictions

So where does this leave us? As the @Ventures presentation makes clear, an awful lot of VC firms look like they’re getting squeezed as they’re forced to take bigger and bigger bets on earlier and earlier stage technologies. (The slide of theirs I find particularly compelling is the one that shows VC money overwhelming concentrated amongst the highest-cost approaches to GHG reduction.) It’s hard to see this having a happy ending for the VC firms in the space.

Many are going to lose money. Some will conclude that greentech simply doesn’t pencil. Others will conclude they need to apply a different investing model if they want to succeed in this space.

Once that happens, we will see a reallocation of capital into technologies and business models that are no less green, but much more profitable. In the meantime, expect much sound and fury signifying nothing more than a bad investment model. But I guarantee it won’t be reported that way.

Note: This first appeared on Grist.

A few observations as to what we can expect from the incoming administration: What they ultimately get done may be a function of what they do first.

First off, our economic downturn is going to be long and deep. The headlines about over-leveraged companies going bust or paying down massive amounts of debt essentially mean that there is a lot of money that will not be invested in the U.S. next year. And by “a lot,” think trillions of dollars. This may be conservative, but in all cases the investment loss is in excess of the $700 billion bailout being provided by the feds.

I have no ability to say how long nor how deep, but money not invested into the economy = factories not built = capital equipment purchases not made = people not hired to service, deliver, and build stuff (green or otherwise). Some recessions driven by temporary external factors, like 9/11, or single-sector bubbles, like the dot-com collapse, are shallow. Recessions driven by a seize up in the financial markets have a habit of being pretty deep.

Why does this matter to the environmental agenda?

The Obama camp has made it clear that energy and environment will be a priority when they get into office. That’s great news.

That said, it’s probably also safe to consider that there will be a massive backlash against Congress in 2010. Let’s hope I’m wrong about the severity of the economic meltdown. But if I’m not, then we’re going to have lots of angry, comparatively impoverished, and jobless voters come November 2009, with a throw-the-bums-out plan in the voting booth. I’m willing to guess that next year’s Karl Rove is already putting strategies together with that math in mind. So let’s assume significant Republican gains in 2010. That essentially means that the big, meaty issues that can only be accomplished so long as Obama has majority control of congress will have to be done quickly. So what are the priorities going to be?

What comes first?

It seems to me that on the energy/environment front, there are three key political issues: GHG policy, Clean Air Act reform, and a national RPS. Those may or may not be the most important long-term issues, but they all have natural constituencies, political inertia, and existing legislative language that on standby waiting for the next administration. Add those up, and my guess is that those issues become the cornerstones of a “what big stuff can we get done quickly” plan.

What’s interesting is that whichever one you start with tends to interfere with one’s ability/scope for addressing the rest. To wit:

1. GHG policy. I’m being very broad here. Maybe it’s a cap-and-trade, maybe it’s a tax, maybe it’s something else. But in any event, there’s a clear mandate to (finally!) do something. So let’s stipulate that something is done. That immediately creates a quandary for the other two issues. An RPS then becomes a tad redundant and raises a host of double-counting questions. Should a solar panel be eligible for carbon offset credits and renewable energy certificates? Should carbon prices have any market relationship to renewable energy certificates? Who shall administer? I’ve heard some in Washington oppose a national RPS on environmental grounds, arguing that an RPS is simply a sloppy way to do carbon. That argument is not without it’s merits, but without taking any sides, it’s clear that the push for a national RPS loses much strength if we already have a GHG policy in place.
2. Clean Air Act overhaul. New Source Review is busted. Massachusetts v. EPA provides a clear path to amend the CAA to include CO2. Historically, politicians have been reluctant to open up the CAA since there is no guarantee that the forces of darkness don’t find a way inside the tent. That said, there does seem to be a growing consensus that something needs to be done. So let’s now assume that this is done first. That immediately makes CO2 a pollutant as regulated by the executive branch, removing Congress’ ability to pass a bill of their own. That might be good, but it probably supplants GHG policy, at least of anywhere near the scale contemplated by Lieberman-Warner. Does it then also remove the impetus for an RPS, for the reasons outlined above?
3. National RPS. The Dems seem to think that they may finally have the votes for a national RPS. As I noted here, I’m not so sure, as the pros/cons tend to split more along geographic than party lines. But let’s assume we get one passed anyway. What does that then do to GHG policy and CAA overhaul? Given some of the goofy ways that some states have chosen to define renewability (see Conn, re: Natural gas fuel cells), it is not entirely implausible that a technology could simultaneously be incentivized under an RPS and penalized under a GHG policy. What about biomass? The PTC rules are weird enough as it is when biomass cofired with coal is not eligible, but biomass commingled with coal is eligible. Might the same confusion come to affect an RPS, with ramifications for New Source Review?

I don’t claim to have any answers, but it seems to me that there is an innate political and legal conflict between each of these activities, if taken to their logical extreme. And so I come again to my question: which do you do first?

My hope

Economically, I like the simplicity and purity of an RPS and fear the complexity and unintended consequences innate to GHG policy (at least in every jurisdiction to date that has tried to do it.) On the other hand, I’m idealistic enough to be concerned about any system that provides a higher value for CO2 reductions in some applications than others. Existing GHG policies have been far from perfect on this front, but they at least start from the premise that all CO2 shall be taxed/capped/priced equally, while an RPS is founded on the premise that some CO2 reductions are more worthy of incentive than others.

Ultimately though, I think the larger issue is legal. So long as the current Clean Air Act remains unchanged, there is a massive legal liability awaiting anyone with the temerity to pass GHG-reducing legislation. Namely, anything one is presently mandated to do under the CAA to reduce criteria pollution causes a demonstrable increase in CO2 emissions by lowering overall fuel efficiency. It is a near-certainty that lawsuits will be filed if companies are federally-compelled raise their CO2 emissions and then federally mandated to pay a penalty for same.

Given this, it would appear that you have to start with CAA overhaul. Use Mass. v. EPA as a motivation to add CO2 to the list of regulated pollutants. Shift the regulatory metric for all regulated pollutants to an output-basis, so that CO2 increases need no longer be a mandated consequence of NOx reduction. One can then separately (and sequentially) decide whether all regulated pollutants ought to be reduced via mandate or economics. I prefer the latter, but this approach at least separates the need to regulate CO2 from the methodology by which it is regulated.

Taking this tack would piss off Congress, who would suddenly lose the ability to regulate CO2 on their own. It would also put a national RPS in jeopardy. But the alternatives all seem worse.

Note: This first appeared on Grist.

With apologies to Little Milton.

Good news: With the incoming Obama administration, we are finally going to get some sort of a greenhouse gas (GHG) bill.

Bad news: We are still having an inane, economically uninformed conversation about GHG policy.

Many of the ideas that pass for Serious GHG Policy are silly, not because they aren’t serious but because they are based on economic theories that are as widely believed as they are at odds with the way all of us (economists included) actually behave.

The crux of the problem lies in the fact that policymakers, economists, and, yeah, some bloggers completely misunderstand the link between costs and prices.

There are a host of GHG models based on upstream carbon pricing, wherein GHG emissions are priced not at the point of GHG release (i.e., where the fire is), but at the point of fuel purchase. This was innate to Lieberman-Warner and is still found in many current cap & somethin’ and carbon tax proposals. The theory is that if you put a cost somewhere in the upstream end of the system, it will cascade downstream to affect point-of-use decisions. The idea is nonsense, worthy of Wolfgang Pauli’s famous put-down: it’s so bad it’s “not even wrong.”

The crazy thing is that outside of idle economic theorizing, no one really believes the idea. When gasoline prices go up, do you expect trucking companies profits to stay the same? When health insurance costs rise, does your boss give you a raise so that your take home pay will be unaffected? When your local phone company outsources directory assistance to some dude in Bangladesh, do their rates fall to reflect their lower cost structure?

Of course not. Yet we assume that if we put a price on carbon at the point of fuel purchase, it will diffuse perfectly through the system, affecting everyone downstream who burns fuel and release GHGs. It won’t. And to the degree that it doesn’t, an upstream GHG price is an economically flawed GHG price, disproportionately shifting the burden of GHG abatement away from those actually releasing GHGs into the atmosphere — and, therefore, failing to provide an effective incentive to reduce GHG emissions.

Obvious as it may be, it bears noting that companies set prices based on a wide number of variables, only one of which is cost:

1. Some customers are more profitable than others, reflecting the reality that it is easier to pass costs along to some customers than others. For example, fuel providers commonly make more profit on small businesses than large businesses, because the small guys have a harder time changing suppliers. Should those fuel providers have to pay carbon taxes on their fuel, they may well decide to “stick it to the little guys,” leaving the biggest users agnostic on GHG emissions.
2. While economics tends to assume that all prices are variable (e.g., $X per widget), many pricing schemes have much more complicated structures, with set-up fees, membership fees, and use fees all combining to (intentionally) hide the full cost of service and make the decision to incrementally use a product appear relatively cheap. (Think of your gym, or your ATM.) In the energy sector, many gas and electric rates have a fixed monthly fee for the contract plus a low variable cost for use. If the cost of upstream GHG emissions is borne in the fixed cost, it will have no more effect on the decision to reduce fossil fuel use than your gym’s initiation fee does on your decision to work out tomorrow.
3. In many cases, much or all of the impact of a change in cost is not borne at all by a company’s customers, but by their owners. When oil prices fall, refinery profits tend to rise, as falling costs boost their profitability. Conversely, when fuel costs rise, airline profits tend to fall, for the opposite reason. It is quite reasonable to assume that a world with upstream GHG pricing will lead to lower profits for fossil fuel producers and distributors (many in the environmental community would very much like to see this). But if it does, that necessarily means that fossil fuel users are not seeing the full price signal. Corporate profits would fall, but day-to-day emission-causing behavior would not change.

None of this is complicated. But it is far too frequently glossed over with grossly simplistic economic theory utterly at odds with the reality of price-setting. And to the extent we base GHG policy on these flawed theories, there is a very real danger that we will craft a GHG policy that won’t work. The stakes are too high to get this wrong.

Note: This first appeared on Grist.

A great frustration for those who (a) really care about reducing CO2, and (b) believe in the power of well-structured market mechanisms is that the current discussion around carbon policy has bastardized the language of environmental economics. There are tremendous economic and environmental benefits to be gained by a true cap-and-trade CO2 system. Unfortunately, all the plans that are currently being bandied about as cap-and-trade structures are really carbon taxes.

To understand why, we need to review a couple basic environmental economic concepts. There are essentially three ways that government can induce environmentally responsible behavior: mandates, taxes, and tradeable permits.

Mandates

The best example of a mandate is the Clean Air Act, and since we first started crafting environmental regulation, this has been the dominant approach. Thou shalt unlead thy gasoline. Thou shalt install a baghouse. Thou shalt comply with Best Available Control Technologies. In all cases, these are top-down, proscriptive approaches that mandate technologies and/or pollution limits. Their great advantage is that their environmental impacts can be known with some degree of certainty. (e.g., if you mandate a phase-out of leaded gasoline in five years, you can be certain that there will be no more lead emissions from tailpipes five years hence.) The disadvantage of these approaches are two-fold:

1. They are economically ignorant. If the mandate does not direct the lowest-cost pollution control solution, the lowest-cost pollution control solution will not be deployed.
2. They are strictly pass-fail, and encourage a nation of D students, environmentally speaking. If a mandate compels my factory to achieve no more than 10 ppm NOx emissions as a prerequisite of operation, I’ll make sure I can achieve 9.9 ppm NOx; but since there’s no incentive to make deeper cuts, I won’t reduce any further. This adds to the economic problem with mandates, since it does not differentiate between the individual who can make deep cuts cheaply and the one who faces huge costs for shallow cuts — and in so doing, fails to maximize pollution reduction.

Pollution taxes

A better tool is a tax. Such models simply price the externality, so that one can still pollute, but only at a price. Relative to mandates, their great disadvantage is that they do not lead to certain reductions. I can mandate the elimination of leaded gasoline and know that leaded gasoline will go away, but if I instead place an added tax on leaded gasoline, I cannot be certain that the tax will be sufficiently high to eliminate its use.

On the other hand, pollution taxes do solve the two problems with mandates. By placing a fixed and known price on pollution, markets are encouraged to use the lowest-cost means of pollution control to minimize their net pollution payment. Moreover, since the tax is paid per unit of pollution emitted, deeper pollution reductions afford greater economic savings. On balance, this gives pollution taxes (in my opinion, at least) a net benefit against mandates. But they still have a couple glaring weaknesses:

1. Most obviously, they include the word “tax,” which is often a political non-starter.
2. They are sticks without carrots. Like income taxes, they constitute a great source of government revenue and, on the margin, do compel markets to factor the price of pollution into their math, but they don’t provide any more direct incentive to invest in pollution reducing technology than an income tax provides an incentive to quit your job.
3. As noted above, they do not guarantee pollution reductions.
4. Finally, they are politically uncertain. Governments are always tempted to fiddle with tax policy, but are unable to fiddle with existing contracts. A factory that installs a scrubber to comply with sulfur pollution regulations will cry foul (and have ample legal protection) if the regulator comes back and tries to rescind their permit five years hence. On the other hand, if sulfur emissions are taxed at$20/ton and government decides to lower or raise the tax five years hence, the same factory cannot readily complain that they invested in their scrubber in anticipation of a permanent tax regime. As a result, it is considerably harder to deploy capital in response to a pollution tax than in other, contractual approaches.

Tradeable permits

In theory, tradeable permits are the ne plus ultra of pollution regulation, correcting all the failures of the above mechanisms. The model is that the government sets an allowed level of overall pollution (thereby ensuring that future pollution levels are known) and then allows pollution sources and sinks to trade among themselves for the rights to emit their pollution levels within that cap. Government’s role is to set the cap and ensure that sufficient measurement and verification is in place between pollution buyers and sellers, but not to stipulate technologies nor price.

These models ensure that markets are always pursuing the lowest-cost pollution-reduction measures, while still ensuring that pollution is reduced to environmentally acceptable levels. The political consequences of a tax are avoided and sticks are perfectly balanced with carrots (since every buyer is matched to a seller at the same price per unit of pollution).

Applying to modern GHG policy

This didactic review is necessary because if you only read the headlines, you might be tempted to conclude that current GHG policy is actually based on the idea of tradeable permits. After all, we talked about carbon taxes and decided we’d do cap-and-trade instead. Since the phrase “cap-and-trade” includes the words “cap” and “trade,” it must include both, right?

Sadly, no.

Every GHG policy out there today — from RGGI to Kyoto — is really a tax masquerading as a cap-and-trade. Notice why:

1. A pollution tax requires polluters to pay money to a regulatory body, who then distributes the proceeds as they see fit. A tradeable permit approach is based on bilateral trading of pollution credits without any government intermediary. Every existing GHG policy has a government intermediary and is therefore structured as a tax rather than a tradeable permit.
2. A tradeable permit model provides an incentive to reduce pollution that is exactly the same as the cost it stipulates for those who choose to pollute. If you want to release 50 units of pollution and I want to reduce pollution by 50 units and I agree to sell you my reduction for $200, you’ve paid $4/unit and I have been paid $4/unit. By contrast, a pollution tax places a cost on pollution, but the only benefit that accrues to those who are reducing pollution is the avoidance of a tax. Which, as noted above, is the same benefit that accrues to those who don’t have any income. All of our current GHG policies are structured more like taxes than tradeable permits since regulatory agencies use the proceeds of their GHG auctions to provide a variety of social goods, not all of which lead to GHG reductions; ergo, less than 100 percent of the proceeds go to GHG reduction, and the value of reduction is less than the cost of pollution.

If the issue were merely semantic, this wouldn’t be worth making a big deal about, but the problems with carbon taxes are real, and they don’t go away simply because we choose to relabel a tax as a tradeable permit. As we go into the next political season and get serious about GHG policy, let’s hope that we don’t lose sight of these realities.

Note: This first appeared on Grist.