The quest to reduce carbon emissions is plagued by a near-pathological case of economic illiteracy.
This illiteracy has caused us to focus on the wrong problems, and the wrong solutions ... and it's stalled the realization of any politically tenable carbon reductions.
Ironically, while the goal of reducing carbon emissions has political allies and adversaries, the economic illiteracy is found on both sides. It has become self-reinforcing. The only solace is that the economists are just as guilty.
Let me first make a few points clear. We must reduce carbon emissions. The comment above in no way suggests that the costs of continued carbon release are even remotely comparable to the (comparatively minor) costs being floated for carbon reduction.
The problem is that the entire debate starts from the presupposition that carbon reduction will cost money. So long as this presupposition exists, we will talk about the wrong issue. The presupposition is not only wrong, but dangerous.
We didn't sign Kyoto because we determined that we couldn't politically afford the reduction. Mr. Dingell is now floating the idea of a carbon tax, seemingly to test out whether the public is willing to pay for carbon reduction. (One wishes we had a giant Mastermind board with black & white pegs to at least give a few hints: "right answer, wrong question.")
Meanwhile, carbon keeps getting emitted, with no politically acceptable solution, because we keep getting sidetracked by economically dubious assumptions. But we in the environmental community must realize that we are part of the problem. Consistently saying that we have to pay to reduce carbon (or the inverse, that we can't afford not to reduce carbon) may be morally appealing, but it is politically -- and environmentally -- toxic, because it reinforces precisely those beliefs that are preventing us from implementing laws that would actually start to reduce carbon emissions.
Allow me to explain in more detail:
The universe of economic modeling that shapes policy is based on the flawed assumption of "full employment." Skip Laitner of EPA (a man worth Googling) is a lone voice crying out against this problem, but let me try to briefly explain. Economic modeling has always been a guess masquerading as science. I can't tell you what I'm going to spend money on tomorrow, and certainly can't be relied on to tell you what the whole nation is going to buy next year. The rub, which causes all economic forecasts to be dubious, is that the models are valid only so long as you can use can assume so-called "full employment." This is not a measure of people at work, but rather the collective use of all resources (capital equipment, people, dollars, etc.), and it can be summed up as "we have a market economy and markets are efficient. Ergo, all present expenses and investments are optimally deployed." With this assumption made, one must conclude that any deviation from our present ideal state is an economic negative, and we need not do anything more than figure out how much any given change will cost (there can't be a benefit associated with said change, because we're already perfect). A half-second's thought points out the fallacy of this logic (and indeed, many Nobel prizes have been given out to people like Solow, Kahneman, and Tversky, who put that half-second's thought in). But the underlying assumption still shapes economic policy making.
To see how this plays out, consider a recent effort to create an investment tax credit for various energy efficiency investment. Congress goes through a process of "scoring" to determine the fiscal impact of the policy and comes up with various costs to the taxpayer of said change -- but never makes any assumption about economic gains from greater efficiency -- because, per full-employment assumptions, such opportunities do not exist. When it comes time for Congress to decide whether to implement the bill, they look at this (incorrect) fiscal score, compare it to other incorrect fiscal scores, and make policy. Grossly incorrect, but it starts from the presumption of full employment.
While we cannot change these assumptions, we can at least adjust our positions to play into the weaknesses of the approach.
Let's look at how we might do so for carbon. When we frame the debate as a carbon tax, cap-and-trade system, or other such mechanism, we frame the political options in an economics vs. environment construct, and we are bound to lose politically. Thus, the only real debate we've had about carbon reduction is of the "can we afford it" type, which is both interesting and irrelevant. As long as that's all we talk about, the one certainty is that we won't get carbon reduction (at least not by politicians who want to get reelected).
It doesn't have to be this way. It is quite consistent to put a charge on carbon while simultaneously driving down total economic costs. Think about what happens when you go to buy something (say, a TV). Once you've figured out the features you want, you buy the cheapest one that meets your criteria; no one argues that the other manufacturers' lost sale is worthy of government intervention. Similarly, we could structure a carbon market such that there is a transfer of revenue from those who generate carbon to those who do not, without net societal cost.
For example, one could say to all power plants that given our average release of about 1,300 lbs of CO2 with every MWh we produce, there will be a new tax charged to everyone who exceeds that number. The revenue will be transferred proportionately to everyone who comes in below it. Thus, the guy emitting 1,500 lbs/MWh pays a couple bucks to the guy emitting 1,100. This could be reset every year based on revised averages, thus slowly raising the bar of expectation, but in all cases ensuring that there is no net fiscal cost.
I mention this only as an illustrative example, and clearly you could put a lot of variants into the mix. To see another person's idea on the same subject, see here.
So how much carbon could you actually reduce without increasing costs? At the risk of being overly quantitative -- gajillions. Let me cite some personal experience. The managers of our company have deployed over 250 cogeneration and energy-recycling projects over the last 30 years, amounting to over $2 billion worth of capital. Every one of them reduced carbon (the least efficient was two times as efficient as the central grid, and the most efficient was cleaner than a solar panel, by generating fuel-free power and reducing on-site fossil-fuel use). These projects have also generated handsome returns (over 15 percent, unleveraged) to our investors and customers, largely without any government subsidy.
I don't mention this to plug our company, but to point out a larger truth. We have identified $350 billion worth of opportunities like these in the country -- in this context, our efforts are peanuts. We haven't scratched the surface, in spite of deploying those billions. But the opportunities are out there.
And that's just in the U.S.! (Indeed, because the opportunities are coincident with manufacturing plants, there are arguably many more in the developing world, creating a neat inversion of the conventional wisdom that the developing world shouldn't have to act on carbon until us first-worlders get our act together. The reality is that it is in all of our economic interests to save fuel.) These are just energy-recycling projects. Add in opportunities for energy efficiency, opportunity fuel use, and conventional renewables, plus the societal costs that you save when you stop subsidizing the dirtier stuff, and you have massive opportunities to profitably lower carbon emissions.
So let's stop talking about costs. Let's offer up solutions like the ones above, that are guaranteed to be fiscally neutral. Let's challenge our legislators to do the same. Call their bluff! If you can't vote on something that might have costs, then structure it to ensure that there are no costs. But let's not put off carbon reduction just because of some goofy economic theories.
Ask Umbra on bike helmets
Ask Umbra on buying carbon offsets
Comments
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GRLCowan Posted 9:36 am
16 Jul 2007
--- G. R. L. Cowan, former hydrogen-energy fan
Oxygen expands around boron fire, car goes
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Sam Wells Posted 11:57 am
16 Jul 2007
Seriously, this is the most significant challenge that mankind has ever faced, and it sounds like it can all be done with a slight of hand and using non-traditional accounting. Perhaps I need it explained better, but my gut feeling is that facing the challenge will require enormous amounts of what is called cold, hard cash.
As the sea levels continue to rise and power consumption continues to increase, I think even our brothers and sisters in Europe - the leaders in Global Warming technology - may even face huge fiscal impacts as well. Just like a Monty Python movie, we're seeing the "run away!" logic as buildings and homes fall into the sea.
Should I mention that many of the worldwide refineries, power plants, and nukes were built next to the ocean?
Gosh, if you're not talking cash you must be talking some Wall Street hedge fund indexed to CO2 or something, and perhaps it IS a good idea to make the top 2% of the world's wage earners to pay for it all! How wonderful. I like that perfectly fine...
Onward through the fog
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GreyFlcn Posted 1:16 pm
16 Jul 2007
We also don't know where the "tipping point" of carbon emmisions is.
Without those two orientating figures, it's impossible to monetize carbon offsets correctly.
Since otherwise we'll just end up with anemic undervalued offsets, which ammount to merely bandaids for the problem, rather than real solutions.
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GreyFlcn Posted 1:19 pm
16 Jul 2007
But instead better financing for mundane solutions.
For instance 20 year fixed-rate low interest loans for retrofitting power plants with effeciency and cogen.
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GreyFlcn Posted 1:21 pm
16 Jul 2007
Since a lot of these things are "put up a lot of money now, get back more over the long run", the only way to shift things is PAY for that risk, and make it a sure thing.
Once it becomes a sure thing, then business decision makers have a nobrainer.
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naturescene Posted 2:51 am
17 Jul 2007
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GreyFlcn Posted 2:58 am
17 Jul 2007
Well, it's oppourtunity cost.
It's also risks. (i.e. How certain is the return-on-investment)
Companies may be able to buy capital intensive projects, but paying for it all upfront is asking for a lot.
If they could pay for it as a loan over a 10 year period, that would definantly soften the blow.
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naturescene Posted 3:59 am
17 Jul 2007
That's not to say that there isn't business opportunity in beating climate change. In fact, facing this challenge can be a net benefit both economically and environmentally. If that's what he was trying to say, then I agree, but I think saying that we can do it without any costs is a poor use of words. That is simply not true.
Still, I'm all for reframing the way we approach carbon reduction -- it's an opportunity rather than a requirement.
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Willpower Posted 4:44 am
17 Jul 2007
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Sean Casten Posted 11:03 am
17 Jul 2007
"Once it becomes a sure thing, then business decision makers have a nobrainer."
This is not precisely right, but it points out the full-employment assumption problem. The fact that something makes money is not solely sufficient to justify capital allocation. Suppose I told you that I had a sure fire stock tip, guaranteed to earn you a 30% return, provided you gave me a million bucks. Would you do it?
Go through the thought exercise. My credibility obviously comes into question. Shortly thereafter presumably comes your ability to line up a million bucks. And then even if you buy all those, you're going to have some question as to whether the 30% is really "guaranteed". Even if you trust me, surely there are other market uncertainties.
Economic theory, however assumes that you will make that investment, because it's a no-brainer. Reframe the question as a business realizing they could invest a million bucks to earn a 30% return on energy efficiency, and the exact same problems arise. Do they trust the guy who says they can make the investment? Suppose, in our thought experiment that the company is a paper mill. They know paper, but they don't know about this new technology. And they'd prefer to see their employees spend their time making paper rather than investing in energy projects. Then there comes the question as to whether they have the million bucks handy. And whether or not they really think that the 30% is legit. This all gets simplified in corporate decision making processes into rules that look something like "don't deploy capital in non-core activities unless you can earn a simple payback of 2 years or less, and then only if we don't have other competing uses of our limited capital." Words are different, but the rationale is no different from our stock broker example.
But now look what happens when you start pricing carbon into the mix. More revenues for energy conservation = faster payback and suddenly businesses are putting money in capital projects with phenomenally high rates of return. Thus, the paper mill that was previously putting capital in 15% rate of return paper machine upgrades at the expense of 30% rate-of-return energy efficiency projects now sees an apparent increase the efficiency project (let's say to 50%, for the sake of argument) by virtue of the carbon credits. But the net result is that their capital is now paying 30% dividends rather than 15. And presto, we're getting greater economic growth by virtue of putting a price on carbon.
But again, note the key distinction. We have not made it a "sure thing", since many of these investments were sure things before. We have simply capitalized on an existing inefficiency in the marketplace, leading to economic growth AND carbon reduction.
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Sean Casten Posted 11:13 am
17 Jul 2007
But the larger point that I'm making is really one of opportunity costs. I will readily spend capital costs if they lead to revenues and/or reduced expenses that earn a return on that capital. The opportunity cost of that capital deployment is that once spent on a given investment, I can't spend it on another. Per my prior response to GreyFlcn, there are lots of really high return investment opportunities in energy efficiency, many of which deliver much higher returns than the places that businesses are presently investing their money. And if I can put money to work at 30% instead of 15%, I'd hardly call it a cost. (Indeed, by giving me more free cash flow, it gives me more money for profits, ultimately leading to reinvestment or distribution to shareholders... driving up GDP growth.)
Ergo, carbon reduction + economic growth. Massive opportunities for carbon reduction and economic savings, and even if these investments don't get us all the way to a zero-carbon world, they are the cheapest source of carbon reductions out there. Since all wallets are finite, they will be the first investments to be made in a world that prices carbon reduction, and therefore we can safely expect to see significant economic growth as a direct result of carbon-reduction policies. If we don't, it will only be because the policies weren't crafted properly to incent efficient capital allocation.
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Sean Casten Posted 11:35 am
17 Jul 2007
Hopefully my prior responses have clarified, but I believe you have confused short-run capital costs with long-term net economic costs. We can broadly generalize that just about all long term benefits require capital investment. The fact that you have to spend money to make money does not mean that the spending is bad though. I personally like to make my own beer, and - not too toot my own horn too loudly - think my homebrew is better than anything I can buy in a store. Whether or not you agree, I can assure you that I have a higher standard of living since I decided to spend $100 on a homebrew kit. Surely you wouldn't say that the idea that I can increase my own beer consumption without any net economic cost is naive or misleading, no? Yeah, I've got capital cost, but the net result is I pay less for beer and drink a better product.
OK, so now let's expand to more significant subjects. Our company put a turbine-generator in place at a tomato canning plant in California. The canning plant makes high pressure steam for one process, then steps down the steam pressure for another process through a valve. This valve effectively throws away the energy they put into the pressurization. We installed three steam turbine-generators in the place of those pressure reduction valves to capture the energy they were throwing away. Whole project cost them just under a million bucks, and they now save $800,000 per year in avoided electricity purchases, all from energy that they were effectively throwing away before. The generators also kept their plant operating during the California power crisis in 2001, meaning that - like my beer - they now have a product (in this case, electricity) that is both cheaper and better than the swill they used to buy. And they're earning a phenomenal return on their investment. AND - every kilowatthour they recover is a kilowatt-hour of carbon-soaked power that the grid no longer has to provide, thereby driving down the overall carbon release from the California power grid.
The specific case is generalizable, as it is typical of the many opportunities that exist throughout manufacturers, hospitals, universities, etc. And yeah, there is a capital cost, but that's the price of economic progress. It just so happens that you can get carbon reduction along with that progress.
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