Energy Policy Archives - Page 63 of 65 - An Economic View of the Environment

What is the Future of U.S. Coal?

Climate concerns have gone mainstream, even in the United States. This has been reflected in the passage by the U.S. House of Representatives of HR 2454, the so-called Waxman-Markey bill, and will soon be reflected in the debates in the U.S. Senate. (I have written a number of blog posts on this topic. If you’re interested, please see: “Opportunity for a Defining Moment” (February 6, 2009); “The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey” (May 27, 2009); “Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal” (June 18, 2009); “National Climate Change Policy: A Quick Look Back at Waxman-Markey and the Road Ahead” (June 29, 2009). For a more detailed account, see my Hamilton Project paper, A U.S. Cap-and-Trade System to Address Global Climate Change.)

At the center of much political attention in the United States is “the future of coal,” a subject that was illuminated by the 2007 MIT study with that title, authored by John Deutch and Ernest Moniz, as well as several reports issued by the U.S. Energy Information Administration (EIA).

CO₂ emissions from coal consumption accounted for 30 percent of U.S. greenhouse gas emissions in 2005, and nearly all resulted from coal’s use in generating electricity. According to EIA forecasts, the vast majority of coal demand over the coming decades will be from existing power plants, with currently existing plants still accounting for two-thirds of total demand in 2030. Therefore, while much attention has been given to how climate policy and technological advances may affect new power plants, over the next two decades a policy that affects both existing and new coal-fired power plants would have far greater impacts than a policy that affects only new plants.

Potential climate policies can be grouped into four major categories: standards, subsidies or credit-based programs, carbon taxes, and cap-and-trade (like Waxman-Markey). The cost of retrofitting existing plants to meet CO₂ emission standards would likely be so high that standards could be imposed only on new plants. While such standards may dampen investments in new coal-fired power plants – as they may require expensive carbon-capture-and-storage at any new coal plant (see below) – standards would be unlikely to affect operations of existing plants. In fact, by increasing the cost of new plants, such standards can encourage generators to extend the life of existing plants. Hence, new source standards hold little promise in this domain.

Likewise, while subsidies or credit-based programs – including renewable portfolio standards — may displace some new coal-fired generation with other types of generation, they will have little, if any, effect on the operation of existing coal-fired power plants. And carbon taxes are opposed by the regulated community because of the additional costs they would place on private industry, and are opposed by environmentalists because of the political challenges.

This leaves cap-and-trade. Such a system would cover both new and existing emission sources, and could have a more pervasive effect on coal use than standards, subsidies, or credit-based programs. For this and other reasons, most policy attention in the United States has been focused on potential cap-and-trade systems.

Coal combustion generates the most CO₂ emissions per unit of energy. As a result, a cap-and-trade system’s effect on the cost of coal use would be significantly greater than its effect on the cost of gasoline or natural gas consumption. For example, a $100 per ton of CO₂ allowance price would increase the average cost of electricity generation from coal-fired power plants by about 400%, the average cost of electricity generation from natural gas plants by about 100%, and gasoline prices by about $1.00 per gallon.

The competitiveness of conventional coal-fired electricity generation relative to other technologies diminishes as the stringency of an emissions cap increases. Therefore, much attention is being given to opportunities to employ carbon-capture-and-storage (or CCS) technologies, which would separate carbon dioxide from other stack gases, liquify it, and store it underground for long periods of time.

Three important caveats about CCS should be considered. First, it is likely that CCS will be economically practical only for new plants, and only when CO₂allowance prices exceed $100 per ton of CO₂ for early adopters (cost estimates have increased over the past few years, as technological and institutional challenges have become clearer). Second, there is significant uncertainty about the cost of CCS, because it has not yet been commercially demonstrated. And third, CCS significantly reduces, but does not eliminate, CO₂ emissions from coal-fired generation.

In light of the growing momentum toward a mandatory U.S. climate policy, the anticipated impacts of such policies on coal use are an important issue. But the remaining uncertainties are great. Impacts of a climate policy on coal use will depend upon the type of climate policy employed, the stringency of the policy, the future price of natural gas, the future cost and penetration of nuclear and renewable technologies, and the cost of coal-fired generation with carbon capture and storage technologies. Are all promising topics for future posts.

Is Benefit-Cost Analysis Helpful for Environmental Regulation?

With the locus of action on Federal climate policy moving this week from the House of Representatives to the Senate, this is a convenient moment to step back from the political fray and reflect on some fundamental questions about U.S. environmental policy.

One such question is whether economic analysis – in particular, the comparison of the benefits and costs of proposed policies – plays a truly useful role in Washington, or is it little more than a distraction of attention from more important perspectives on public policy, or – worst of all – is it counter-productive, even antithetical, to the development, assessment, and implementation of sound policy in the environmental, resource, and energy realms. With an exceptionally talented group of thinkers – including scientists, lawyers, and economists – now in key environmental and energy policy positions at the White House, the Environmental Protection Agency, the Department of Energy, and the Department of the Treasury, this question about the usefulness of benefit-cost analysis is of particular importance.

For many years, there have been calls from some quarters for greater reliance on the use of economic analysis in the development and evaluation of environmental regulations. As I have noted in previous posts on this blog, most economists would argue that economic efficiency — measured as the difference between benefits and costs — ought to be one of the key criteria for evaluating proposed regulations. (See: “The Myths of Market Prices and Efficiency,” March 3, 2009; “What Baseball Can Teach Policymakers,” April 20, 2009; “Does Economic Analysis Shortchange the Future?” April 27, 2009) Because society has limited resources to spend on regulation, such analysis can help illuminate the trade-offs involved in making different kinds of social investments. In this sense, it would seem irresponsible not to conduct such analyses, since they can inform decisions about how scarce resources can be put to the greatest social good.

In principle, benefit-cost analysis can also help answer questions of how much regulation is enough. From an efficiency standpoint, the answer to this question is simple — regulate until the incremental benefits from regulation are just offset by the incremental costs. In practice, however, the problem is much more difficult, in large part because of inherent problems in measuring marginal benefits and costs. In addition, concerns about fairness and process may be very important economic and non-economic factors. Regulatory policies inevitably involve winners and losers, even when aggregate benefits exceed aggregate costs.

Over the years, policy makers have sent mixed signals regarding the use of benefit-cost analysis in policy evaluation. Congress has passed several statutes to protect health, safety, and the environment that effectively preclude the consideration of benefits and costs in the development of certain regulations, even though other statutes actually require the use of benefit-cost analysis. At the same time, Presidents Carter, Reagan, Bush, Clinton, and Bush all put in place formal processes for reviewing economic implications of major environmental, health, and safety regulations. Apparently the Executive Branch, charged with designing and implementing regulations, has seen a greater need than the Congress to develop a yardstick against which regulatory proposals can be assessed. Benefit-cost analysis has been the yardstick of choice

It was in this context that ten years ago a group of economists from across the political spectrum jointly authored an article in Science magazine, asking whether there is role for benefit-cost analysis in environmental, health, and safety regulation. That diverse group consisted of Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and myself. That article and its findings are particularly timely, with President Obama considering putting in place a new Executive Order on Regulatory Review.

In the article, we suggested that benefit-cost analysis has a potentially important role to play in helping inform regulatory decision making, though it should not be the sole basis for such decision making. We offered eight principles.

First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change. But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs.

Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations. Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation.

Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision.

Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions, and to explain why they have selected actions for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests. Factors other than aggregate economic benefits and costs may be important.

Fifth, benefits and costs of proposed policies should be quantified wherever possible. But not all impacts can be quantified, let alone monetized. Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making. If an agency wishes to introduce a “margin of safety” into a decision, it should do so explicitly.

Sixth, the more external review that regulatory analyses receive, the better they are likely to be. Retrospective assessments should be carried out periodically.

Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs. Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.

Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population.

From these eight principles, we concluded that benefit-cost analysis can play an important role in legislative and regulatory policy debates on protecting and improving the natural environment, health, and safety. Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis.

If properly done, benefit-cost analysis can be of great help to agencies participating in the development of environmental regulations, and it can likewise be useful in evaluating agency decision making and in shaping new laws (which brings us full-circle to the climate legislation that will be developed in the U.S. Senate over the weeks and months ahead, and which I hope to discuss in future posts).

National Climate Change Policy: A Quick Look Back at Waxman-Markey and the Road Ahead

Like any legislation, the Waxman‑Markey bill has its share of flaws, but its cap-and-trade system has medium and long‑term targets for reducing greenhouse gas emissions that are sensible, and the cap‑and‑trade system is — for the most part — well designed. With some exceptions, the bill’s cap‑and‑trade system will achieve meaningful reductions of carbon dioxide and other greenhouse gas emissions at minimal cost to the economy.

There has been much lamenting about the corporate give-away in the bill, but this is unfounded, as I explained in detail in my May 27^th post on The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey. Concerns have also been expressed — such as by a number of Republican members of Congress during last Friday’s floor debate in the House of Representatives — about negative impacts on the international competitiveness of U.S. firms. The only real solution to the international competitiveness issue in the long term is to bring non‑participating countries within an international climate regime in meaningful ways. (On this, please see the work of the Harvard Project on International Climate Agreements.) But that solution is fundamentally outside of the scope of the domestic policy action of any individual nation, including the United States.

In the meantime, the Waxman‑Markey approach of combining output‑based updating allocations in the short term for select sectors with the option in the long term of a Presidential determination (under stringent conditions) for import allowance requirements for specific countries and sectors was sensible and pragmatic (see my June 18^th post on Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal).

That’s the good news. But the bad news is that last-minute changes in the bill changed what was a Presidential option regarding long-term back-up border adjustments (tariffs) to a requirement that the President put such tariffs in place under specified conditions. This moved the legislation considerably closer to risky protectionism, as President Obama rightly noted in comments to the press on Sunday.

Also, the compromise amendments with the House agriculture committee that provide for generous numbers of potential offsets from the agricultural sector (regulated not by EPA, but by USDA!) are troubling — not in terms of driving up compliance costs, but in terms of reducing the real environmental performance of the system. This is because of the general problem of limited additionality of claimed reductions under offset (or emission-reduction-credit) systems, as opposed to cap-and-trade systems, plus the well-known difficulties of measuring non-point emissions, let alone emissions reductions, from agriculture.

These and other design issues will be important topics when the Senate takes up its own climate legislation, although the debate in that body on some of these issues will likely be quite different. For example, there is likely to be more interest in the Senate in the use of a “price collar,” a mechanism to constrain both the maximum and the minimum market price of allowances over time. This would be a move beyond the safety-valve mechanism that is provided in the House legislation.

When the action moves to the Senate, the greatest attention and the greatest skepticism should be directed not to the cap‑and‑trade mechanism, which is — for the most part — well designed in Waxman‑Markey, but rather to other elements of the legislation, some of which are highly problematic. While the titles of Waxman‑Markey that create the cap‑and‑trade system are ‑‑ on balance ‑‑ sensible, and will result in meaningful emissions reductions cost effectively, the other titles of the bill include a host of conventional standards and subsidies, many of which (under the cap‑and‑trade umbrella) will have minimal or no environmental benefits, but will limit flexibility and thereby have the unintended consequence of driving up compliance costs. That’s the soft under‑belly of this legislation that needs to be selectively, surgically repaired.

It is the fault of economists — myself included — that we have given so much attention to the cap-and-trade system that we have ignored these other important elements of the legislation, elements that unfortunately can degrade significantly the cost-effectiveness of the package while providing little if any incremental benefits to the environment. Even the Congressional Budget Office, in its excellent economic analysis of HR 2454, focused exclusively on the bill’s cap-and-trade program. Going forward, CBO, EPA, and independent analysts need to examine the bill’s other elements, and assess what those elements provide at what incremental cost.

A broader question — also raised by House Republicans in the floor debate — is whether the United States should be moving towards the enactment of a domestic climate policy before a sensible, post‑Kyoto international agreement has been negotiated and ratified. Such an international agreement should include not only the countries of the industrialized world, but also the key, rapidly‑growing economies of the developing world ‑‑ China, India, Brazil, Korea, Mexico, South Africa, and Indonesia ‑‑ which are and will increasingly be major contributors to emissions.

It’s natural for such a question to be raised about the very notion of the U.S. adopting a policy to help address what is fundamentally a global problem. The environmental benefits of any single nation’s reductions in greenhouse gas emissions are spread worldwide, unlike the costs. This means that for any single country, the costs of action will inevitably exceed its direct benefits, despite the fact that the global costs of action will be less than global benefits. This is the nature of a global commons problem, and this is the very reason why international cooperation is required.

The U.S. is now engaged in international negotiations, and the credibility of the U.S. as a participant, let alone as a leader, in shaping the international regime is dependent upon our demonstrated willingness to take actions at home.

Europe has put its climate policy in place, and Australia, New Zealand, and Japan are moving to have their policies in place within a year. If the United States is to play a leadership role in international negotiations for a sensible post‑Kyoto international climate regime, the country must begin to move towards an effective domestic policy ‑ with legislation that is timed and structured to coordinate with the emerging post‑Kyoto climate regime.

Without evidence of serious action by the U.S., there will be no meaningful international agreement, and certainly not one that includes the key, rapidly‑growing developing countries. U.S. policy developments can and should move in parallel with international negotiations.

So, the Waxman‑Markey bill has its share of flaws, but it represents a reasonable starting point for Senate deliberation on what can become a national climate policy that will place the United States where it ought to be -‑ in a position of international leadership to help develop a global climate agreement that is scientifically sound, economically rational, and politically acceptable to the key nations of the world.