conversableeconomist

The Mundane Cost Obstacle to Nuclear Power

I\’ve long believed that the main problems with expanding nuclear power related to health and safety concerns: for example, the small chance of a plant malfunctioning, along with issues related to waste disposal and possible links between nuclear power technology and weapons technology. But Lucas Davis argues persuasively in \”Prospects for Nuclear Power\” in the Winter 2012 issue of my own Journal of Economic Perspectives, which is freely available on-line courtesy of the American Economic Association, that I\’ve been assuming too much. Here\’s Davis (citations omitted):

\”Nuclear power has long been controversial because of concerns about nuclear accidents, storage of spent fuel, and about how the spread of nuclear power might raise risks of the proliferation of nuclear weapons. These concerns are real and important. However, emphasizing these concerns implicitly suggests that unless these issues are taken into account, nuclear power would otherwise be cost effective compared to other forms of electricity generation. This implication is unwarranted. Throughout the history of nuclear power, a key challenge has been the high cost of construction for nuclear plants. Construction costs are high enough that it becomes difficult to make an economic argument for nuclear even before incorporating these external factors. This is particularly true in countries like the United States where recent technological advances have dramatically increased the availability of natural gas. The chairman of one of the largest U.S. nuclear companies recently said that
his company would not break ground on a new nuclear plant until the price of natural gas was more than double today’s level and carbon emissions cost $25 per ton. This comment summarizes the current economics of nuclear power pretty well. Yes, there is a certain confluence of factors that could make
nuclear power a viable economic option. Otherwise, a nuclear power renaissance seems unlikely.\”

The argument from Davis is complemented by some other recent discussions of nuclear power. The
Federation of American Scientists has a report out on  The Future of Nuclear Power in the United States, edited by Charles D. Ferguson and Frank A. Settle. The most recent issue of the Economist magazine (March 10) has a 14-page cover story on \”Nuclear Power: The Dream that Failed.\”
Finally, a Report to the Secretary of Energy by the Blue Ribbon Commission on America\’s Energy Future was released in late January.

Here is some basic background from Davis in his JEP article. The first figure shows nuclear power plants under construction around the world. Notice that the plants under construction in the United States and western Europe dropped off to near-zero in the 1990s. The recent spike in plants under construction is driven by the \”other\” category, which is largely China, but it remains to be seen how many of these plants will end up being completed.

The next figure shows rising costs of constructing nuclear power plants in the United States. The costs are per kilowatt-hour of capacity, and so adjusted for size. The costs are also adjusted for inflation.

Finally, this figure shows the slowdown in construction times–for example, plants started in the 1960s were completed in 8.6 years while those completed in the 1970s took 14.1 years. Moreover, there was growing uncertainty as to whether a nuclear power plants would be completed: 89% of plants announced in the 1960s were completed, compared with only 25% of those announced in the 1970s being completed. 

Of course, it\’s not possible to separate cleanly the safety concerns over nuclear power from these cost issues: additional safety precautions–and the accompanying paperwork–are part of what drives up costs. But perhaps the more fundamental story here is that technological progress in nuclear power hasn\’t been increasing fast enough to assuage concerns about safety and to drive down costs. Stephen Maloney digs into this in some detail in Chapter 2 of the FAS report, \”A Critical Examination of Nuclear Power\’s Costs.\”

\”Since the nuclear industry’s inception more than 50 years ago, its forecasts for costs have been consistently unreliable. The “first generation” plants, comprising both prototype reactors and the standard designs of the 1950s-1960s, failed to live up to promised economics. This trend continued with the construction of Generation II plants completed in the 1970s, which make up the present nuclear fleet.

\”First, the total costs were far higher than for coal-generated electricity. In particular, the capital cost of nuclear plants built through 1980 were, on average, 50 percent higher than comparably-sized coal-fired plants, adjusting for inflation and including backfits to meet Clean Air Act standards. Second, there were extraordinary cost escalations over the original low cost promises. Nuclear plant construction costs escalated approximately 24 percent per calendar year compared to 6 percent annual escalation for coal plants. Third, the economies of scale expected were not achieved in the Generation II designs. The scale-up of nuclear plants brought less than half the economic efficiencies projected.

\”In addition, over 120 nuclear units, approximately half the reactors ordered, were never started or cancelled. The total write-offs were more than $15 billion in nominal dollars. … In the late 1970s, the Atomic Industrial Forum (AIF), predecessor to the Nuclear Energy Institute, identified the main drivers of unmet expectations as growing understanding of nuclear accident hazards, failure of regulatory standardization policies, and increased documentation standards to ensure as-built plants actually met
safety standards. The combined effects doubled the quantities of materials, equipment, and labor needed, and tripled the magnitude of the engineering effort for building a nuclear power plant.\”

Of course, it\’s possible to sketch business and technological scenarios under which nuclear power plants of the future use simpler, safer designs, which combine with economies of scale in production to drive down costs. But such predictions haven\’t held true over the history of nuclear power, and they don\’t seem to be holding true recently, either. Here\’s one of many examples, from Maloney:

\”In June 2006, a consortium of companies announced plans to build two more reactors at the South Texas Project site for an estimated cost of $5.2 billion. NRG, the lead company, made history by becoming the first company to file an application with the NRC. CPS Energy, a municipal utility, was one of its partners. In October 2007, CPS Energy’s board approved $206 million for preliminary design and engineering. In June 2009, NRG revised the estimate to $10 billion for the two reactors, including finance charges. A few weeks later, this estimate rose to $13 billion, including finance charges. Later that year, the estimate reached $18.2 billion …\” Cost overruns of similar magnitude aren\’t just a U.S. phenomenon; for example, they also have occurred at recent nuclear power projects in France and in Finland.

To be sure, there are promising new nuclear technologies out there. One hot topic is small modular reactors, discussed both in the Economist article and by Daniel Ingersoll in Chapter 10 of the FAS report. But at some point, a degree of skepticism seems appropriate. The Economist has a wonderful quotation from Admiral Hyman Rickover, who drove the process that created America\’s nuclear submarines, and commented back in the 1950s:

\”An academic reactor or reactor plant almost always has the following basic characteristics: (1) It is simple. (2) It is small. (3) It is cheap. (4) It is light. (5) It can be built very quickly. (6) It is very flexible in purpose. (7) Very little development will be required. It will use off-the-shelf components. (8) The reactor is in the study phase. It is not being built now. On the other hand a practical reactor can be distinguished by the following characteristics: (1) It is being built now. (2) It is behind schedule. (3) It requires an immense amount of development on apparently trivial items. (4) It is very expensive. (5) It takes a long time to build because of its engineering development problems. (6) It is large. (7) It is heavy. (8) It is complicated.\”

Finally, arguments over appropriate disposal of nuclear waste will surely continue. For an overview of these issues, a useful starting point is the Report to the Secretary of Energy by the Blue Ribbon Commission on America\’s Energy Future that was released in late January. Personally, I didn\’t find the Commission report to be especially encouraging about resolving these issues. For example, the first recommendation is to start a process of encouraging communities to volunteer for being nuclear waste disposal sites, which they think might take 15-20 years. Having just watched the argument over a possible repository at Yucca Mountain in Nevada run for 25 years, before the decision of the Obama administration to halt that process, this time frame seems optimistic. Of course, there are alternatives: consolidated storage facilities, and technologies for processing nuclear waste. But the alternatives aren\’t cost-free, either.

Nuclear power isn\’t going away. Plants that have been working well still have several decades to run, and the marginal costs of running them are now low. Additional nuclear power plants will be built in countries where the government makes it a priority, or perhaps in some settings where other sources of power are extremely high cost. But as the U.S. enters what seems to be a time of cheap and plentiful natural gas, building a substantial number of new nuclear power plants in this country seems highly unlikely.

conversableeconomist

U.S. Gasoline Prices and Consumption in International Context

Gasoline prices are spiking up toward $4 per gallon, so it\’s a useful time to review prices over the last couple of decades and some international comparisons. Here\’s a figure I generated using the ever-helpful FRED (Federal Reserve Economic Data) website maintained by the St. Louis Fed showing gasoline prices since 1990.

The overall pattern here is fairly clear. Gasoline prices were fairly flat through the 1990s at between about $1 and $1.50 per gallon. Starting around 2000, gasoline prices start rising. There\’s a lot of volatility in the pattern, and in particular, gasoline prices drop off when demand for gasoline falls during recessionary periods (as shown by the shaded areas in the figure). But the overall pattern of rising gasoline prices from about 2000 up through 2008 is pretty clear. Gasoline prices are now headed back toward their level before the recession-induced fall in prices in 2008.

Most supply-and-demand explanations of gasoline markets emphasize that supply often adjusts fairly slowly. The process of searching for and discovering oil, and then drilling, transporting, refining, wholesaling and retailing it, takes many economic interconnections. Thus, when  demand falls in a recession, the production process of oil doesn\’t drop off sharply–instead, prices fall. At other times, however, a disruption in this chain of supply can create a drop in the quantity that would otherwise have been available later in the process, and so prices rise.

The overall pattern of rising prices through most of the 2000s is usually attributed to the growth of demand for oil outstripping the growth of supply–where much of the rising demand for oil comes from rapidly growing economies like China, India, and Brazil. From this perspective, it seems utterly unsurprising that the price of gasoline has rebounded back near the peaks it reached earlier in 2008.

Although I think most Americans have a general idea that gasoline is often taxed more highly in other countries than it is here, the magnitude of these taxes isn\’t always well-known. Here\’s a table from Christopher R. Knittel\’s article, \”Reducing Petroleum Consumption from Transportation,\” in the Winter 2012 issue of my own Journal of Economic Perspectives, comparing gasoline taxes across countries.

The United States taxes gasoline at about 49 cents to the gallon, counting both federal taxes and the average of state taxes. By the time you get to the bottom of the list, you see that countries like the United Kingdom, Germany and Netherlands have gasoline taxes about eight times as high at roughly $4/gallon. Population densities and living patterns are different in the United States than  in these other countries, and I wouldn\’t advocate raising taxes to those levels.  On the other side, it\’s hard to believe that phasing in an increase in U.S. gasoline taxes to Canadian levels of 96 cents per gallon would be an unsustainable blow to the U.S. .economy, perhaps with a substantial of the money earmarked for offsetting income tax cuts and part earmarked for long-term deficit reduction. There are a variety of environmental and geopolitical reason why it might be reasonable policy for the U.S. to put some price disincentives in place for petroleum use.

Here\’s one more figure from Knittel. The horizontal axis of the graph shows the price of gasoline in each country, taxes included. The vertical axis shows the quantity of gasoline used for transportation in each country, measured in gallons per year per capita. This is part of the considerable body of evidence suggesting that when energy prices are higher, people and firms find ways to conserve.

Many Americans do truly hate the idea of higher energy taxes, so I don\’t expect this kind of proposal to make any political progress. Instead, Americans like to pretend that by setting technology standards to require more fuel efficient cars over time, the country can conserve energy without facing a cost. I explained in a post last week, \”Are the New Auto Fuel Economy Standards For Real?\” why this less flexible approach actually imposes higher costs as a way of encouraging energy conservation.

conversableeconomist

Are the New Auto Fuel Economy Standards For Real?

Politicians are predisposed to like a technology standard, like the Corporate Average Fuel Economy (CAFE) standards for automobile miles-per-gallon, as a way of holding down petroleum use. After all, it sounds a lot better to voters than enacting a gasoline tax or a carbon tax! Pass a law that better-mileage cars will be phased in over the next decade or two, and politicians can boast of their great achievement –sidestepping the fact that promised aren\’t achievements and rules are made to be changed.

Thus, when I heard about the plans for a dramatic increase in CAFE standards, I was skeptical. In the most recent issue of my own Journal of Economic Perspectives, Christopher R. Knittel discusses various aspects of  \”Reducing Petroleum Consumption from Transportation.\” As Knittel writes: \”A new CAFE standard in place for 2011 seeks to increase average fuel economy to roughly 34.1 miles per gallon by 2016. The Environmental Protection Agency and Department of Transportation are currently in the rule-making process for model years 2017 and beyond, with President Obama and 13 automakers agreeing to a standard of 54.5 MPG by 2025.\” Knittel provides evidence to back up my skepticism about the past use of CAFE standards, but he also argues that those future standards–unbelieveable as they may at first appear–are technologically achievable.

Back in 1975, against a backdrop of a dramatic rise in oil prices and concern over dependence on imported oil, the U.S. enacted the Corporate Average Fuel Economy (CAFE) law, requiring that over the average of their cars sold by each company, the average had to start at 18 miles-per-gallon, and then rise to 27 mpg by 1985. Higher gasoline prices provided a strong inducement for people to buy these more fuel-efficient cars, but when gasoline prices dropped in the mid-1980s, the CAFE standards stagnated. Here\’s a figure from Knittel showing how CAFE standards flattened out after 1985–and also showing the planned increase to take place.



The lack of any increase in the CAFE standards was only part of the story. Knittel explains: \”[T]wo features of the original CAFE standards reduced their effect. First, sport-utility vehicles were treated as light trucks, and thus could meet a lower miles-per-gallon standard than cars. Perhaps not coincidentally, in 1979 light trucks comprised less than 10 percent of the new vehicle fleet, but this share rose steadily
and peaked in 2004 at 60 percent. Second, vehicles with a gross vehicle weight of over 8,500 pounds, which includes many large pickup trucks and sports-utility vehicles, were exempt from CAFE standards.\”

Taking these factors together, actual fuel economy for the U.S. fleet of cars hasn\’t been rising much, although it has edged up in the last few years with higher gasoline prices. My own interpretation is that the CAFE standards effectively became nonbinding–that is, they weren\’t pushing anyone to buy a different car than they otherwise would have purchased, and they weren\’t adding to fuel economy. Here\’s the data:

So, is it technologically possible meet the future increase in miles-per-gallon standards? Knittel argues \”yes.\” He points out: \”By world standards, these [currently existing] miles-per-gallon standards are not aggressive. After accounting for differences in the testing procedures, the World Bank estimated that the European Union standard was roughly 17 MPG more stringent in 2010 than the U.S. standard …\”

Moreover, Knittel has carried out a series of studies looking at technological progress in cars, and the tradeoffs between weight, engine power, and fuel efficiency. He finds: \”On average, a vehicle with a given weight and engine power level has a fuel economy that is 1.75 percent higher than a vehicle with the same weight and horsepower level from the previous year. …In the medium run, automakers can adjust vehicle attributes by trading off weight and horsepower for increased fuel economy. In Knittel (2011), I find that reducing weight by 1 percent increases fuel economy by roughly 0.4 percent, while reducing horsepower and torque by 1 percent increases fuel economy by roughly 0.3 percent.\”

By Knittel\’s calculation, getting from the new-car average fuel economy standard of 29 mpg in 2010 to 34.1 mpg in 2016 is do-able. If technological progress continues to improve mileage by 1.75% per year, and ways are found to reduce weight and engine power by about 6%, the standard for 2016 is achieveable.

But what about that planned standard of 54.5 mpg by 2025? Knittel explains that the number is somewhat inflated: \”Taken literally, it would require fundamental changes to rates of technological progress and/or the size and power of vehicles. The 2025 number is a bit misleading. In the law, the 54.5 miles-per-gallon standard is based on a calculation from the Environmental Protection Agency based on carbon dioxide tailpipe emissions. It also includes credits for many technologies including plug-in hybrids, electric and hydrogen vehicles, improved air conditioning effifi ciency, and others. On an apples-to-apples basis, Roland (2011) cites some industry followers that claim that the actual new fleet fuel economy standard in 2025 is more like 40 miles per gallon. Achieving 40 miles per gallon by 2025 is certainly possible. At a rate of technological progress of 1.75 percent per year, 40 miles per gallon requires additional reductions in weight and engine power of less than 7 percent.\”

But although the planned mileage standards do appear–to my surprise–technologically feasible, it remains to be seen whether they are politically feasible, and also whether they are even a sensible public policy idea.

On the political side, the U.S. political system found a way for most of the last three decades to have fuel economy standards on the books as a matter of law and public relations–but to have standards with very little bite. Let\’s see whether the fuel economy standards planned for the future actually cause some real changes in the U.S. auto fleet, or whether they are quickly riddled with exceptions.

But at a deeper level, it\’s not even clear that fuel economy standards are a good policy idea. Knittel explains: \”At a basic level, it focuses on the wrong thing—fuel economy instead of total fuel consumption. CAFE only targets new vehicles and leads to subsidies for some vehicles. Finally, CAFE pushes consumers into more-fuel-efficient vehicles without changing the price of fuel, leading to more miles traveled. The empirical size of this last effect, known as “rebound,” is a matter of ongoing research,
but to the extent that rebound occurs, it necessarily leads to greater congestion, accidents, and criteria pollutant emissions relative to the status quo.\” A considerable body of economic research suggests that if your policy goal is to reduce petroleum consumption, a gasoline tax or a carbon tax accomplishes the goal at a far lower social cost than fuel economy standards–although for politicians the explicitness of that cost seems to make it a nonstarter.

For more discussion of this topic, I recommend \”Automobile Fuel Economy Standards: Impacts, Efficiency, and Alternatives,\” by Soren T. Anderson, Ian W. H. Parry, James M. Sallee, and Carolyn Fischer, in the Winter 2011 issue of the Review of Environmental Economics and Policy.  The publisher has made article freely available here.
 

conversableeconomist

U.S. Is Already a Net Exporter of Oil

Added 12/16
A reader emails this only slightly snarky and completely accurate note pointing out that this post is mistitled:

\”Read you article in the Conversable Economist, December 2, 2011 titled \”US is Already a Net Importerr of Oil\”. Great if it were true, but you have the facts all wrong. Before you write any more articles on the subject of oil, please learn the difference between oil and petroleum products.\”

Original post follows.
 ___________________________
 
\”U.S. exports of gasoline, diesel and other oil-based fuels are soaring, putting the nation on track to be a net exporter of petroleum products in 2011 for the first time in 62 years.\” This according to Liam Pleven and Russell Gold in a November 30 Wall Street Journal story: \”U.S. Nears Milestone: Net Fuel Exporter.\”A graph of U.S. oil imports and exports in the last 10 years tells the story. 

To be sure, part of the reason for this change is that demand for energy in the U.S. is down in the sluggish aftermath of the Great Recession, while demand for energy in other parts of the world is rising. For example, the U.S. is now a net exporter of oil to Brazil, Mexico, Argentina. While exports and imports will bounce around in the short-run, over the longer run it appears that the U.S. is on track to become an energy exporter of oil, coal, and even natural gas (as technology improves for shipping liquified natural gas.


At no time in my life has the U.S. been a net exporter of petroleum products, and my mind is still trying to accept that this shift is real. I\’d posted back on October 7 about America as Conventional Energy Powerhouse?!? Amy Myers Jaffe, an energy expert who runs the Baker Institute Energy Forum at Rice University, wrote: \”By the 2020s, the capital of energy will likely have shifted back to the Western Hemisphere, where it was prior to the ascendancy of Middle Eastern megasuppliers such as Saudi Arabia and Kuwait in the 1960s.\” 

But it seems to me that the sensible policy response to America\’s new role as an energy exporter is what I\’ve called The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy (October 24, 2011). As I summarized the proposal: \”As the name suggests, it has two parts. On one side, there would be a national commitment to move ahead with all deliberate speed in developing the vast U.S. fossil fuel energy resources that are now technologically available. On the other side, the United States would enact a appropriate carbon tax to offset concerns over the risks of climate change. The Drill Baby Carbon Tax basically takes the view that while the United States is working on phasing down fossil fuels and moving to alternative energy resource, let\’s produce a greater share of the fossil fuels that we consume here at home.\”

conversableeconomist

"Big Oil"–Actually Small and Vulnerable

When it comes to Big Oil, I run into a lot of people who are still living in the 1960s. They still think that Exxon and Mobil and Shell and BP and a few others dominate world oil markets. The October 29 issue of the Economist has a nice article (\”Big Oil’s bigger brothers\”), which puts the modern reality of Big Oil in context. 


When it comes to reserves, the big country-owned firms control 80% of the world\’s oil, while the private oil companies are bit players. 



ExxonMobil, Shell and BP do continue to have enormous expertise in getting to hard-to-reach oil. When world oil prices are high, and this costly technology gets put to work, they can make high profits. But their technological leadership is under continual challenge  both from the state-owned oil companies and from small technology-intensive private firms–often working together. Moreover, Big Oil is very vulnerable to a drop in oil prices. As the Economist writes: 


\”Life is getting harder for the supermajors. Their edge over their rivals—the ability to extract oil from difficult places—is terrifically useful while prices are high. But since it is terrifically costly to extract oil from difficult places, their competitive advantage fizzles if oil prices fall. If it does, their bumper profits could vanish like a pool of petrol into which a lighted match has been carelessly dropped.\”

conversableeconomist

The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy

The Drill-Baby Carbon Tax is my proposed grand compromise for energy policy in the United States. As the name suggests, it has two parts. On one side, there would be a national commitment to move ahead with all deliberate speed in developing the vast U.S. fossil fuel energy resources that are now technologically available. On the other side, the United States would enact a appropriate carbon tax to offset concerns over the risks of climate change. The Drill Baby Carbon Tax basically takes the view that while the United States is working on phasing down fossil fuels and moving to alternative energy resource, let\’s produce a greater share of the fossil fuels that we consume here at home.

Personally, I like both sides of the Drill Baby Carbon Tax. But for many, it\’s a proposal with something to like and something to loathe. Is there any chance for at least some environmentalists and some of those who favor aggressively developing our domestic energy resources to support such a compromise?

A number of environmentalists have been warning about the dangers of climate change in near-apocalyptic terms. If it is, as often claimed, the preeminent environmental issue our time with a risk of extraordinarily large and even catastrophic costs, then surely a carbon tax should be worth accepting some other tradeoffs.

At a more subtle level of argument, many environmentalists would be horrified by a proposal that would involve taking pollution from U.S. and dumping it elsewhere; but after all, a policy in which the U.S. burns imported fossil fuel is only saving environmental costs in the U.S. while imposing them elsewhere. From a global environmental perspective, if fossil fuel resources are to be developed, better that it happen here under the eye of U.S. regulatory agencies and courts and everyday U.S. citizens, rather than in Nigeria or Russia. Moreover, if energy development was happening in America, U.S. citizens would need to face the reality of what they are using.

By trying to block, for example, a pipeline from Canada that would bring oil from the \”tar sands\” to the U.S., environmentalists are missing the fact that these resources are going to be developed somewhere in the world–and carbon emissions are the bigger issue. For example, Nature magazine editorialized in its September 15 issue: \”In fact, the pipeline protests say more about the sorry state of the environmental agenda than anything else. It is true that greenhouse-gas emissions from oil extracted from the sands are 15–20% higher than those from average crude oil if assessed on a life-cycle basis, but industry officials are correct in pointing out that this is on a par with other dirty oils produced in the United States and elsewhere using steam injection. And halting this pipeline is unlikely to halt development of the tar sands or other dirty sources of energy. What is missing, now as ever, is a policy to address the larger climate threat.\”

For those in favor of developing U.S. domestic energy resources, it\’s  important to be clear such a policy isn\’t going to have much affect on the average price over time, which is set in a global market of supply and demand. However, oil produced in North America is less susceptible to disruptions and cutoffs that can cause sharp fluctuations in world prices and stagger economies. If more oil was produced here, there would be less reason for a U.S. military presence in the Middle East, and fewer trigger points for conflict over oil around the world. Perhaps most important, if oil is going to be produced somewhere, having it produced and refined by U.S. workers creates jobs here, rather than having the U.S. run a large trade deficit in part because of importing oil produced somewhere else. 

Of course, many of those who favor expanding domestic oil drilling don\’t think the evidence for climate change is very strong, and don\’t think a carbon tax is justified. But essentially everyone acknowledges that burning fossil fuels creates standard pollutants: sulfur oxides, nitrogen oxides, particulate matter, and the like. Even if reducing carbon emissions is unimportant, reducing these other pollutants has some gains. The distaste for a carbon tax would also have to be weighed against the gains from additional U.S. jobs, a less volatile world energy supply, less pressure to seek political stability in the Middle East, and a lower U.S. trade deficit. And for advocates of developing domestic energy resources, imagine the political power of generously offering a grand compromise that might co-opt and defang the climate change issue!

What might the specific dimensions of the Drill Baby Carbon Tax look like? On the production side, the concrete and goal would be how much the U.S. ramped up its domestic fossil fuel production. Earlier this month, I blogged on \”America as a Conventional Energy Powerhouse?\”, where an energy expert predicts that thanks to horizontal drilling and other technological developments, \”[b]y the 2020s, the capital of energy will likely have shifted back to the Western Hemisphere …\” The process here would be make sure that environmental regulations are met, but not to let those regulations be used to shut off developing these fossil fuel resources.

On the carbon tax side, the question is how large a tax is justified by the existing scientific evidence. A useful starting point here is a paper by three economists: Michael Greenstone of MIT and Elizabeth Kopits and Ann Wolverton of the EPA. All three of them participated in a group that tried to calculate a social cost of carbon for the federal government. (Greenstone was Chief Economist on the staff of Obama\’s Council of Economic Advisers in 2009 and part of 2010.) In March 2011, they published a working paper on \”Estimating the Social Cost of Carbon for Use in U.S. Federal Rulemakings: A Summary and Interpretation.\”

The social cost of carbon (SCC) depends to some extent on what discount rate one uses. A higher discount rate makes future costs less salient in the present, and vice versa. They write (footnotes omitted): \”For 2010, the central value is $21 per ton of CO2 emissions and sensitivity analysis is to be conducted at $5, $35, and $65. The $21, $5, and $35 values are based on the average SCC across the models and scenarios examined for the 5, 3, and 2.5 percent discount rates, respectively. The $65 value—the 95th percentile of the SCC distribution at a 3 percent discount rate—was chosen to represent potential higher-than-expected impacts from temperature change.These SCC estimates also grow over time based on rates endogenously determined within each model. For instance, the central value increases to $24 per ton of CO2 in 2015 and $26 per ton of CO2 in 2020.\”

For economists, of course, a natural approach is to phase in a carbon tax at the level that matches the social cost of carbon, so that users of fossil fuels need to pay the social costs that they are imposing, and will have an incentive to adjust their behavior accordingly. How much of a boost would a carbon tax at these levels cause to, say, gasoline prices? A Congressional Budget Office Report from October 2008 looked at \”Climate-Change Policy and CO2 Emissions from Passenger Vehicles.\” The CBO estimate is that a carbon tax at $28/ton of carbon would add about 25 cents/gallon to the price of gasoline–if gas is $4/gallon, this would be a price increase of about 6%. A carbon tax would also affect coal and natural gas, so those prices would rise as well. This price increase is certainly noticeable; after all, part of the point is to provide incentives to developing non-carbon sources of energy. But on the other side, after the gas and energy price fluctuations of the last few years, it is hardly an unprecedented change for Americans to handle. U.S. gasoline prices, for example, would still be far below the levels common in Europe. In early October, the U.S. Energy Information Administration reported that the average U.S. price for a gallon of regular gas was $3.70, compared with almost $8/gallon in Germany, France, Italy, and the United Kingdom. 

 Of course, I\’m well aware that the Drill Baby Carbon Tax would be hard to legislate. At least some of the same environmentalists who complain that people are highly reluctant to believe the science of climate change will be themselves highly reluctant to accept the evidence that a realistic carbon tax should be set at this level–and instead will want something truly punitive. At least some of the those who favor additional development of U.S. fossil fuel resources will be dead set against a tax that would raise the price of this energy.  There would be dispute over how to use the $100 billion or more in likely revenues from a carbon tax of $20-25 per ton of carbon: for example, these revenues could be used as part of a package for long-run reduction of budget deficits, or could finance cuts in other taxes. It would probably be necessary to yoke the rising domestic fossil fuel production and the rising carbon tax together, so neither one could increase without the other increasing as well.

But while the practical details are daunting, perhaps this is one of the rare cases where for both extremes,  the prize is worth the compromise. And I suspect that plenty of folks in the middle might buy into the grand compromise of the Drill Baby Carbon Tax.

conversableeconomist

Variable Electricity Prices

Traditionally, households were billed for electricity at a flat rate. You could make investments in energy conservation, and the savings would be the quantity of electricity saved multiplied by that flat rate. But in the wholesale market, electricity rates fluctuate a great deal. When demand is highest, the system operators need to bring expensive \”peaking\” power plants on-line, and prices jump. With new \”smart meter\” technology, it is becoming possible for consumers to react to these fluctuations in electricity prices. In \”Dynamic Pricing
and Its Discontents\” in the Fall 2011 issue of Regulation magazine, Ahmad Faruqui and Jennifer Palmer offer a nice readable overview of the possibilities. If you\’re teaching a basic economics class and looking for a nice vivid modern real-word example of consumers adjusting to price changes that doesn\’t involve hypothetical pizzas and haircuts, electricity pricing might be a good choice.

Here\’s the underlying issue that causes wholesale electricity prices to fluctuate: \”Since electricity cannot be stored and has to be consumed instantly on demand, and since demand fluctuates based on lifestyle and weather conditions, the electric system typically has to keep spare “peaking” generation capacity online for
times when demand may surge on short notice. Often, these “peaking” power plants are only run for 100–200 hours a year, adding to the average cost of providing electricity. Dynamic pricing incentivizes electricity consumers to lower their usage during peak times, especially during the top 100 “critical” hours of the year, which can account for anywhere from 8 to 18 percent of annual peak demand.\”

Smart meters are coming: \”By 2015, according to the Institute of Electric Efficiency, about half of the nation’s 125 million residential customers will have smart meters. The institute anticipates that by 2020, nearly all customers will be on smart meters. Thus, a major technical barrier to dynamic pricing should be lifted in the next five to 10 years.\”

Consumers respond when faced with variable prices: \”However, almost all analyses of pilot results show that customers do respond to dynamic pricing rates by lowering peak usage. Indeed, in 24 different pilots involving a total of 109 different tests of time-varying rates — covering many different locations, time periods, and rate designs — customers have reduced peak load on dynamic rates relative to flat rates, with a median peak reduction (or demand response) of 12 percent…. In other words, the demand for electricity does respond to price, just like the demand for other products and services that consumers buy.\”

Consumers who have better technology to adjust their electricity use react more strongly:  \”During the past few years, a variety of new technologies have been introduced to help customers understand their usage patterns (through web portals and in-home displays, for example), to automatically control the function of their major end-uses such as central air conditioning and space heating equipment (smart thermostats), and to manage all their other appliances and plug-loads (home energy management systems). … Looking across all 39 pilot results with enabling technologies, the median peak reduction is 23 percent, 9 percentage points
higher than the median across all 109 results.\”

Many low-income customers would benefit from dynamic pricing: \”Some people speculate that because low-income customers typically use less power, they have little discretion in their power usage and are thus unable to shift load depending on price. As a result, low income customers would be hurt by dynamic pricing.
However, empirical evaluation of this speculation has indicated that most low-income customers would immediately save money on their electricity bills from dynamic pricing. In general, when customers are placed on a revenue-neutral dynamic rate, we expect roughly half of the customers to immediately see bill increases and half to see bill decreases. Customers who use more load in the peak hours than the average customer would see higher bills, while customers who use less load in the peak hours than the average customer would see lower bills. …  Because the low-income customers tend to have flatter load shapes, roughly 65 percent of the low-income customers were immediately better off on the CPP [critical peak pricing] rate than on the flat rate. In other words, even without any change in electricity usage, more than half of low-income customers are better off on a dynamic rate.\”
Total savings? \”At the national level, an assessment carried out for FERC twoyears ago showed that the universal application of dynamicpricing in the United States had the potential for quintupling the share of U.S. peak demand that could be lowered through  demand response, from 4 percent to 20 percent. Another assessment quantified the value of demand response and showed that even a 5 percent reduction in U.S. peak demand could lower energy costs $3 billion a year.\”

conversableeconomist

More on Hating Biofuels: The National Research Council

I\’ve posted here and here on how many international organizations hate government subsidies for biofuels. Now it\’s time for the National Research Council to have a whack at this pinata. The Committee on Economic and Environmental Impacts of Increasing Biofuels Production of the National Research Council has published: \”Renewable Fuel Standard: Potential Economic and Environmental Effects of U.S. Biofuel Policy.\” The report was mostly written under the chairmanship of Lester Lave, but was completed after his death last May. As befits a report from the NRC, it is a sober-sided discussion that lays out evidence at great length without seeking to take a particular explicit policy stance. Here are the eight major findings of the study, with a few quick comments from me, as quoted from the \”prepublication copy\” that can be downloaded free of charge:

FINDING: Absent major technological innovation or policy changes, the RFS2-mandated consumption of 16 billion gallons of ethanol-equivalent cellulosic biofuels is unlikely to be met in 2022.
RSF2 is the committee\’s way of referring to the Renewable Fuels Standard passed into law in 2005 and revised in 2007. Cellulosic biofuel is not from corn or soybeans or animal fat, but instead from certain kinds of grasses or wood chips. Cellulosic biofuel has the theoretical advantage that the sources for such fuel are cheap and abundant; however, producing fuel from these sources is harder than producing it from corn or soybeans or sugar, and the technologies for converting cellolosic material to biofuels are far from cost-effective. Indeed, they write \”no commercially viable biorefineries exist for converting lignocellulosic biomass to fuels as of the writing of this report.\”

FINDING: Only in an economic environment characterized by high oil prices, technological breakthroughs, and a high implicit or actual carbon price would biofuels be cost-competitive with petroleum-based fuels.
Indeed, the case for biofuels probably comes down to either very high oil prices or technological breakthroughs that make is much cheaper, because as the next finding notes, it\’s not at all clear that biofuels reduce greenhouse gas emissions.

FINDING: RFS2 may be an ineffective policy for reducing global GHG emissions because the effect of biofuels on GHG emissions depends on how the biofuels are produced and what land-use or land-cover changes occur in the process.
Expanded production of biofuels will almost certainly involve clearing and planting additional land. Depending on how it is done, this process can release more carbon than biofuels save. In addition, it\’s important to remember that the biofuels and agricultural products operate in a global market, so it\’s not just an issue of how U.S. biofuels policies affect clearing and planting of U.S. land, but how it affects clearing and planting of land all around the world.

FINDING: Absent major increases in agricultural yields and improvement in the efficiency of converting biomass to fuels, additional cropland will be required for cellulosic feedstock production; thus, implementation of RFS2 is expected to create competition among different land uses, raise cropland prices, and increase the cost of food and feed production.
FINDING: Food-based biofuel is one of many factors that contributed to upward price pressure on agricultural commodities, food, and livestock feed since 2007; other factors affecting those prices included growing population overseas, crop failures in other countries, high oil prices, decline in the value of the U.S. dollar, and speculative activity in the marketplace.
Many U.S. households can find ways to adjust without too much pain to a slightly higher price of food. But food products are sold in global markets, and for many people around the world, higher food prices can have dire consequences for nutrition and health.

FINDING: Achieving RFS2 would increase the federal budget outlays mostly as a result of increased spending on payments, grants, loans, and loan guarantees to support the development of cellulosic biofuels and forgone revenue as a result of biofuel tax credits.
Even if explicit subsidies for biofuels are allowed to expire, as they are scheduled to do at the end of 2012, the mandates for consuming biofuels will remain in place, which will raise costs for consumers. Also, gasoline is taxed and biofuels are subsidized, so a movement from gasoline to biofuels will reduce government tax revenues.

FINDING: The environmental effects of increasing biofuels production largely depend on feedstock type, site-specific factors (such as soil and climate), management practices used in feedstock production, land condition prior to feedstock production, and conversion yield. Some effects are local and others are regional or global. A systems approach that considers various environmental effects simultaneously and across spatial and temporal scales is necessary to provide an assessment of the overall environmental outcome of increasing biofuels production.
Biofuels are commonly sold on their environmental merits. The committee is saying here, in a very polite way, that when different feedstocks are considered, along with their effects on air, soil, and water, these purported environmental gains have not yet been convincingly demonstrated. 

FINDING: Key barriers to achieving RFS2 are the high cost of producing cellulosic biofuels compared to petroleum-based fuels and uncertainties in future biofuel markets.

I\’m a supporter of expanded energy R&D efforts. Maybe some scientists will find a way to make biofuels that are both cost-effective and clearly an environmental gain, in a way that doesn\’t drive up food prices around the world. But at this stage, subsidizing production of biofuels or mandating that they be used in certain quantities–especially for technologies like cellolosic biofuels that don\’t exist on a commercial basis–is putting the cart way in front of the horse.

conversableeconomist

America as Conventional Energy Powerhouse?!?

I\’ve been trying to wrap my mind around the issues and possibilities created by the new technologies for extracting oil and gas from North America. Amy Myers Jaffe, an energy expert who runs the Baker Institute Energy Forum at Rice University, has a nice provocative short article in the most recent issue of Foreign Policy magazine called  \”The Americas, Not the Middle East, Will Be the World Capital of Energy.\” Jaffe writes: 

\”By the 2020s, the capital of energy will likely have shifted back to the Western Hemisphere, where it was prior to the ascendancy of Middle Eastern megasuppliers such as Saudi Arabia and Kuwait in the 1960s. The reasons for this shift are partly technological and partly political. Geologists have long known that the Americas are home to plentiful hydrocarbons trapped in hard-to-reach offshore deposits, on-land shale rock, oil sands, and heavy oil formations. The U.S. endowment of unconventional oil is more than 2 trillion barrels, with another 2.4 trillion in Canada and 2 trillion-plus in South America — compared with conventional Middle Eastern and North African oil resources of 1.2 trillion. The problem was always how to unlock them economically.

But since the early 2000s, the energy industry has largely solved that problem. With the help of horizontal drilling and other innovations, shale gas production in the United States has skyrocketed from virtually nothing to 15 to 20 percent of the U.S. natural gas supply in less than a decade. By 2040, it could account for more than half of it. … Meanwhile, onshore oil production in the United States, condemned to predictions of inexorable decline by analysts for two decades, is about to stage an unexpected comeback.\”

Jaffe\’s article sent me back to the sober-sided Annual Energy Outlook 2011 published in April by the U.S. Energy Information Administration. Here\’s a figure showing how the new \”enhanced-oil recovery\” techniques are expected to raise oil production in the lower 48 states in a way that offsets declining production from Alaska. The report says: \”Rising world oil prices, growing shale oil resources (i.e., liquid oil embedded in non-porous shale rock), and increased production using EOR [enhanced oil-recovery] techniques contribute to increased domestic crude oil production from 2009 to 2035 in the AEO2011 Reference case (Figure 95). The Bakken shale oil formation contributes to growth in crude oil production in the Rocky Mountain Region, and growth in the Gulf Coast region is spurred by the resources in the Eagle Ford and Austin Chalk formations. Some of the decline in oil production in the Southwest region is offset by production coming from the Avalon shale formation.\”

And here\’s a figure showing that the share of U.S. oil consumption that is imported peaked in 2005, and is expected to fall over the next couple of decades. The report says: \”[W]hile consumption of liquid fuels increases steadily in the Reference case from 2009 to 2035, the growth in demand is met by domestic production.The net import share of U.S. liquid fuels consumption fell from 60 percent in 2005 to 52 percent in 2009. The net import share continues to decline in the Reference case, to 42 percent in 2035 …\”

Of course, there are potential environmental issues. There are issues about what kinds of risks are posed by these technologies for extracting oil, as well as about the conventional pollutants and carbon dioxide emitted by burning these fossil fuels. But for the next few decades, substantial quantities of fossil fuels will continue to be used. The carbon dioxide produced will be essentially the same regardless of where these fossil fuels are produced. Thus, if the local environmental issues can be worked out–that is, the issues about extracting these resources and about conventional pollutants–then there is no inconsistency in moving toward fossil fuels produced and refined by U.S. workers, rather than imported fossil fuels produced and refined by foreign workers, as we continue to seek ways of reducing global carbon emissions.  

conversableeconomist

Everybody Hates Biofuels

I hope that reports from international agencies will include some interesting facts, but I don\’t expect them to have policy recommendations that are more than fluff. Thus, it\’s stunning to me that a June 2011 report from 10 international agencies–FAO, IFAD, IMF,OECD, UNCTAD, WFP, the World Bank, the WTO, IFPRI and the UN HLTF–have come out with a strong and clear recommendation that governments drop their biofuel subsidies. 

The report is called \”Price Volatility in Food and Agricultural Markets: Policy Responses.\” It describes the situation of global prices in agricultural products over the last few years like this:

\”Irrespective of any conclusion that might be drawn concerning the long term trends, there is no doubt that the period since 2006 has been one of extraordinary volatility. Prices rose sharply in 2006 and 2007, peaking in the second half of 2007 for some products and in the first half of 2008 for others. For some products the run-up between the average of 2005 and the peak was several hundred percent. On the rice market the price explosion was particularly pronounced. The price rises caused grave hardship among the poor and were a major factor in the increase in the number of hungry people to more than one billion.8 Prices then fell sharply in the second half of 2008, although in virtually all cases they remained at or above the levels in the period just before the run-up of prices began. Market tensions emerged again during 2010 and there have been sharp rises in some food prices. By early 2011, the FAO\’s food price index was again at the level reached at the peak of the crisis in 2008 and fears emerged that a repeat of the 2008 crisis was underway.\”

The 10 agencies point to a number of factors affecting food prices: growing world population and incomes, weather-related disruptions, and others. But then they focus quite particularly on biofuels subsidies (I\’ve dropped footnotes and paragraph numbers from the quotation that follows).

\”Between 2000 and 2009, global output of bio-ethanol quadrupled and production of biodiesel increased tenfold; in OECD countries at least this has been largely driven by government support policies. …  Biofuels overall now account for a significant part of global use of a number of crops. On average, in the 2007-09 period that share was 20% in the case of sugar cane, 9% for both oilseeds and coarse grains (although biofuel production from these crops generates by-products that are used as animal feed), and 4% for sugar beet. With such weights of biofuels in the supply-demand balance for the products concerned, it is not surprising that world market prices of these products (and their substitutes) are substantially higher than they would be if no biofuels were produced. Biofuels also influence products that do not play much of a role as feedstocks, for example wheat, because of the close relations between crops on both the demand side (because of substitutability in consumption) and the supply side (due to competition for land and other inputs).

\”At the international level, crop prices are increasingly related to oil prices in a discrete manner determined by the level of biofuel production costs. … Since both energy and food/feed utilise the same input, for example grain or sugarcane, increases in the production of ethanol reduce the supply of food and result in increases in its price. This relationship between the prices of oil, biofuels and crops arises due to the fact that, in the short run, the supply of crops cannot be expanded to meet the demand by both food and energy consumers.

\”If oil prices are high and a crop\’s value in the energy market exceeds that in the food market, crops will be diverted to the production of biofuels which will increase the price of food (up to the limit determined by the capacity of conventional cars to use biofuels – in the absence of flexfuel cars and a suitable distribution network). Changes in the price of oil can be abrupt and may cause increased food price volatility. Support to the biofuel industry also plays a role. Subsidies to first-generation biofuel production lower biofuel production costs and, therefore, increase the dependence of crop prices on the price of oil. Such policies warrant reconsideration.\”

And so the 10 international agencies offer what strikes me, by the standards of these kinds of reports, as a shockingly blunt recommendation:

\”Recommendation 6: G20 governments remove provisions of current national policies that subsidize (or mandate) biofuels production or consumption.\”