Any mention of climate policy was noticeably missing from President Obama's recent state of the union address. This is unfortunate because every day of inaction on climate policy by the United States government is another day that American consumers must pay substantially higher prices for products derived from crude oil,
such as gasoline and diesel fuel. Moreover, a substantial fraction of
the revenues from these higher prices goes to governments of countries
that the US would prefer not to support.
So, what is the cost
of a single day of delay? US crude oil consumption is approximately 20m
barrels per day and roughly 12m barrels per day are imported. An oil
price that, because of climate policy uncertainty, is $20 a barrel
higher than it would otherwise have been implies that US consumers pay
$400m per day more, of which $240m per day is paid to foreign oil
producers. Dividing these figures by the United States population
implies that every US citizen is paying about $1 per day more for oil -
and more than half of that may be going to an unfriendly foreign
government.
Why does this climate policy price premium exist? It
is not due to a dearth of readily available technologies for producing
substitutes for conventional oil. A number currently exist that are
economic at oil prices significantly below current world prices of
$80-90 per barrel. Several even have the potential to scale up to
replace a large fraction of US oil consumption.
Tar sands and heavy oils, gas-to-liquids and coal-to-liquids
are all available to produce substantial amounts of conventional oil
substitutes at average costs at or below $60 per barrel. If these
technologies were currently in place throughout the US, the world price
of oil would not exceed that price, because any attempt by conventional
oil suppliers to raise prices beyond that level would immediately be
met by additional supply from producers of oil substitutes.
But
if these technologies are financially viable at current world oil
prices, then why don't they exist in the US? That's because they
require massive up-front expenditures to construct the necessary
production facilities. These fixed costs, plus the variable costs of
production, must be recovered from sales over the lifetime of the
project - and future climate policy can substantially increase the
variable costs of these technologies.
Climate policy
uncertainty impacts of the economic viability of these technologies
because of the increased carbon intensity of the gasoline and diesel
fuel substitutes they produce. Almost double the greenhouse gas
emissions result per unit of useful energy produced and consumed relative to conventional oil. Therefore, if the
US decided to set a significant price for carbon dioxide (CO2)
emissions at some future date, either through a cap-and-trade mechanism
or carbon fee, investors in these technologies would immediately
realise a massive loss - because they would have to pay the price fixed
for all of the CO2 emissions that result from producing and consuming
these oil substitutes.
To understand this point, suppose that a
technology exists to convert coal to an oil substitute that is
financially viable at an oil price of $60 per barrel and that this
technology produces double the CO2 per unit of useful energy relative
to oil. At a $90 per barrel oil price, this technology could be
unprofitable for a modest price of carbon dioxide (CO2) emissions
because of its substantially higher carbon intensity. For instance, at
a $100 per ton price of CO2 emissions - which is roughly twice the
highest price observed in the European Union's emissions permit trading
scheme - the total cost per barrel of oil equivalent, including the
cost of the additional emissions, could easily exceed $90 per barrel.
A
solution to this investment impasse is a stable, predictable price of
carbon into the distant future. Although there is currently a regional
cap and trade mechanism for CO2 emissions in the Northeast US, permit
prices in the Regional Greenhouse Gas Initiative (RGGI) have been
extremely modest - less than $5 per ton of CO2. California also plans
to implement a cap-and-trade mechanism in 2012. No significant
coal-mining activity takes place in the participating RGGI states or in
California. But such regional cap-and-trade programmes are unlikely to
set prices for CO2 emissions for a long enough time and with sufficient
certainty to encourage investment in facilities to produce conventional
oil substitutes. In other words, despite regional experiments with
cap-and-trade, it is the national climate policy uncertainty that
remains the major factor in preventing these investments.
If
prospective investors in the major fossil fuel-producing regions of the
US knew the cost of the CO2 emissions associated with these alternative
technologies over the lifetime of each alternative fuel project, they
would be able to decide which projects are likely to be financially
viable at that carbon price. Particularly for coal-to-liquids, much of
this investment would take place in the US because of the massive
amount of available domestic coal reserves. This investment would also
provide much-needed new domestic high-wage jobs.
New sources of
supply of conventional oil substitutes would reduce oil prices, create
new jobs in the United States and reduce the amount of money sent to
governments, whose interests are counter to the US. Finally, this price
of carbon would raise much-needed revenues for the US government and
stimulate investment in lower carbon energy sources, such as wind,
solar and biofuels. A modest, yet stable long-term price of carbon
might even stimulate so much investment in conventional oil substitutes
and low-carbon energy sources that the long-term net effect of this
carbon price could be lower average energy prices across all sources.
The
investments in these technologies need not result in higher aggregate
CO2 emissions. For example, coal-to-liquids produces a concentrated CO2
emissions stream that is ideally suited to the deployment of carbon
capture and sequestration (CCS) technology. Consequently, a carbon
price high enough to make CCS financially viable, yet reasonable enough
to make this technology competitive with conventional oil, would
address both concerns.
If there are concerns that committing to a
modest carbon price may be insufficient to address climate concerns,
this commitment could be stipulated only for investment projects
initiated within a certain time window. The US government could reserve
the right to increase this CO2 emissions price for projects initiated
after that period. This logic has not escaped the Chinese government,
where General Electric and Shenhua, a major Chinese coal producer,
recently announced a joint coal gasification project, which is
financially viable because the Chinese government can provide the
necessary climate policy certainty.
The choice is stark: either
we can continue to wait to implement the perfect climate policy, and in
the meantime pay higher prices for oil, and watch countries like China
that are able to provide climate policy certainty to investors move
forward with this new industrial development; or we could commit to a
modest climate policy and so unleash the new technologies and new jobs
made possible by this more favourable investment environment.
