Chaos unfolding without control of greenhouse gases

Chaos unfolding without control of greenhouse gases

Relevance of carbon taxes and cap-and-trade

Martin and Elizabeth David

26oct09 Chaos unfolding with CO2E 2

Outline

1. Consequences of climate change

2. Our decision problem

3. Institutions

4. Mechanisms for affecting CO2e

5. Weaknesses of current legislation

6. Discussion


Why reduce CO2e now?

• Sea levels may rise 3m; major rivers may cease to flow; both extreme drought and extreme rainfall events are likely.

• The probabilities of these events over the next 50-100 years are uncertain.

• The last 20 years contain 10 of the warmest global climate years in 120 years.

– The trend in the last 20 years exceeds the past.

– The level exceeds any levels detected from geological data over 100,000 years.


Extreme events are decisive to risks of GW

• Class 5+ tropical storms

• Flooding of low-lying areas due to increased probability of rainfall events over 3 inches

– implies loss of crops, less infiltration, dam failures

• Melting of glaciers: Greenland, Antarctic, and Himalayas forebode

– sea level rise

– drought in major rivers


What to do now?

Take no action• “Eat drink

and be merry for tomorrow we die.”

Act now

to abate CO2e emissions• We may avert some of the worst

possible futures.• We can adapt to

– change in sea level– local climate regimes.

No success is assured, its likelihood is uncertain.


What does uncertainty mean?

• Future climate events are drawn from a distribution likely to have a higher mean and more variance than the past 120 years.– Both floods and droughts are more likely.– Warming makes some land uninhabitable:

• Islands and seacoasts• Areas without access to potable water• Areas too boggy to cultivate (Siberia)

– Likelihoods are not estimable from historic data.


Weitzman’s distribution game

Conventional deck of cards: A=1, K=13mean = 7, Pr(n) =1/13 where 0<n<14

1. Replace 6,7,8 with Random draws from n≠ 6,7,8variability rises, mean is constant

2. Replace 1,2,3 with Random draws from n> 3mean rises, variability shrinks with duplicates

3. When higher numbers are added to the deck – 14,15,16,17,18,19 – mean and variability rise.If the highest card comes from a rising distribution,

predicting risk of extreme events is impossible.


How can CO2e be reduced?

• Supply

– Increase thermal efficiency of fossil fuel consumed• fix leaky pipes and storage facilities• cogeneration, geothermal HVAC• reduce losses on transmission grids

– Increase sources of renewable energy• Solar, wind, tides, harnessing photosynthesis

• Demand

– Reduce fossil energy consumption• Increase thermal efficiency of structures• Reduce fossil-powered vehicle use or increase miles/gallon


Institutions & Mechanisms

Generic requirements

• Monitoring / transparency

• Enforcement / stipulated penalties

• Self-enforcing institutions

CO2e specific options

• Carbon Tax

• Cap-and-trade

• Command and Control (CAC)


Institutions: controls on producers -1

• Regulated public utilities

– siting, price, investment, emissions

• Electricity grid and pipelines

– siting, construction, access– V.L. Smith (Nobel ‘02) pioneer in institutions

• Agencies: FERC / WI/PSC / EPA


Institutions: controls on producers 2

• Large energy consumers

– emissions

• Small energy producers (solar & wind)

– access to grid, price for energy

• Commercial /residential

– building codes, weak incentives for cogeneration


How to reduce CO2e emissions?

Create incentives for people to change “business as usual” activities

• Make plant managers see emissions as costly to their business– Punitive approach: penalties for emissions– Positive incentives for emission reductions

• Make consumers realize that emissions are expensive to them and their health– Punitive approach: penalties for emissions– Positive incentives for emission reductions


Reducing CO2e emissions

• Approach will vary by producing industries

– Regulated public utilities

– Other large users of fossil fuels

– Smaller industrial & commercial activities

• Approach will vary across consumers

– Poor can not afford to pay more for energy

– Wealthy can invest in alternative energy sources


Mechanisms: Carbon Tax 1

• Tax emissions (CO2e) from fossil fuel use to all businesses and consumers

– monitoring emissions must be continuous and precise

– all emissions must be covered



• Scope: tax fossil fuels (CO2e) used by• Consumers• Exporters• Business investors, including capital goods• Governments & Nonprofit organizations

• Flexibility– Tax rate can be adjusted up/down

• If reduction in CO2e exceeds policy target, rate can be lowered.

– Incentive for all users to reduce CO2e



Drawbacks

• New nationwide bureaucracy

• “Stickiness” of tax rates

– legislators loathe to change tax rates

• Measurement of CO2e needed for all producing establishments

– Can tax purchases, knowing carbon content, when taxing emissions is impractical.


Mechanisms: Cap-and-trade

• Scope: Encompass all CO2e releases by plants within the USA

• Permit attributes

– emission allowed (denomination)

– life (period during which permit is valid)

– transferability (eligible purchasers)

• Enforcement

– monitor emissions

– stipulated forfeitures


Mechanisms: Cap-and-trade 2

Drawbacks

• Continuous monitoring of CO2e essential

• Multi-year permits encourage hoarding

• Issuing permits (at no cost) in proportion to past emissions subsidizes facilities in proportion to past insults to the environment


Chicchetti’s options for Public Utilities

• Historic utility (HU) model– Build new capacity (requires PSC OK)– Sell energy product (price determined by PSC)– Maximize reliability of delivery

• Demand-side management (DSM) model– Encourage users to reduce energy purchases– Purchase renewable energy from dispersed

sources (e.g. residential solar panels)• Regulators must make DSM more profitable than

the historic utility model.


Mechanisms: Command and Control

• Regulations specify allowed emissions– EPA required to regulate emissions that

impact public health• Allowed emissions established by protocol

which entails public comment, review, and notice of final rules– Rule-making may take many years.– Rules may differentiate among types of

emitters (e.g., agricultural and industrial emissions.)

– Rules can be challenged in court.


Weaknesses of current legislation:Questions that must be answered affirmatively

• Scope

– Are all fossil fuel users affected?

• Strength of incentives for change

– Are users aware & induced to change?

• Distribution of cost and benefits

– Is the societal impact distributionally neutral?


Weaknesses: (ACES) American Clean Energy and Security Act

• Reduction:

– base year: 2005 (EU uses 1990)

– 2020 target: -17% (EU target 20%)

– 2050 target: -83%

• Failure to auction all discharge permits

– CBO estimates close to $1000 billion revenue from auctioning all permits.

– CBO estimates $300 billion from ACES.


Weaknesses: American Clean Energy and Security Act

• Withdraws EPA power to regulate CO2e

• Permits purchase of offsets in lieu of reductions• Excludes small facilities • No incentives for small combined-cycle

electricity generation

– valuable to raise thermal efficiency to 80%• Examples: shopping centers, large buildings


Carbon tax or cap-and-trade now!

• Act now

• Insist on transparency

• Expect resistance to good policy

Questions?

Contact: [email protected]


Uncertainty trumps business as usual

• Homeowners insure against fire risks <0.01• Nationally, we need policies that provide

infrastructure to:– mitigate costs of extreme events, even if they

occur 50+ years from now– adapt our economy to be robust to more

extreme meteorological events• Reducing CO2e emissions (insurance that)

reduces the risk of events from extreme draws in the unknown distribution of bad outcomes.


What to do?

• Netherlands is strengthening its dykes; removing habitation from below sea level.

• US needs to plan for diversion of the Mississippi into the Atchafalya R.

• US needs to cease unsustainable water withdrawals (mining water) and subsidizing water for irrigation


The “commons”,success & failures of economic science

• Commons can be governed without private ownership

• Elinor Ostrom (2009 Nobel, economics)

• Behavioral science– insight into how decision-makers perceive risk

and justice• Kahneman [& Tversky] (2002 Nobel economics)

– the prisoner’s dilemma and bubbles• Cassidy New Yorker 10/5/09, (John Nash 1994

Nobel economics)


The following slides were not discussed

• I will be happy to answer questions


Benefits of CO2e reductions should use a distribution of outcomes

Benefit-cost analysis• requires projecting estimated distributions for

more than 100 years– historic evidence on climate

• lacks fine geography• reflects a distribution that has shifted recently

– historic US national economic data• about 80 years for national product; 50 years for

industrial sectors

• Projections for 2110 are highly uncertain


6. How do we transfer wealth to the future?

• Future productivity > present– resource base > present

• Techno fix (US bias)• Increased human resources (increased ability)• Greener earth – sustainable use of the environment

– We drink our own sewage.

• Land resources endowed to future must have sustainable characteristics.

• Built environment must be sustainable and suitable for coming climate conditions.

• Financial assets bequeathed are irrelevant.


4. Time over generations

• Insurance is a metaphor for paying premiums now (investing) to ameliorate risk of future disasters.

• How do we value future benefits?

– We need to assess risk under uncertainty.• Historic data certain to understate future risks.

– Extreme events will dominate the value of current precautionary behaviors.


Time over generations

• Rate of time preference– individual consumption: What compensation do I

need to wait for pleasurable consumption next year, as against immediate consumption?

• Expressed as a discount rate: 1/(1-r) for 1 year; (1-r)-n for n years.

– bequest motive: What portion of my lifetime wealth should be used to endow consumption for the next generation?

• Typically involves a negative rate of discount as individuals forego consumption to benefit children, land trusts, or foundations


Strength of bequest motive

• Clearly evidenced by parental financing of children’s education

• Relatively few empirical estimates of strength• Studies of charitable contributions give some

estimates of willingness to endow persons outside the family and for facilities that are operable past 50 years into the future

• Public facilities – space research, schools, levees, dams – give some evidence of motives to bequeath outside the family and to future generations.


What social rate of discount is appropriate to climate change?

>0. Benefits in 100 years are worth little at discount rates >.01

=0. No discounting is appropriate

< 0. People living now, will pay a premium to assure that future have not less access to well-being than those alive today.

No answers are available from existing research.


Institutions: controls on producers 3

• Farms and agriculture cooperatives

– production subsidies, special loan terms

– CRP subsidies to reduce run-off

– economic pressure from suppliers and buyers• little market power for farmers• great market power for inputs and purchases

– some problems eased by agricultural services from USDA, cooperatives

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Chaos unfolding without control of greenhouse gases