The Inevitability of Carbon Pricing and Preparation Strategies

The Inevitability of Carbon Pricing and Preparation Strategies

It has become clear in recent years that global carbon pricing, or at least a globally extensive set of regional carbon pricing, is extremely likely to occur in the near future. Many places have continental, national, or regional carbon trading schemes set up such as Europe although the early years there were beset with significant problems and are only now beginning to reorient. Eight of the largest Big Oil companies around the globe are being proactive in calling for a global price on carbon. The biggest companies in the U.S., Chevron and Exxon-Mobil, declined to be a part of that but Exxon-Mobil CEO Rex Tillerson recently called for a revenue-neutral global carbon tax that would differ in each country. Climate scientist James Hansen has long called for a fee-and-dividend carbon tax which is also revenue neutral. Just recently, in a segment on NPR’s Living on Earth, he reiterated his dislike for the cap-and-trade approach, preferring a flat tax with the dividend returning to the public. With these calls come more news analysis discussion of carbon pricing. BP’s CEO Bob Dudley gave a very clear account of the inevitability, importance, and dynamics of carbon pricing as well as all the factors involved, in the Reuters news story referenced below. Much of this increased carbon pricing news is happening in a lead up to the Paris climate summit (COP21) which just concluded with an historic agreement. 

A Direct Carbon Tax vs. a Cap-and-Trade Carbon Emissions Market

Among those who favor carbon pricing there are those who favor a more market-based approach like emissions trading systems (cap-and-trade) and there are those who favor more of a blanket carbon tax on production and consumption. The cap-and-trade approach has been strongly criticized. The European Union Emissions Trading System (EU ETS) which began a decade ago was wrought with unfair emissions allowances and unscrupulous carbon offsetting schemes. Then the price of carbon dropped out during the economic downturn, making the system even more ineffective. It is just now starting to work, say some advocates. Other regional carbon markets, in California and other Western states (Western Climate Initiative - WCI) and the U.S. Northeast (Regional Greenhouse Gas Initiative – RGGI) have been deemed moderately successful so far. Obama’s Clean Power Plan (CPP) is similar to a carbon market as well as an air pollutant market in the sense that states must comply but are given flexibility about how to comply. Direct carbon pricing that ratchets up through time, many argue, would be simpler to implement and account than dealing with the complexities of allowances and offsets in a cap-and-trade system. 

 

Free market advocates tend to see carbon pricing as penalty costs for carbon emitters, both sellers and buyers. Of course, the goal of any carbon tax or market is just that, to put pressure on sellers and to make lower carbon and zero carbon options more competitive. One question is how far upstream to levy the tax. Another is how to distribute the dividend. A strength of a cap-and-trade system is that it has a cap while the tax doesn’t – the tax itself provides the disincentive that ends up becoming a market-imposed cap. But what that cap becomes is dependent on several factors: distribution of allowances, carbon offset evaluation, and energy demand expressed through the financial markets. The effectiveness of a tax depends on how the dividend is distributed. Both approaches have uncertainties especially if certain interests can unfairly advance their own interests at the expense of the overall goal of reducing emissions.

   

Stewart Taggart notes that “…about 10% of global carbon emissions are now covered by some form of pricing.” The EU ETS accounts for about three-quarters of the global market and will likely set the pace for a general global carbon price. However, the price is currently thought to be undervalued due to excess permits on the market. There is a call by some to withdraw some permits to boost prices. A gradually rising price suggests that a gradual decrease in demand for emissions will result and that is the goal – to decrease emissions. Forecasters seem to be predicting a 2020 price range between $20 and $35 per tonne. Companies are inputting these prices into their business models to see costs and how different scenarios compare. 

    

The Murky Future of Coal

By all accounts coal will get the short end of the stick as carbon pricing kicks in and emissions caps get ratcheted down through time. The only possible redeeming path for coal seems to be carbon sequestration which could be partially funded by carbon pricing. While there are many carbon capture and sequestration projects in progress, including enhanced oil and coal-bed methane recovery projects, it is also acknowledged that these projects are not economical and require some form of incentives or subsidization and likely, carbon pricing revenue, to work and become more widespread. In that sense carbon pricing could help coal but it is unclear at what price and how much. This will likely help incentivize carbon capture and storage projects - CO2 enhanced oil recovery projects, CO2 enhanced coal-bed methane projects, and gas power plant CO2 capture and storage projects. Obama’s Clean Power Plan is also slated to have a big negative affect on coal utilization in the U.S. There also seems to be more disapproval of exporting coal judging by the cancellation of export terminals in Western Canada. Coal investment will more and more be looked at in terms of a stranded resource liability. Financial bodies like the World Bank have announced they will no longer even consider funding coal plants. A coal industry spokesman in Europe even fears that the coal industry will become vilified like slave traders were once vilified.]

 

Emissions evaluations show that coal burning is the highest greenhouse gas emitting source and that developing countries, mainly China and to a lesser extent India are the highest emitters. Therefore, it can be argued that reducing coal use in these developing countries should be of the highest priority for reducing carbon emissions. Switching power burn from coal to gas is the biggest factor in the U.S reduction in carbon emissions over the last seven years. It seems likely that the worldwide coal market is set to contract, except in certain regions and their sources: including China, India, Australia, and Indonesia. At present, coal is still the most viable economic path for some of these countries for reducing energy poverty but that will change eventually with improvements in renewables and gas availability and infrastructure.

Distributing the Dividend

Australian scientist Tim Flannery suggests that costs per tonne of “third way technologies,’” those developing carbon capture technologies that are likely to be benign, should act as a guide for the capital needed to be raised by carbon pricing. Likewise that cost should guide what should be paid by emitters. James Hansen’s fee-and-dividend scheme would pay the dividend to the public, presumably to help offset higher energy costs. A strategy for those developing carbon capture, transport, and storage technologies would be to accurately assess their cost per tonne when technologies are deployed.

Conservative economist Gregory Mankiw acknowledges the usefulness of a carbon tax in mitigating emissions and advocates that the dividend be distributed to people through the reduction of sales taxes, income taxes, and other taxes. The reduction in taxes will offset higher prices for carbon intensive energy: electricity, gasoline, oil, natural gas, etc. The key for U.S. acceptance of such scenarios, he says, is to convince the voting public of the benefits, then the politicians on the right will accept it. Like others, he favors a carbon tax over cap-and-trade for its simplicity. He also sees it as a market-based solution, in line with deregulation. In the past, advocates of such scenarios have advocated coupling carbon taxes with rolling back regulations but that is not at all likely. It does not make much sense at this point. Others (Elon Musk for obvious reasons) have advocated distributing the dividend to clean energy tech development. However, it has also been shown that distributing the dividend towards clean energy development is not likely to be effective since current incentives are far more than the revenue would provide (only 20-50% of current incentives by one estimate). It can help reduce direct government clean energy subsidization but would not help offset cost increases for lower-income people. Thus any of these scenarios (reducing taxes and funding clean energy) are likely to disproportionately affect the poor.

It is unclear to me how a carbon tax would affect imported fossil fuels to the U.S., mainly oil but also some Canadian gas. A price at sales point would seemingly be more equivalent and fair. However, if we assess and tax U.S upstream greenhouse gas emissions (mainly methane), how do we assess foreign upstream emissions, especially if other countries don’t have similar or comparable emissions assessments and regulations? Would this give advantage to foreign producers like Saudi Arabia, Russia, and Qatar? That would be very unfortunate and unfair, especially since OPEC has been pushing for market share and competitive advantage. Many would argue that such countries with poor human rights records and financial support of terrorism and oligarchies do not deserve to be rewarded any further.

The new carbon tax proposed for Alberta in Canada (supported by the populace as well as tar sands developers surprisingly enough) appears to not be revenue neutral, but instead to be split: some to a public dividend, some to encourage energy efficiency, some to encourage compliance in oil & gas by increasing methane emissions reduction but also encouraging increasing natural gas production so that coal power can be retired sooner, and some for renewables development. Carbon capture and storage is also a big part, particularly for tar sands operations. Coal is the big loser and is slated to be phased out completely as a power plant fuel by 2030. With this as a model, as well as the specter on the horizon of new regulations requiring reduced methane emissions particular to upstream oil and gas sites and facilities, perhaps oil & gas companies should be proactive and begin to acquire and implement further methane emissions reduction technologies, as they did fairly successfully early on with so-called “green completions.” However, it may be more difficult to be proactive in the current commodities price environment. Even so, being proactive with measuring and capturing the maximum amount of leaking methane from upstream systems now would probably be a smart strategy for oil and gas companies. However, another important issue is whether those emissions have been properly assessed and if significant further reductions are even possible with current technology. Another gamble is whether newer and better technology will displace that available now. Such a proactive strategy would also help validate natural gas as a low carbon rather than a medium carbon resource. This, in turn, could help gas producers who use fracking (>80% in the U.S.) become more acceptable to a doubting public.

Emissions Assessment and Reduction Strategies

Oil & gas companies would also be wise to be proactive in trying to model a post-carbon pricing world. Ten of the largest global oil companies are trying to do just that by attending, sponsoring, and interacting at the Paris (COP21) Climate Conference generally in support of a clear policy of global carbon pricing so that their business models can be adjusted accordingly. Reduction of the corporate climate footprint will pay in the future. For gas producers in dry gas areas the use of ‘field gas’ or CNG to run drilling rigs, frack pumps, and fleet vehicles and the increased use of CNG can be incentivized as lower carbon alternatives to diesel. Reduced trucking also reduces carbon emissions so water pipelines and processing facilities are also incentivized. Emissions assessments may become more detailed and regulated. Continuous remote air and water monitoring of well sites, impoundment ponds, and processing facilities could become the norm.

Utilities can buy more wind, hydro, and solar capacity. They can also incorporate more battery storage for frequency response. Carbon pricing also incentivizes efficiency improvements. More ‘combined heat and power’ (CHP) generation is likely. Carbon pricing with or without dividends to the clean energy sector could help renewables. Dividends going to clean energy could make it easier to reduce and eventually phase out direct renewable energy credits. Thus renewables would have less of a need for government (taxpayer) subsidization but could also be helped by taxes on emitters.

  

Energy Market Disruption

There is little doubt that carbon pricing will disrupt energy markets. It will be a great incentive to wind and solar and allow wind in particular to be very competitive in more electricity markets. Even the threat of carbon pricing is affecting markets. The investment community may come to see investments in outdated carbon-intensive coal mines and power plants as investments in “stranded assets.” This is already happening with utilities fighting to preserve old plants through profit guarantees. Financiers at the Paris meeting have suggested a carbon disclosure system where the weight of companies’ investments in high carbon projects could be determined. CEOs are calling for “climate competent” boards so they can be able to negotiate and navigate their adjustment strategies and fully assess their corporate carbon portfolios. Government de-subsidization of fossil fuels, carbon pricing, devaluation of potential stranded assets, and increased low to zero carbon investment, have also been called for by some business leaders. A company might want to calculate their carbon exposure in terms of life-cycle emissions. Expectations should be to assess and reduce emissions by process, by company, by industry sector, and ultimately by region, country, and world. Carbon costs and liabilities are also being considered by investors.

The Alberta example shows that the devil may be in the details of a carbon tax. Emphasis will likely be on keeping prices as low as possible for utility ratepayers, discouraging coal and high emissions projects, increasing renewables and storage, and reducing emissions from the gas sector. By making gas more emissions friendly its use in replacing coal could be expanded, for potentially quick emissions reductions where applicable.

Some biofuels may benefit but accurate assessment of emissions for these sources have varied so one version would have to be agreed upon. This is true for several emissions sources. How would biomass sources like wood-burning power plants and waste-to-power plants be treated with their increased pollution? Would carbon pricing cause more to be built since they have been considered close to carbon neutral (although that has been debated) thus increasing particulate matter and several other unhealthy pollutants? Sources like bio-CNG, or biogenic gas collected from landfills, should benefit, as otherwise such gas would leak into the atmosphere and not be captured. Energy efficiency of large buildings would need to be improved and most efficiency investments would thus have some further incentives and decreased payout times. Electric Vehicles (EVs) and possibly Natural Gas Vehicles (NGVs) would theoretically be even more favored over gasoline and be incentivized relatively or possibly de-incentivized to some extent. Since EVs use electric of variable sources their subsidization or de-subsidization would likely be realized through available electricity pricing based on regional carbon evaluations. This could vary by area as different areas are decarbonized to different degrees. Oil derived fuels like diesel and gasoline would likely rise in price more than natural gas or lp gas. Higher electricity prices along with recently extended federal renewable energy credits in the U.S. will make rooftop solar a little more economic than at present and forward modeling with ratcheting up carbon pricing will decrease the payout times.

     

The Role of Natural Gas in World with a Price on Carbon

Gas is the least greenhouse-gas-emitting fossil fuel. Its advantages over coal have allowed it to replace coal in power burn thus leading the U.S reduction in CO2 emissions. As stated earlier, one thing the gas industry needs to do is assess and reduce methane emissions and other CO2 emissions from upstream, midstream, and downstream. This would provide a better understanding of the rates of emissions, sustainable goals for emissions reductions, and provide the public with better assurances of emissions reductions capabilities. What will be the role of gas in de-carbonizing the economy? Most reasonable scenarios would favor increased natural gas usage in the near term, for replacing coal in power plants, for replacing heavy polluting diesel in ships, train engines, long-haul trucks, drilling rigs, fleet vehicles, buses, lp gas for cooking and heating, and other equipment, and for replacing fuel oil for heating where applicable. Every one of these switches to gas (or lp gas) involves significant net carbon emissions reduction, available inexpensively with current technology and more cost effective over the mid-term than current fuel usage and more cost effective than switching to renewables. Gas is ready to go – if it can be supplied (current supply is overflowing), if it can be pipelined to markets, if infrastructure is in place (well underway) and if businesses, government entities, and individuals participate. There is some disagreement among policy-makers and environmentalists whether gas should be encouraged or discouraged. Encouragement in the short-term might be vital to quick emissions reductions capabilities. Discouragement may happen in the long-term but certainly after reduction in coal and petroleum usage and adoption of feasible alternatives. LNG offers safe and portable supplies of gas to various pipeline and plant sizes. Pipelined gas is cheaper and has lower carbon and pollution footprints since it does not have to be liquefied and then re-gasified which uses energy. CNG is much less processed than LNG as it is simply compressed. Some oil and gas companies utilize field gas to run equipment which is very low impact, cost effective, and localized. Coal-to-gas and diesel-to-gas switching should continue and be slightly more attractive under a carbon pricing scenario that ratchets up. There would perhaps be less concern about an unexpected rise in nat gas prices relative to coal or diesel. The current gas glut and ease of availability of shale gas should keep gas prices reasonably low for some time in the U.S. even with LNG exports and increased domestic use.

Current fossil fuel use in the world makes up about 85% of all fuel use. Natural gas makes up about 25% of the total while coal and oil make up about 30% each. Renewables: hydro, wind, and solar make up about 15% and of that 15% hydro makes up the most, however, hydro has very little room to expand. The implication is that natural gas use will need to expand if these climate commitments are to be met. Thus infrastructure: pipelines and LNG receiving infrastructure will need to expand even if there is some oversupply at present. If China and other countries are to replace coal plants with gas plants to reduce emissions as the U.S. has done they will need vast infrastructure investments and implementation in the short-term. This will also help their domestic gas industries including Chinese shale gas which is viable but behind schedule mainly due to costs of infrastructure. Renewables will also be added vigorously but in order to meet the climate targets gas use and infrastructure will have to be expanded, as it can lead to these reductions faster. With the addition of uncoventional gas resources the reserve supply of gas has more than doubled, also potentially doubling the time of transition from coal to gas. However, the climate models and new commitments require a faster transition away from coal and eventually a transition away from gas in the more distant future. Supply and infrastructure projects need to be designed for both the short-term and the long-term.    

    

Post-Paris Accord

Now that 195 countries have agreed to non-binding emissions cuts it remains to be seen how each country will approach such commitments. Certainly regional and national carbon prices by way of taxes and carbon trading markets will be a part of the picture. I would expect various announcements soon. Most of the more alarmist environmentalists have condemned the agreement mostly because it is non-binding and cuts (as of now) do not meet the 2 deg C. target, but they are heading that way. As it is now the Paris Accord has similarities to Obama’s Clean Power Plan, where each country has the flexibility to arrange its energy sources as it deems necessary to get to the emissions targets. One reason it had to be non-binding is that U.S. Congress would have voted down any binding agreement – by not ratifying it. While Hansen and others called for a global carbon price that would ratchet up rather quickly, it seems more likely and more pragmatic to do things on a country or regional basis. Eventually, all countries will have to acknowledge a price on carbon, even detractors like Saudi Arabia and Russia, who could stand to lose. Global carbon pricing would strongly affect any countries that have their economies disproportionately dependent on fossil fuel sales, some of the same countries that are now struggling due to low oil prices: Venezuela, Nigeria, the Arab Gulf States, Iran, Iraq, Russia, etc. It is unclear (to me) how regional/national carbon pricing will affect countries who do not participate. One would think that since they are parties to the agreement, that they also pledge to tax or market carbon to help monetize de-carbonizing their respective economies. Accurate emissions reporting, accountability, and enforcement of non-compliance are also issues of concern. The accord has been hailed as the beginning of the end of the fossil fuel era. However, there is still much fossil fuel to be produced and the mix is likely to change from coal to gas for electricity production where gas is available. The LNG market has potential and could be a help for countries to meet their commitments as are renewables, carbon sequestration, and energy efficiency measures. The low cost of coal in Asia from Indonesia, China, and Australia is still attractive. Indonesian coal production is causing some environmental problems as well.

The hope for a single official global carbon price is probably out. However, regional and national carbon pricing based on the EU ETS current price is likely a beginning, with ratcheting up in the future. The Paris commitments are a first step. If governments and utilities commit to reductions, incentivize renewables, and de-incentivize coal (by not buying it) then there would be no need for pricing. However, it is likely that de-incentivizing by making coal more expensive is likely. Since gas is just as economic as coal and even more so in some places, one might reason that in the near-term gas use should be promoted – by excluding it in the carbon pricing for a time. This is not likely to happen. Before shale gas began to tap significant new reserves it was not even a possibility. Still, it remains factual that coal-to-gas switching in power generation has been the most significant factor by far in reducing US CO2 emissions and offers near-term solutions to some other places as well. Infrastructure is an issue in whether it is plausible. China has failed to meet their targets on shale gas production and their high well costs and lack of infrastructure make it more difficult to compete with coal. Both Germany and the UK, together who emit 45% of EU greenhouse gases, have been advocating for a carbon price floor of $30 per tonne for new coal power (by making them purchase additional permits on the EU ETS), particularly the significantly more polluting lignite plants in Germany. China expects a nationwide ETS to be in operation in 2017. Regional ETSs are in operation now. The integration of localized carbon pricing and regionalized carbon pricing will likely lead toward a more or less global pricing mechanism, but there may well be uncertainties to work out. Asked about the viability of the Paris agreement, conservative David Green of the New York Times stated that it will be costly and that he favors a market approach based on innovation – a very vague comment. While innovation in the form of Flannery’s “third way technologies” for capturing and sequestering atmospheric carbon can, should, and probably will be helpful, they too will be costly as will geological and agricultural sequestration schemes. The Paris accord is all about commitments by countries. But another trend is commitments by businesses to reduce emissions. 81 companies including General Motors, Walmart, Ikea, and Goldman Sachs signed on to the American Business Act on Climate before the Paris meetings. This attests that corporate climate action has indeed gone mainstream.

The Clean Power Plan has compelled states to come up with plans to decarbonize as will the Paris accord to countries. Thus, modelling emissions, power source portfolios, and costs of emissions reduction accurately has become very important. Countries, states, and utilities need to decide which coal plants to retire, which to convert to gas, where to build new gas plants, solar farms, and wind farms, how much renewables and battery storage to add, what efficiency upgrades to invest in, and how much it all will cost. New simulators such as Energy Innovation’s new Energy Policy Simulator may be one method of doing this by quickly comparing different scenarios. 

Those who say that carbon pricing is not inevitable or necessary should consider that even flexible requirements such as the Clean Power Plan and the non-binding COP 21 Accord could well be considered a form of carbon pricing. This is perhaps even better than global carbon pricing or the messy uncertain nature of allowances and emissions trading as it gives areas the mandate of making regional commitments based mainly on power plant emissions, the largest source. Thus utilities and power markets, the main consumers of emitting fuels have the first mandate to reduce. Other rules such as methane emissions reductions in the oil & gas sector will happen but are quite tiny compared to power plant emissions. CAFE standards for vehicle emissions is another means and is set to happen before 2025 in the U.S. according to agreements. The EV market in the U.S. is still lagging behind initial hype and cost-effectiveness but should improve enough in the coming few years or so to make more of a mark. Battery storage technology and pricing has improved and will likely continue to improve so that will gradually make more and more of a mark as well. The biggest player in the emissions reductions toolkit (along with coal-to-gas switching) is still likely to be energy efficiency improvements.  

  

The Social Cost of Carbon (and incorporating it into the carbon rebate)

The U.S. government has most recently valued the social cost of carbon at about $41 per tonne. Due to the spatial distribution of pollution sources among lower-income peoples it has been argued that the social costs of fossil fuel emissions in the form of pollution are disproportionately taken on by those lower-income people. It is also argued that a carbon tax will disproportionately affect the same lower-income people through increased prices for energy and consumer goods. Thus, some have argued for the dividend of a carbon tax to favor the lower-income people. Dr. Roberton Williams has noted that even though a reduction in corporate taxes might be better for the economy as a whole than the reduction of payroll taxes, it would disproportionately benefit wealthier people and thus reduction of payroll taxes would be fairer and more equitable overall. Economist Chad Stone argues that carbon rebates should be designed to “fully offset the impact of a carbon tax on the purchasing power of low- and moderate-income households.” Williams, like Hansen, and possibly Tillerson, favors the “lump-sum rebate” whereby the total tax collected is divided by the population and a check is mailed to each person. Such a scenario would favor the poor and those with the lowest carbon footprint will also save by using less power. This would have a redistribution effect. However, as such, it would likely be spurned by the political right as proof of the conspiracy of the left to redistribute income. Even so, no one would argue that a carbon tax should favor the wealthy or over burden the poor. For this reason I think that any carbon tax in the U.S. would have to be in the form of the lump-sum rebate to be fairest.

    

References:

Oil Bosses to Meet in Latest Climate Change Offensive – Reuters news story, Oct. 7, 2015

Germany, the UK, and the Need for Carbon Tax Floors – by Stewart Taggart – in Linkedin Pulse, Oct. 10, 2015

Atmosphere of Hope: Searching for Solutions to the Climate Crisis – by Tim Flannery, Atlantic Monthly Press, 2015

This conservative economist makes the case for a carbon tax – Q & A, posted on Grist.Org, Oct. 12, 2015

Climate Change is Regressive. A Carbon Tax Doesn’t Have to Be. – posted in Climate Progress, Oct. 13, 2015

How to Decarbonize the U.S. Energy System, in 14 Charts – by Gavin Bade, in Utility Dive Newsletter, November 5, 2015

Why are oil and gas companies calling for more action on climate change? – by Bob Dudley (CEO of BP) – news story from Reuters, Nov. 12, 2015

Bill Nye the Science Guy Knows How to Fix Climate Change, story/interview by Simon Worral, in National Geographic, Nov 15, 2015

Storms of My Grandchildren: The Truth About the Coming Climate Catastrophe and Our Last Chance to Save Humanity – by James Hansen, (2010)

Alberta’s New Carbon Tax Isn’t Revenue Neutral. That’s the Best Thing About It – updated by David Roberts, in Vox Energy & Environment (vox.com), Nov. 25, 2015

UN Climate Conference Starts Monday. Here’s What Oilpros Need to Know – by Jeff Reed, posted in Oilpro (oilpro.com), Nov. 27, 2015

The Coming Global Carbon Price Boom – by Stewart Taggart, posted in LinkedIn Pulse, Nov. 27, 2015

The Climate War: True Believers, Power Brokers, and the Fight to Save the Earth - by Eric Pooley, (Hyperion Press, 2010)

Paris COP21: Global Financiers Hop Aboard the Zero-Carbon Bandwagon – by Fred Pearce, in Yale Environment 360 Digest, Dec. 4, 2015

Know Your Carbon Emissions – by Robert Rapier, posted in OilPro, Dec.7, 2015

10 Reasons a Carbon Tax Is Trickier Than You Think – by David Roberts, posted in Grist.org, Nov. 19, 2012

Five Energy Trends Driving Climate Progress in 2015 – by Ben N. Ratner, in Environmental Defense Fund (EDF) Voices: People on the Planet, Oct. 29, 2015

COP 21 Compliance Requires Favorable Natural Gas Policies - by Alvaro Rios, in Drilling Info Blog, Jan.12, 2016