Results filed under: “economics”

Click here for part 1, and here for part 2.

The California utility commission has created a program where the renewable energy producer who offers the lowest sales price for renewable energy will be guaranteed that price throughout the life of the contract. This price will still be higher than the going rate for electricity on the open market. What does the difference between the renewable energy price and the regular energy price tell us, and how can it be applied to a cap and trade system?

Let's take the concept of the California program and move it to an electricity market I know a little more about, Houston. Clearly, the point of the program is to incentivize the generation of renewable electricity. But the same goal could be achieved by taxing electricity that generates carbon. If we assume that the price of electricity is 10 cents/kWh, and the renewable feed-in tariff will be 2 cents/kWh, then we could achieve the same goal of promoting renewable power by levying a tax on non-renewable power. As long as the tax was higher than 2 cents, it would be cheaper to purchase the renewable energy.

Every area has its own mix of power sources: coal, oil, natural gas, nuclear, hydro, and renewable. The particular mix of power sources will dictate how much carbon is in the baseline available electricity. In Harris County, an average 1000 kWh of electricity produces 990 lbs of CO2. Or, to flip it: 1 ton of CO2 is generated by 2,018 kWh of electricity.

The program with my assumed prices (we don't actually know what the premium for renewables will be yet) is that the carbon-free power costs 2 cents more per kWh, then we have learned that the externality cost of a ton of CO2 is approximately $40.

Now here's the problem with a feed-in tariff: it affects producer behavior but not consumer. The utility commission will raise the money to pay the feed-in tariff by charging all of its customers a fee. It is, essentially, a small carbon tax.

Why not bypass the whole feed-in tariff concept and begin taxing carbon directly? A true carbon tax can incentivize not just renewable energy, but all kinds of steps to reduce carbon emissions. Carbon can be reduced through use of renewable energy, but also cleaner fossil fuels and carbon capture. Carbon reduction programs should be technology neutral.

Feed-in tariffs require regulatory agencies to pick winners and losers in technology. Cap and trade (which is really just another word for carbon tax) would allow innovation in any number of technologies, and let the market decide which one was best.

Before I continue my comments on cap and trade and the externality costs of dirty power, I want to quickly address some points raised by a college friend of mine who now works in the nuclear industry. Scott Friend comments:

[You are] just hitting the two extremes of the spectrum: dirty coal, and clean solar, and it makes me wonder what your take is on how this legislation effects our other options.

I'll address two things separately. First: he is correct that I am just hitting the two extremes. That was done for simplicity of the analysis. What really happens is that the electricity being replaced by solar is not necessarily coal. Every local grid has its own mix of coal, hydro, natural gas, nuclear, and renewables. Depending on that mix, the electricity you consume has a different carbon impact. For example, if you live in Texas, then this website will tell you the emissions of the electricity you consume county by county.

Because of this and other factors, the externality cost that emerges from California's experiment will not be exactly applicable everywhere in the country. What California's program will do is provide a methodology by which the cost of carbon may be determined for areas around the US, and thus for various electricity generating technologies.

The "other options" Scott referred two fall into two categories: classical renewables (wind, solar, hydro) and nuclear. Classical renewables are not without their own environmental impacts: hydro alters the environment of native species, wind turbines can chop up a flock of birds faster than Capt. Sullenberger, and solar requires vast stretches of unoccupied land.

And nuclear can melt an entire city's face off. Now, lets be clear: there hasn't been a major nuclear accident in decades. In their own perverse way, the events of Chernobyl and Three Mile Island were good for society. While those in the immediate area around those plants felt the consequences of those failures, they were object lessons in what not to do for the nuclear industry. There's a reason that there's been no release of radiation from a US plant since TMI. After you burn yourself a couple of times on a hot pot, you figure out how to use a potholder.

Unlike solar, nuclear plants does not need to be incentivized. If regulations were no obstacle, I'm sure nuclear plants would spring up around the country. In fact, its the opposite that is true: the customers need to be incentivized to allow nuclear power plants to be built in their area.

We already have the answer on how to do this. The feed-in tariff concept can go both ways: utilities could offer nuclear power plants permits in exchange for reduced energy costs. What if nuclear power cost 20% less? 40%? How low would a nuclear plant be willing to go? Let the market decide how much people think the risk of having your face melted is worth compared to the reduced cost of electricity.

The point is that carbon is not the only externality. The perceived safety of the power source is also a societal effect that could be, but currently is not, priced into power.

Click here for part one.

Last time, we talked about externalities, and how they apply to environmental policy. The short version: activities which pollute have an adverse effect, and thus a cost, to society. Those costs are not incorporated into the cost of the polluting activity, i.e. electricity that pollutes costs the same as electricity that doesn't. A price which incorporated externalities would allow the market to decide whether or not the polluting activity was a better choice. How to incorporate the cost of these externalities on electricity pricing? It is perhaps an unimaginative answer to say the government must impose them, but can you think of a better way?

Once we come to the conclusion that the externality costs of pollution should be incorporated into electricity costs, we must now answer a difficult question, that is, the monetary cost of the externality. When a kWh of electricity produced from coal is concerned, how much worse off is society? Two cents? Ten cents? Am I asking alot of questions? Sorry. Here come some answers.

Put yourself in the place of a power producer. You are considering expanding your business and making more power. You will sell your electricity on the open market, which currently has a value of $0.10 cents. You have the option of building a coal power plant or a solar power plant. The coal plant will pollute, but costs less. You build a coal plant.

Now, perhaps you are in an area where the utility is considering a feed-in tariff. The feed-in tariff will guarantee you a higher price for electricity than you would get for your coal power. (Feed-in tariffs are why Germany is a world leader is solar, despite a rather poor climate for sunshine.) In the classical feed-in tariff situation, the tariff is set by the utility. Under this situation, there are two possible outcomes. Either the tariff is too low, and you decide to build a coal plant, or the tariff is too high, and you build the solar plant, but the system is inefficient (there is a price at which you would have still built the solar farm, which is the outcome I wanted, but I would have had money left over to pay someone else to also build a solar farm.)

Enter the California Public Utilities Commission and their reverse auction proposal. The commission will set the feed-in tariff at the lowest price that a utility is willing to sell solar power. In other words, they will let the market decide what the actual value of the externality price is!

There are two exciting results from this proposal. The first, obviously, is that more solar power will be built in California, which will reduce pollution and spur the growth of the alternative power market. The second is that we will have an answer from a free market that tell us exactly what the externality price of pollution is.

How does this result potentially apply to cap and trade? Stay tuned to part 3.

Sitting right behind health care on the President's agenda is climate change legislation. Any meaningful change will take one of two forms: either cap and trade or a carbon tax. Republicans will attack this bill as raising taxes on working American families. And, in a very real sense, they will be right.

Ask yourself a question: why do we use fossil fuels now? Why doesn't everybody have solar panels and wind turbines? Cost, as always, is the answer. Energy from fossil fuels is cheaper to generate than energy from the sun. Yes, the fuel for solar energy is "free", but the cost of generation doesn't just include the raw fuel, but also the capital cost of the generation equipment. A typical coal power plant is a Kia, and solar panels are, say, a Jaguar. Or, if you prefer irony, a Hummer.

If the government wants to incentivize the purchase of green energy, then they either need to increase the cost of dirty power or reduce the cost of clean power to level the playing field. There are three mechanisms that they can use:

1)    Reduce the cost of the generation equipment with subsidies.
2)    Provide subsidies for the production of alternative power, increasing its value relative to dirty power.
3)    Increase the cost of dirty power through taxes.

That's it. Those are the variables that can be modified by the government. Either cap and trade or a carbon tax fall into category 3. In order for carbon to actually be reduced, the cost of carbon must increase until clean generation is cheaper.

Let me quickly address some typical complaints. First, liberals: "People are installing solar power right now! Why can't we all just do the right thing. No, not smash pizzeria windows with garbage cans. Why can't we all just buy solar panels and hold hands and make the world a better place?"

To which I reply, shut your pie hole, hippie. That's not how the world works. If you are willing to pay more for solar power than for dirty coal, then that's a luxury expense. If you can afford it, and that's how you want to spend your money, then you are free to do so. But people who can't afford it, or, more importantly, businesses that have to keep their prices low to remain competitive, won't impose this cost on themselves.

And conservatives: "It isn't the government's role to take MY money and give it to some hippies who want solar panels. I should be able to purchase whatever power is cheapest and let the market dictate whether or not alternative power should survive."

And I almost agree with that point of view, except that the current market evaluation ignores part of the cost of that cheap dirty power. Tim Harford, the official economist of ObscureCraft (since he is the only one I have read) talks in his book, The Undercover Economist, about the cost of externalities. The example he uses is driving. When I drive, there is a tangible cost to me: the purchase of the car, the maintenance, the gas, and the taxes. But when I drive, I impose on others. I clog up the streets, I help create traffic, I emit pollution, and sometimes (all the time) I drive like a total asshole. Each of those actions has a cost to others. Pedestrians and bicyclists are less safe, ice caps melt a little bit more, noise, etc. Clearly I am making other people less well off than they would have been if I didn't drive. I have therefore created a cost to them that I am not paying. This is called an externality cost.

In the example of power, the dirty power has an externality cost in climate change, the consumption of finite natural resources, and the global social cost of sustaining petro-dictatorships, to name a few examples. But these externalities are not built into the cost of dirty power. If we truly accounted for the full cost of dirty power, there's a good chance that renewable energy would come out ahead.

Climate change legislation will raise taxes on working families. It will increase the cost of dirty power until it becomes cheaper to buy clean power. That is what it must do to have any effect. But the extra cost for dirty power is a tangible representation of the externality cost we are already paying.

Actually valuing these externalities is one of the hardest questions in economics. In part 2, I'll talk about a California program that might have come up with an answer.