The Economics of Global Warming,
SGE Evening Seminar
October 10, 2006
Review of Panel Discussion by Terry Dinan, Congressional Budget Office; Glen Sweetnam, Department of Energy and Joseph A. Barbera, M.D., Co-Director of the George Washington University Institute for Crisis, Disaster, and Risk Management
Terry Dinan of the Congressional Budget Office stated that current policies to account for external costs contain conflicting incentives with uncertain net effects and are not linked to carbon content.
One market failure involves the external effects of emissions from the combustion of fossil fuels—that is, the costs that are imposed on society by the use of fossil fuels but that are not reflected in the prices paid for them. The other market failure is a general underinvestment in research and development (R&D) that occurs because investments in innovation may yield “spillover” benefits to society that do not translate into profits for the innovating firm. The first market failure yields inefficiently high use of fossil fuels; the second yields inefficiently low R&D.
To solve these problems there are two types of policy solutions:
· The first policy solution would reduce carbon emissions by increasing the costs of emitting carbon, both in the near term and in the future, to reflect the damages that those emissions are expected to cause.
· The second policy solution would increase federal support for R&D on various technologies that could help restrain the growth of carbon emissions and would create spillover benefits.
Policymakers could increase the cost of emitting carbon by setting a price on those emissions. That could be accomplished by taxing fossil fuels in proportion to their carbon content or by establishing a “cap-and-trade” program under which policymakers would set an overall cap on emissions but allow fossil fuel suppliers to trade rights (called allowances) to those limited emissions. Either a tax or a cap-and-trade program would cause the prices of goods and services to rise to reflect the amount of carbon emitted as a result of their consumption. To the extent that a carbon tax or allowance price reflected the present value of expected damages, such policies would encourage users of fossil fuels to account for the costs they impose on others through their emissions of greenhouse gases.
Reliance on a single policy as mentioned above would not produce results as effective as the two policies working together in a hybrid approach. Phasing in price increases would allow firms to gradually replace their stock of physical capital associated with energy use and to gain experience in using new technologies that emit less carbon. Firms would have an incentive to invest in developing new technologies on the basis of their expectations about future prices for emissions. Federal support of research and development of technologies would lead to lower emissions through improvements in energy efficiency.
Glen Sweetnam of the Department of Energy reported on the macro economic effects of limiting US greenhouse gas (GHG) emissions. Reductions in both energy-related carbon dioxide (CO2) emissions and other greenhouse gas emissions in all sectors play a role in lowering total GHG emissions. If the market response in the industries that produce these gases is not as large as represented in the engineering-based abatement curves supplied by the Environmental Protection Agency more pressure will be put on energy markets to reduce their emissions raising the GHG permit prices, unless permit prices are constrained by a safety-valve mechanism.
Since the cost of GHG permits under the cap-and-trade program raises the cost of using fossil fuels, all sectors of the energy economy respond with lower overall energy use and a shift away from fossil fuels where economical. Because of coal’s relatively high CO2 content per unit of energy content and its relatively low price, GHG permit prices have a larger impact on the cost of using coal than they do on the other fossil fuels. By far, the largest changes in GHG emissions and fuel use are projected in the power sector, which accounts for over 90 percent of coal use and can be switched to technologies that can generate electricity using a variety of other energy sources.
In contrast to coal, the power sector is projected to increase its use of nuclear and renewable fuels in cap-and-trade cases. Industrial energy consumption is projected to be between 2.0 percent and 3.2 percent lower in 2020 and between 4.5 percent and 7.9 percent lower in 2030. In the transportation sector, energy consumption is projected to be between 0.7 percent and 2.2 percent lower in 2020 and between 1.2 percent and 4.9 percent lower in 2030. Reducing energy-related GHG emissions would require a shift away from fossil energy sources that currently account for 86 percent of US energy consumption. The costs of such a shift are inherently very uncertain.
Reported by Melvyn Sacks
Chairman, SGE Evening Seminar Committee