Carbon Costs May Be Far Higher Than Previously Thought

A pair of economists at Economics for Equity and the Environment (E3) have just released a study positing that the social cost of carbon is far higher than previous estimates, by up to an order of magnitude. The official estimate used by the US government is $21 per metric ton of CO2 as of 2010, and various estimates go up to about $100-200, e.g. the Swedish carbon tax is 101 Euros per ton, and James Hansen recommended $115 per ton. In contrast, the E3 study’s range, using newer estimates of damages, goes up to $900 per ton of CO2 as of 2010, escalating to $1,500 in 2050, when the discount rate is low and the price is based on a worst case scenario (95th percentile) rather than the average.

One should bear in mind that the discount rate used to get the high numbers is 1.5%, in line with what was used by the economists at Bjorn Lomborg’s Copenhagen Consensus to arrive at the conclusion that climate change mitigation was a waste of time. It’s not a radical estimate, although some commentators have wrongly confused it with zero discount rate; it’s in line with the long-term risk-free bond yields. Even using average rather than worst-case damages (but still averages coming from the newer, higher estimates) would give a carbon tax of $500 as of 2010, escalating to $800 by 2050.

The carbon content of gasoline is such that a $900/ton tax would be almost to $8 per gallon of gasoline, or $2 per liter. For diesel, make it $9 per gallon. Good transit advocates are engaging in fantasy if they think this, even together with other costs such as air pollution, would eliminate driving; however, it would severely curtail it, inducing people to take shorter trips, switch some trips to public transportation, and drive much more fuel-efficient cars. All three are necessary: not even in Switzerland has the transit revival gotten to the point of abolishing the car. However, the current US car mode share – 86% for work trips – is unsustainable and has to go down under any scenario with a high carbon tax.

More intriguing would be the effect on electricity consumption and generation. Current coal-fired plants in the US would see an average tax of about $0.89 per kWh; natural gas plants would be taxed $0.49 per kWh. Cities already have an advantage there – New York City claims 4,700 kWh of annual electricity consumption per capita, while the current US average is about 13,000. Obviously, in both cases, fossil-fired electricity consumption would crash, while solar and wind power would become a bargain, but it would be easier to do this in large cities. But again, urban revival has its limits; suburban houses would still exist, just with much more passive solar design and extensive solar panels.


  1. Danny

    An off the cuff calculation using these links:

    shows that in order to pay for our defense related expenditures with a gas tax, we would need to spend $4/vmt, about $80/gallon at a 20mpg average, and it would have to do so without a single drop in VMT, which we all know would happen quite drastically at those prices.

    That is pretty sad. I am extremely skeptical of the more extreme estimates of climate sensititivity, but even if I gave in and demanded a carbon tax using the highest known model of climate sensitivity, I still would be receiving a pretty good bargain on my benefit/cost ratio.

    • Alon Levy

      I think you made an order of magnitude or unit conversion error. The US has a total of 3 trillion VMT and consumes 130 billion gallons of fuel, give or take. A tax of $4/VMT covers nearly the entire GDP, let alone government spending.

      • Danny

        oops…wasn’t exactly an order of magnitude though…I calculated using march ’11 numbers but thought they were the VMT stats for the entire year of 2010. I should have been more careful with the google.

  2. Paulus Magnus

    I suspect that statistic is a bit misleading and actual per capita energy use for cities like New York is higher. Heating oil and steam heating won’t appear on the electricity use, but they are major features of the Northeast (while the South and Southwest are pretty dependent on electrical air conditioning). Steam heating, if cogenerated from waste heat, is of course a freebie. Potentially, a lack of electrical intensive industries in the area would also distort NYC’s numbers if they weren’t careful about how they got their numbers.

    Raising the price of electricity by basically an order of magnitude would essentially kill the American economy. While that would lower energy consumption, I think that’s probably the wrong way to do so.

    I also suspect nuclear would be the preferred build instead of massive solar and windfarms. It’s cheaper, per kilowatt generated, and the political problems will likely be the same as trying to do the massive solar and wind investments otherwise needed (all hail the NIMBYs). Locating nuclear in places like Wyoming would probably eliminate much of the complaints actually.

    • Nathanael

      New solar and wind are cheaper per killowatt than new nuclear. You simply have your facts wrong.

      Anyway, at this point wind has reached “grid parity” and solar is very close. The result: any form of carbon tax on old fossil fuel plants, even a fairly low one, and there WILL be a massive shift to solar — the market will demand it.

      I pay 11 cents a kilowatt-hour for 100% renewable electricity here in upstate NY. I’m sure the price would go up in the short term if there was a large charge on the dirty old coal plants where other people get their electricity, but it would spur a boom in solar construction and pretty soon the price would be back down again. Even assuming that my current price has hidden subsidies, the price would stabilize no higher than 22 cents a kilowatt hour, worst case; This is manageable.

  3. Joseph E

    Paulus, you wrote “Raising the price of electricity by basically an order of magnitude would essentially kill the American economy”.

    This is incorrect. The “order of magnitude increase” will be entirely in the form of a carbon tax. That tax money would go back into the national economy, either thru cuts to other taxes of thru increased government spending.

    This is why Britain and Germany and just about every other country in Europe manage to survive with gasoline prices 2 or 3 times higher than ours. The price difference is due to higher taxes, which stay in the local economy.

    On the other hand, even a 50% to 100% increase in the wholesale price of oil or coal is enough to put the economy into recession. When the price went up in 2008, consumers spent more on gas (and food and electricity, as other energy-related prices rose in sync with oil), and less on everything else, creating the recent global recession. The temporary run-up in oil prices this year has had a similar effect, slowing growth to a minimum.

    Fortunately, high energy taxes will actually decrease the price of oil and energy, by reducing demand. As long as the tax money makes it back into the national economy (thru a rebate of the payroll tax, or building more transit and hiring more bus drivers, for example), a high tax should have only a minor short-term effect on economic growth, mainly due to decreased growth in the oil energy (offset by increased investment in natural gas, nuclear, wind and solar)

    • Paulus Magnus

      The problem is the sheer size of the one proposed and the effects it would have upon industry and transportation. A small tax in the realm of $20/ton which is dedicated to infrastructure (on a strict cost-benefits ratio, meaning electrical and freight sectors would likely have the priority) alongside a regulatory approach (such as prohibiting the construction of further coal plants, leading to their phase out via attrition over the next fifty years) is what would work best. If you’re taxing it at a high level, and then just off-setting other taxes, you’ve gone beyond the most practical, pragmatic, and efficient use of the tax. Realistically, I don’t think you’d be able to find enough worthwhile projects to spend $116 billion per year in investing in CO2 reduction measures.

      • Alon Levy

        Well, Sweden is doing fine with its €101/ton tax. Its per capita GDP growth is very high by first-world standards, its employment-to-population ratio is among the world’s highest, and so on. For the US to adopt a similar carbon tax (say, $126/ton, the PPP equivalent of €101/ton) would raise enough revenue to cut other taxes, or vastly reduce the deficit – it’s nearly the same as total payroll tax receipts, which would allow the money to effectively be diverted to job creation.

        The point of carbon taxation – or cap-and-trade – is that setting a high price would induce the private sector to find its own ways to reduce carbon emissions. Households would find it worthwhile to install rooftop solar panels and improve their insulation systems, utilities would switch to renewable energy to lower their prices and be more competitive, and so on.

  4. BBnet3000

    It seems to me like none of this is politically possible in the US, certainly not on the nationwide level. On the state level, people will be pretty reluctant to want any policy that could be perceived as making them less competitive with other states (and at least in the short term, that is the case isnt it?).

    The thing is, we are going there anyway. Energy prices are going up. We can keep that in the form of revenue or send it away in the form of costs. Thats the real choice here.

    • Nathanael

      This is what’s wrong with the US. Everything which would help the country is perceived as “politically impossible”.

      In the meantime, if you own any buildings, retrofitting them to be highly energy efficient and to run on 100% renewable energy will pay back bigtime within 10 years, as the fossil fuel prices skyrocket anyway. Most people don’t think that long term sadly.

      • Danny

        That is only true if energy costs continue to skyrocket. Alternative energy has serious bubble potential…and it could be that those with the long term alternative energy vision right now could end up like homeowners in 2009-2010 who thought back in 2005 that if they didn’t buy a house at that moment then they would likely never own one…or fiber-optic-infrastructure investors in 2002, who thought back in 1999 that because the technology was practically future-proof that it was impossible to overinvest.

        When it comes to technology adoption, there is some serious flaws to the buy-in-early approach. Sometimes it works, but sometimes it kills you. An organization I work with bought into a flashy new ERP system powered by Progress Databases back in the early 90’s, and they were at the forefront of technology. Now they have so much lock-in that after about the 30th abandoned attempt at getting a new system, they continue to use that old once-fashionable system…a system that was already obsolete by the time I graduated from elementary school.

        Gust Avrakotos: There’s a little boy and on his 14th birthday he gets a horse… and everybody in the village says, “How wonderful. The boy got a horse!” And the Zen master says, “We’ll see.” Two years later, the boy falls off the horse, breaks his leg, and everyone in the village says, “How terrible!” And the Zen master says, “We’ll see.” Then, a war breaks out and all the young men have to go off and fight… except the boy can’t ’cause his legs all messed up. and everybody in the village says, “How wonderful.”
        Charlie Wilson: Now the Zen master says, “We’ll see.”

        • Alon Levy

          I don’t know if alternative energy is really a bubble, but one smart investor pronounced it the next bubble, after housing. If it’s like previous bubbles, what will happen is that people will invest huge amounts of money into solar panels, wind turbines, etc., only to see the demand for them crash. Maybe the impetus will be peak oil rather than climate change legislation, and then a new cheap dirty energy source (e.g. tar sands) will bring fuel prices down. Maybe there will be a lot of conservation, and the demand for energy will dip below the installed alternative energy capacity. Or maybe there will be demand destruction coming from a prolonged depression.

      • Nathanael

        Oh, the *tech* is gonna get better; if you buy an actual installation now, you are buying renewable energy at higher prices per kilowatt than you will later.

        But the general trend — fossil fuel costs up, renewable costs down — is unstoppable. And all the new, cheap forms of renewable energy are going to be electricity-convertible. So an efficient house which runs on electricity is going to pay off, period.

        Here in NY, we have so-called electricity “deregulation” (which actually involves a lot more regulation than “regulated” electricity) so I buy my electricity from a co-op which buys it from whatever the current cheapest renewable electrical source is. I’m not locking myself into a technology at that end. My investments have been in an efficient-running house.

      • Wad

        @Alon, alternative energy sounds more like a fad than a bubble. There’s no technical distinction between the two, but a fad is an activity that comes on real strong and disappears on its own momentum.

        What’s driving the investment side of alt-energy is the Obama presidency. The most money has already been made in 2008, before Democrats made stronger political gains in November. Investors anticipated more favorable government support for alt-energy with Democrats in power. GOP control would knock out the sentiment for investment.

        A bubble, on the other hand, takes investment levels far beyond the ability of markets to be able to realize the gains. Try selling a property now for anything close to matching 2000s levels. Or in the case of the late 1990s, the ascendancy of dot-coms and their business strategy — the momentum play — forced older companies to try to match the outsized performances of the Internet companies.

        There’s one other sector exhibiting the same bubbly activity the stock market did in the 1990s and real estate did in the 2000s: healthcare. Everybody, with good reason, expects healthcare’s costs to stampede like a bull. That’s bad news for working folks and the sick, but it’s the kind of trend businesses like to see.

        Exorbitantly high healthcare costs, the kind seen in the U.S., attracts tremendous business activity as well as capital. That’s a good thing on the upside, as that capital must be deployed throughout the sector. This also filters down into new jobs.

        The bad news: Healthcare is well on the same path to be unable to realize its gains. Costs are going up, and so far out of reach that some of the costs will be unpayable. This will lead to the same systemic shock that affected the banks after 2007, and the U.S. must now bail out the “too healthy to keel over” healthcare sector.

  5. Danny

    I agree that consumption efficiency will probably be a good investment for the short term, as it is one of a few available energy investments that can be found with less than 10 year paybacks.

    But I can’t help but laugh at the people who are going the route of installing hundreds of car batteries to store every last drop of energy from their short and small wind turbines and 10% efficiency solar cells, while taking trips to all the fast food places in town to get some used cooking oil for their biodiesel volvos. It might eventually pay off in a few decades, but what will they do when the bubble crashes and their neighbor with the Ford Expedition buys 30% efficiency solar cells for his house with a mere 1-2 year payback period?

    The real problem with thinking long term on investments is that in order for long-term investments to pay off, you have to be really good at forecasting long term. I do some production forecasting for a large manufacturing firm right now, and I can barely average 90% forecast accuracy on a near commodity product with a mere 3 month horizon. That accuracy puts me at about the 98th percentile of forecasters in this industry. If I were to try to predict 10 years into the future, my forecast accuracy would probably be less than 30%.

    In other words, if you are making long term investments, you are either a fool or a god.

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