Carbon Pricing Is Just One Piece of the Puzzle: Towards a Comprehensive Climate and Energy Policy – Part 3

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by: Michael Hoexter

In part 1 of this very long blog post, I described how the current economic crisis has reversed the prestige and standing of two competing schools of economic thought that are also attached to distinct worldviews, monetarism/supply side vs. Keynesianism.

In part 2, I suggested that the main policy instrument discussed by climate activists, carbon pricing in both its cap and trade and carbon tax forms, uses the toolkit of the now somewhat discredited monetarist/supply-side school. I attempted to document the benefits but also questionable assumptions involved in reliance on carbon pricing as the mainstay of climate and energy policy. Part 3 discusses how there are multiple ongoing market failures that have a decisive impact on climate policy rather than the singular failure of discounting the impact of carbon emissions.

Absolute and Local Carbon Minima, a.k.a. Peaks and Valleys

If you can imagine our societal carbon emissions as the height of these contours, we must descend from the highest peak to the lowest valley in order to reduce the carbon content of the atmosphere and slow the acidification of the ocean. Carbon pricing without other policy support will push us down the nearest downward slope but will in many locations not get us to the lowest valleys of zero or negative net carbon emissions.

Another potential limitation of carbon pricing involves the target carbon dioxide level that will enable us to maintain a livable climate. With climate scientists and climate activists urging us to take on very ambitious goals that mean a net subtraction, not just a reduction in the rate of emission, in the current amount of carbon in the atmosphere within a period of decades, it would seem we are targeting what might be called an “absolute minimum” of carbon emissions. The renewable electron economy that I have promoted or the nationally-advertised Repower America proposal by the Alliance for Climate Protection are targeting something close to the absolute minimum in carbon emissions in an advanced energy-intensive economy. In general any proposal that seeks to replace fossil fueled transport and other end-use machines with electric end-use devices can target zero emissions, as we have a number of ways to achieve very low or no carbon emissions in the electricity generation sector.

A carbon pricing system, especially in its first years, will encourage investment in what might be called “local minima” or the currently less expensive carbon reduction technology or practice. In some cases, these local minima may be zero-carbon or potentially part of a net zero carbon emitting economy, but in most cases these choices will entail the more efficient use of fossil resources or switching to “second-best” alternative fuel systems like substituting natural gas for petroleum. Many of the easier-to-achieve fuel efficiency measures for fossil fuels are necessary investments (switching to a more efficient internal combustion engines, for instance), especially if we assume that they will have a useful lifetime of perhaps ten years. However commitments to second-best, long-lived infrastructure with a useful lifetime of 40 or 50 years that commits us to a lot of carbon emissions during that period appear to be ultimately a waste of resources. If we take, for instance, the proposal in the Pickens Plan to convert our transport system to natural gas (which cuts emissions by only 35% relative to petroleum), this would involve massive investment in a new compressed natural gas infrastructure, though the size of this investment would be smaller than the conversion to an all electric transport infrastructure (assuming just an evolutionary increase in the energy content and manufacturing efficiency of batteries).

Imagine, as a model of this phenomenon, a 3-dimensional undulating surface like a contour map of a mountainous landscape with height equaling the rate we are adding carbon dioxide (or you like carbon dioxide equivalents) to the atmosphere. We are currently at the top of the highest mountain as a society though perhaps individual firms and organizations are already doing better than they were and could be pictured on a “downslope”. If we look down from the (rising) mountain top we are on we see a number of different routes downward. Some of the paths lead eventually to valleys, the floor of which are still at a high “altitude” (some net carbon emissions) and which are surrounded by “ridges” (local peaks in carbon emissions).  Other paths lead to valleys that are at “sea level” or zero emissions and some might even lead to valleys below sea level (carbon negativity). Not all paths are “arrayed equally” before us as some require the traverse of intermediate peaks and ridges (infrastructure investments or evolution of technology).

A carbon price will drive us down this mountain toward some of the valleys but I believe because of its structure and foreseeable price evolution, will drive us without a strong assist from other policy instruments towards “local minima” that are not necessarily the “absolute minima”, the deep Rift Valleys and Death Valleys that we are targeting. A policy scheme that hinges largely on carbon pricing assumes that local minima will lead to the absolute minima, yet only in the (still extremely important) areas of energy efficiency, in particular electrical energy efficiency and land use, is this true. Therefore carbon pricing can be seen as, potentially, an effective incentive for energy efficiency but not necessarily arriving at the zero or negative carbon society. Focused as it is on the market, it does not aid us to see much beyond the horizon of concerns of individual market actors, and therefore we may be missing the “big picture”.

New Low/Zero-Carbon Infrastructure: Enabling Effective Market Choice

The densely settled cities and towns of Europe and Japan already offer residents functional and price-competitive alternatives to oil-dependent passenger transportation. With aggressive carbon pricing, the attractiveness of already existing lower carbon options will increase, leading to extension of these services but less of a requirement for the building of new infrastructure than we will find in the US and Canada under a carbon pricing regime.

It is a common lament heard around US metropolitan areas with fairly good public transportation or walkable downtowns and neighborhoods that people with awareness of global warming or other ecological impacts complain that they “have to use” their cars to do certain errands or to get to work. I live in a part of Northern California with much better than average public transportation but where use of automobiles is the difference between living an average as opposed to a restricted lifestyle. The areas of the US where automobile use is optional to lead a comfortable or middle class lifestyle are extremely limited. Peak Oil analysts warn of (or celebrate) the “end of suburbia” with a rise in petroleum prices as supplies decrease. In the US (and Canada), almost ever aspect of life depends on relatively cheap fossil fuels.

Carbon pricing will push us gently at first towards more efficient use of our existing infrastructure but will not by itself build or point us towards the zero-carbon enabling infrastructure. In order for economic actors to be able to respond to carbon pricing, they will need to have the concrete choice of modes of transport and modes of living, that are undergirded by a changed infrastructure. Our current infrastructure in the US commits us to emit carbon copiously. In Europe and Japan, particularly in the area of transport, the amount of infrastructure change required to go to a zero-carbon society is less though these countries also happen to have less options in the area of clean electricity generation than the US. For transport in these more densely populated countries, carbon pricing may be enough to push for expanded use of existing low and potentially zero carbon infrastructure, as this involves intensified use and expansion of existing rails and public transport. The relative population density of these societies and historically higher energy prices are a boon to more efficient end use devices.

Building new infrastructure, even if it will support a lower or zero carbon emissions, will, in an era of fossil fueled construction machines and industrial processes, represent more emissions for the period of building that infrastructure. This is unavoidable if we need rapidly to achieve essentially a zero net carbon emissions society, which will inevitably require new infrastructure. If we assume a longer timeframe, it is conceivable that the contribution of emissions from large infrastructure projects would be less, though the delay in building that infrastructure would have many negative consequences.

Infrastructure, the Persistent Market Failure

The 2007 collapse of a bridge carrying Interstate 35 in Minnesota was a high profile event that called attention to years of neglect in maintaining and building infrastructure in the US. While infrastructure is taken for granted by participants in commerce, it has become more difficult to persuade legislators and the public to pay for infrastructure and its maintenance in an anti-tax era. The idealization of markets as self-sufficient and self-sustaining has functioned as a justification to ignoring the failure of infrastructure.

In the recent era of idealization of the market, market externalities were considered to be exceptional circumstances or “unmentionables” in an era of ideological polemic. We are re-discovering now that in fact those externalities may in fact be more common and may represent an unavoidable and even necessary part of all economies. Nicholas Stern’s observation that carbon emissions are the greatest market failure of modern industrial economies may be true but contains within it the implication (not necessarily Stern’s personal view) that market failures, even in this massive and long lasting form, are events bounded in time rather than persistent and “business as usual”.

If instead we assume that the market coexists with and even requires both natural and social positive externalities and creates or falls victim to negative externalities for which it fails to fully account, the organization and replenishment of positive externalities and the management of negative externalities becomes as vital an economic activity as the activities of market actors within the market. These natural and social externalities of the positive type are sometimes treated as “public goods” by economists but are more easily recognized by economists of the Keynesian persuasion. Despite the efforts of these economists, the examination of public goods is a minority concern within contemporary economics, especially in models that assume or imply a self-sufficient or all-encompassing market.

Project Better Place is a start up that hopes to build a network of electric vehicle battery swap and fast recharge stations which will allow subscribers to their service to use electric vehicles with little regard to the state of charge of their batteries. Better Place is a private company partnering with large automobile manufacturers and with governments to develop a new infrastructure design. Public-private partnerships may help build new infrastructure but maintaining and extending existing infrastructure involves substantial government participation and investment.

The building and maintenance of infrastructure seems to be one area where market participants are not likely to be moved voluntarily, i.e. by their wants, to address. It is here that governments have stepped in to fill in where private market participants have either lost interest (passenger rail), abandoned assets, or not built (roads and bridges) the necessary infrastructure to keep the economy going. In the era of idealization of markets, it was assumed that markets could provide or did not really require the public goods which had in the earlier part of the 20th century had been assumed to be the province of government. These efforts have not yielded much in the way of actual progress in creating infrastructure owned and operated by private industry. We are now facing, in the US, an aging infrastructure that, furthermore, is not designed to support a functional zero-carbon society.

The “confession” that markets cannot provide these services would until recently be considered something like apostasy within those areas of economics and the economical “common sense” promoted in the media and in policy circles. On the other hand, if one takes the perspective of an economic historian or a Keynesian of most varieties, the notion that government would provide or help finance these services would seem to be the norm. While it may seem an unusual move to some, all I am assuming is that markets are not perfectable or self-sufficient.

The efforts then made to represent carbon pricing as the main means to achieve a zero-carbon society by steering market actors via the price signal ignores the persistent market failure in the area of infrastructure and reveal the degree to which the assumptions of the market paradigm have been internalized in the climate policy community. If we are to re-adopt at least some of the lessons learned by Keynes and those who worked in his tradition in the post-WWII period, climate policy might look quite different.

A Choice of Infrastructures…and Fiscal Stimulus

As discussed elsewhere and implied above, the choice of energy infrastructures has a lot to do with which target carbon dioxide concentration we are attempting to achieve and how fast we want to achieve it. As I highlighted in the preceding post about the post-carbon decision space, we are facing in the area of infrastructure a number of areas of choice that can be outlined as follows:

1)    Energy sourcing and generation (renewable, nuclear, fossil)
2)    Energy distribution system (wires, pipelines, rail, road)
3)    Form of transport energy (electricity, gas, biofuel, hydrogen)
4)    Form of building energy (electricity, liquid, or gas)
5)    Balance between individual vs. aggregated group conveyance
6)    Balance between grid-tied vs. autonomous vehicles
7)    Balance between guideway-constrained vs. road-going vehicles

For instance the renewable electron economy that I written about can, in a number of configurations, get us to or very close to a zero net emissions society. The ambitious Repower America plan currently advertised on TV throughout the US foresees generating most electricity renewably. To achieve society-wide net or near-zero emissions, I would add to its scope, powering land transportation using electricity either directly through wires or stored in batteries, which is the intention of many advocates of electric transport.

In order to move rapidly into a zero-emissions world, overhead trolley wires like these in British Columbia would need to be built over many high traffic streets to enable dual mode and dedicated trolley buses and trolley trucks to use grid electricity for locomotion. More efficient than on-board energy storage and available now, this solution involves the building out of the electrical distribution system for transportation in cooperation with electric utilities. Dual-mode vehicles could attach and detach from the grid as needed within a few seconds.

To make the zero net emissions renewable electron economy a reality, a number of large pieces of infrastructure are required to allow electricity to come from clean sources, to be used efficiently in buildings, and to be used in a majority of transport tasks. Firstly the Unified National Smart Grid, which is contained in the Repower America plan, would involve the building of a number of high voltage transmission lines from high renewable energy resource areas (windy Great Plains, sunny Southwest, offshore high wind areas) to existing transmission lines with sufficient capacity or directly to regional and national demand centers. Furthermore, local grid reinforcement and energy storage facilities would need to be built to balance renewable resource fluctuations and allow quick re-charging of large numbers of electric vehicles during times of peak demand. Electrification and build-out of the rail system needs to occur to allow for increased freight and passenger traffic with zero emissions. High traffic roads may need to be electrified with overhead wires or other means to allow large vehicles to traverse them without the need to store all energy on-board. The degree to which batteries or portable energy storage devices progess in durability and energy content will reduce the need for electrifying roads, though rail electrification, the internationally recognized top choice in rail locomotion, is a no-brainer in any scenario.

Other clean or cleaner energy proposals require more or less new infrastructure though they have other drawbacks or do not target zero or negative net carbon emissions. A clean hydrogen economy would require 2-3 times the generating capacity as the renewable electron economy as well as improvements in hydrogen storage and distribution. Hydrogen fueled transport would also require the build-out of Unified National Smart Grid with approximately 3 times the transmission capacity. An energy economy dependent on, still experimental or speculative, 4th generation nuclear plants, would not require as much long-distance transmission and energy storage but would require a similar build out of electric transport infrastructure. A shift of transport to natural gas and electricity to renewables, as recently advanced by T. Boone Pickens, would require less build-out of an electric transport infrastructure or at least a delay thereof but the expansion of a the natural gas distribution network, in all probability financed and owned by the private sector as is our petroleum infrastructure. Pickens’ proposal, however, does not target zero net emissions.

Investment for the new clean energy infrastructure for the United States economy as a whole will, over a period of a decade or two, number in the trillions of dollars, though these trillions will largely be spent in the United States on productive assets. Furthermore, it is not clear that a carbon price will provide the appropriate incentive/disincentive to motivate an economic actor (who?… mostly governments or public-private partnerships) to build pieces of this infrastructure, though it might provide revenue for these projects. In this regard, well-informed leaders of governments and their advisors will need to take many of the key steps, informed one hopes by a process not unlike the decision space tool.

While advocates of carbon pricing and in particular the carbon tax have attempted to emphasize that most carbon pricing proposals are revenue neutral or of low cost, if one is concerned about forging ahead rapidly towards a carbon neutral society, as well as funding employment-generating infrastructure projects, it would make sense to use some of the revenue from carbon pricing schemes to help fund these efforts. If one advances from a view of economics that takes public goods for granted to one that sees the building and maintenance of public goods as necessary and a part of the scope of government involvement in the economy, the financing of this type of project eventually through a combination of tax and use fee revenue becomes a key task (in the depths of a deep recession, Keynesians would turn to deficit spending followed by paying off the resulting debt during better times through taxes and use fees).

Electricity and Markets: An Uneasy Mix

The equipment required to run a regional or national high voltage electric grid is so large and long-lasting that fast-paced markets looking at quarterly earnings statements discount the value of such investments. Private corporations under government regulation or government owned utilities are able to take a long-term planning perspective to allow the building out of the largely unseen but still massive electricity generation and distribution system.

The market mechanism assumes that there are multiple actors that can supply or demand a good or service from each other and market participants can legally “dispose of” relationships that are no longer profitable for either party. The electricity system, at least one that is professionally managed on an interconnected grid, is a natural monopoly because of the physics of electrical circuits and difficulties of energizing and managing those circuits all the time. Furthermore, electricity in most settings needs to be produced and consumed immediately, so cannot be easily stored or inventoried like most other goods. In other words, it is economically inefficient for there to be two or more electric grids built in one area, as the electricity transmission and distribution system is such a huge expense that consumers would end up needing to pay for the resulting doubled expense.

There have up to the 1990’s been two main forms of ownership of the electricity system both within the US and abroad: public or state ownership and investor-owned regional monopolies overseen by government regulators.

Within the same timeframe that the first climate policies were formulated in the late 1980’s and 1990’s, politicians in the US were attempting to experiment with deregulation of the power industry with mixed and sometimes disastrous results. In deregulation, regional power generation markets were to be created within which competition was to be maximized and therefore, it was hoped, the economic efficiencies of the market would be brought to the utility industry. In deregulation efforts worldwide, public power companies were sometimes sold off to investors and private monopolies were required to open their distribution systems to privately owned generators.

To create a wholesale electricity market, non-profit independent system operating companies were formed that functioned as an exchange that brokered wholesale generation bids from generators to electricity retailers and managed day to day grid functioning. Consumers were also allowed to buy electricity from power companies (not specific generators) that did not actually serve them power through the distribution network but nevertheless operated generators or at least paid for power generation somewhere else. The regulated investor owned power companies that had acted as regional monopolies and still owned most of the power distribution system in a given area, spun off unregulated subsidiaries to develop and own new generators anywhere on the national power grid.

While deregulation has had some benefits in opening up a very conservative industry especially to renewable generators owned by third-parties, the declared goal of lower electricity rates has not been achieved, so the claimed efficiency benefits of deregulation and markets have not taken place with the electric grid. Deregulation has also caused the utilities to look long and hard at investing in their transmission and distribution infrastructure, which is not only for their own use but has also become an asset to their competitors in the area of retail power delivery.

While Enron undoubtedly attracted some bad actors outside of the norm, its early success and downfall are also an expression of a broader economic culture that uncritically idealized markets and trading. The interaction of Enron’s trading culture and business model and the electric grid helped expose deep flaws in the rush to deregulate the electricity industry.

In almost every account of the future post-carbon energy system, electricity will play an even more central role. The mechanisms introduced into the electricity industry via deregulation do not get us much closer to building the vital additional electric infrastructure that will be required for a transition to non-carbon sources: a renewable supergrid and self-generated renewable energy on private premises. In fact, the primary competition in electricity will be at some point in the future not between generators of similar types but between different technologies and systems of delivering electricity, self- or local generation and centralized generation and distribution. While partisans of either the local vs. the continental and trans-continental options can be found in abundance, we currently do not need to foster direct competition between the distributed vs. centralized modes of distribution except in theoretical discussions as there is so much carbon-dependent energy to replace by any means with little time to do so. Some in the climate community support conventional 3rd generation and new forms of nuclear power as climate solutions, these too are not easily developed and delivered by conventional market mechanisms without large government assists; they will continue to require an intimate relationship with government for research and development, insurance and waste disposal.

To realize the most likely near-term technological solution to reducing carbon emissions from electricity, the Repower America program, one would need large-scale cooperation and public financing options to create a Unified National Smart Grid that tapped into the resources of the best renewable energy regions of the US. Given the size of this investment it behooves us to find the most efficient means to finance this project, which also could function as an economic stimulus over the short and medium terms. As always with the electrical system, there will need to be efforts including industry representatives, regulators and legislators, independent of ideological commitments, to find the best solution appropriate to this technology and the challenges ahead. Some parts of this grid may be investor-owned while others may become part of the already existing federally owned electricity transmission system. Despite the deregulatory efforts of the past two decades, the electrical industry, more than, for instance, consumer electronics, is by its physical structure, more Keynesian than free market/monetarist, requiring a combination of public and private initiative to grow and thrive.

Scientific Research: Another Persistent Market Failure

Bell Labs, one of the few industry-owned laboratories that engaged in basic scientific research flourished during an era where scientists were able to take a longer view via the support of the AT&T telephone monopoly and from the US government. In the era after telephone deregulation, Bell Labs like other industry based laboratories became focused more on projects with more obvious commercial applications; rather than being an innovation panacea, markets focus scientists and administrators on research that will more immediately affect the company’s bottom line and competitive position vis-a-vis other companies.

Unless they are extreme market ideologues willing to throw everything upon the altar of unregulated markets, most political actors realize that government has and will continue to have a key role in funding basic scientific research of all types including research in the area of energy and climate. In a plenary session focused on carbon pricing at the 2009 American Economic Association meeting, the panel discussion, while informative, was airtight in its focus on the singular market failure of carbon emissions and the carbon pricing solutions. After I commented from the floor that clean energy infrastructure would not necessarily get built via carbon pricing, Lawrence Goulder of Stanford, brought up that research was another ongoing market failure that was not addressed by carbon pricing. As it turned out this was the only voice from the podium that brought up boundary conditions which fall outside or to one side of the idealized model of market actors responding to pricing.

Most people who are concerned about climate change support an increase in government funding for clean technology research. It is encouraging that President-elect Obama has appointed some world renowned scientists to his team, including his Secretary of Energy, Steven Chu and has talked of $15 billion per year in funding for clean energy research. Some call for still more funding in this area.

Despite the unanimity among all science advocates and their political allies, it is rare to find economists who factor this into the foundations of their economic models. The ongoing role of government in this area may be too obvious but calling it a “market failure” may help spur more realistic economic modeling of how technology change occurs.

Waiting for a Technological “Deus Ex Machina”

In ancient Greek drama, playwrights tied up loose ends in the plot by lowering a "god" via a rigging "machine" to distribute justice or other plot instruments deemed necessary. Because of the rapid changes in the area of information technology and software, consumers have come to expect "deus ex machina" solutions to their everyday technology wishes and headaches. Breakthroughs on the level of more basic technologies including in the area of energy, have not been as rapid and seems to require more patience than is typical in our society.

In the area or scientific research and innovation as well there are advocates, largely not economists, who are hoping for a “deus ex machina” in the area of one or many technological breakthroughs which would make the transition to a post-carbon economy cheap and easy. These advocates feel that one must pay attention only or largely to finding an as yet undiscovered technological fix for our clean energy and climate dilemmas. Some in this camp take the view that this must be a massive government funded research program, using the metaphor of the Apollo project, while others feel that daring and innovative entrepreneurs will lead us into a post-carbon world. As the latter view meshes perfectly with the monetarist/supply-side view of economics, the Bush Administration despite its indifference and/or hostility to aggressive climate action, occasionally spoke of the ability of entrepreneurs to innovate in the area of clean energy.

Some of Google’s clean energy initiatives, the Breakthrough Institute, and a number of venture capitalists have notably come forward with the notion that we will innovate our way out of this problem with minimal extra expense to the general population. While each of these actors is convinced that they have a fresh, even revolutionary message, this discourse touches a well-worn groove in the American psyche, and carries with it the various fantasies we all have for devices that will make our lives easier and more painless. Additionally this view underplays other failures of the market, including its dependence upon but tendency to neglect public goods like infrastructure.

To emit zero or negative net carbon into the atmosphere, we are going to need at least an evolution of current technology, if not a revolution in some technologies, to live well according to our current standards. These changes will eventually bring down the costs of most of these technologies. However, making carbon strategy contingent on a breakthrough or revolution in technologies is choosing perhaps a politically more comfortable but nevertheless a higher risk strategy than we really need to adopt. More perniciously, this type of technological over-optimism functions in actual fact as a block to taking action now in improving and deploying the already good technologies in search of the perfect, cheap clean technologies. The political comfort comes from postponing or ignoring expenditure of funds now on existing adequate technologies and infrastructure, in a sense reassuring the public that no costs will be incurred now.

Google’s RE<C (Renewable Energy cheaper than Coal) is one such initiative that has many laudable intentions yet ultimately encourages passivity in deploying real existing technologies that are not yet cheaper than coal. Google’s announcements imply, echoing the concerns of some climate activists on the global scene, that worthwhile post-carbon technologies MUST be affordable for rapidly industrializing countries (China and India) overlooking or downgrading the existing technologies that are slightly more expensive but affordable now in some of the developed countries. I have pointed out elsewhere that this phenomenon is “making the perfect (cheap and clean) the enemy of the good (mid-priced and clean)”.

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