Cross-price elasticity: conservation vs. oil

As I emerge from a long hiatus (Argentina and catching up with work upon my return), I’m going to ease back into blogging with a very brief econ 101 post.  Hopefully my economic intuition and vernacular aren’t too rusty (feel free to tear into this post* — it’s the only way I’ll get back in stride).  From the LA Times:

John McCain returned to Santa Barbara this week not to assert his opposition to offshore drilling — as he did when he ran for president in 2000 — but to make the calculated gamble that high gas prices have trumped voters’ desire to protect the environment…

We talk a lot about the environmental benefits of higher fuel prices as people change their lifestyles to reduce their consumption of fossil fuels.  However, it’s easy to forget that in some locales, the opportunity cost equation for environmental protection can include increased oil supply.  Essentially, conservation and fuel are an odd sort of complements.  When the price of fuel goes up, the demand for environmental protection curve shifts inward.  In the past, it seems that this cross-price interaction has been relatively inelastic, but this might be changing as we arrive at new reaches of the fossil fuel demand curve:

Los Angeles Times polls show that, in California, opposition to offshore drilling has not weakened even during past energy crises. But new national polls have shown that the country, burdened by exploding gas prices, supports drilling in sensitive areas.

Keep in mind that the impact on world oil prices from drilling in specific sensitive areas is likely to be small and somewhat temporally distant (see: ANWR), but this fact can easily be obscured by rhetoric and poor information.  Luckily, politicians usually try to stay away from those kinds of things…

*I’m guessing Daniel and I might not be friends anymore by this afternoon.

Climate policy as diplomacy

Ryan Avent has been doing a lot of good blogging about cap and trade recently. Today he assesses the political environment — the combination of near certain defeat for the Lieberman-Warner bill this summer with likely election returns this fall — and argues:

Congress is almost certain to be more Democratic next year, and the White House will be more friendly to climate bills whoever the president is (but substantially more so if Obama is the victor). … Democratic leaders are watching now to see how their opponents plan to fight, so that next year, they’re prepared to use their majority to effectively counter opposition en route to a truly good climate bill.

I thought this was a bit optimistic about how smoothly Democrats would operate next year, a point I made (rather sarcastically) in the comments.

In response, Ryan offers up a pitch-perfect response:

Ah, but you failed to take into account the fact that Obama is going to CHANGE WASHINGTON WITH CHANGE WE CAN BELIEVE IN YES WE CAN.

This is still making me chuckle after repeated reads.

I happen to agree that among the presidential candidates Obama would get a climate bill with the least amount of political wrangling and infighting. But relative to what? There is going to be pork all over the floor before this thing gets done and that is just the facts. The domestic political machine has to run its course and President Obama is not going to be able to strong-arm Congressman Dingell into rolling over on Detroit or Senator Reid into greenlighting Yucca Mountain.

So why do I think that Obama could get a bill with less partisan hackery even while I’m pessimistic he’ll do much to change Washington? I think it’s because I view Obama as being most concerned among the candidates about America’s standing in the world and with reaching out to our partners. Having America perform an about-face on climate policy could be a key part of a broader diplomatic strategy of engagement and cooperation. This could then put indirect pressure on Congress to deliver a well-designed bill.

In the end I guess I am agreeing that Obama does have the best chance of getting legislators to work with him on climate policy but I am positing a different channel through which this works.

I think the challenge he will face if he chooses this strategy is to simultaneously be realistic about the domestic policy constraints he faces and not promise allies things that he cannot deliver, while at the same time having a clear set of goals that do indeed signal American leadership on global climate policy along with concrete strategies for how he is going to get people on board with his goals.

Tight

Yes, this McCain-Clinton idea to suspend the gas tax is stupid. I think the best quote I’ve seen so far comes from Len Burman via Greg Mankiw:

Yesterday I was on the NewsHour to talk about the gas tax holiday. I asked if there was another guest and the producer said, “We tried, but we couldn’t find anyone to argue the other side (that the gas tax holiday made sense).”

The more interesting part of the discussion is not the piling on — though certainly people should be pointing out how mind-bogglingly stupid this proposal is — but the discussion about tax incidence. Most commenters are arguing that producers will benefit more than consumers from the tax holiday, because summer oil supply is very tight. As Greg Mankiw describes it:

What you learn in Economics 101 is that if producers can’t produce much more, when you cut the tax on that good the tax is kept . . . by the suppliers and is not passed on to consumers.

Or here’s Paul Krugman:

Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory: if the supply of a good is more or less unresponsive to the price, the price to consumers will always rise until the quantity demanded falls to match the quantity supplied. Cut taxes, and all that happens is that the pretax price rises by the same amount.

But Tim Haab is not so sure that supply is less responsive than demand. He nails the theoretical explanation. In fact, if you really want a great straightforward description of tax incidence, see this pair of posts he wrote just last month. Pay particular attention to the chart in the second post, which graphically depicts what he says here:

Only two cases are clear cut. If buyers are price insensitive and and sellers are price sensitive (top right panel), the buyer will bear the burden of the tax. If sellers are price insensitive and buyers are price sensitive (bottom left panel), sellers will bear the burden. In cases where both are sensitive or both insensitive, the results are unclear and depends on the relative sensitivities.

But in arguing today that producers are more price sensitive than many people may think he gets some facts badly wrong. Specifically he uses this chart to argue:

So when will supply of gas be perfectly inelastic? The most obvious answer to me would be when refineries are running at full capacity over the relevant range of prices. That is, regardless of the market price, refineries can’t keep up. Is that the case? The chart to the right gives U.S. refinery capacity and gasoline consumption in gallons per day from 2002-2007. On average, U.S. refineries produce at about 50% capacity. (emphasis added)

No. Just… no.

The problem is Tim compares refining capacity data to gasoline consumption. This is an apples-to-oranges comparison. Capacity is measured by the input — crude oil — and this is being compared to a specific output, gasoline. But refineries produce many things besides gasoline — jet fuel, home heating oil, etc. — and even if every U.S. refinery were optimized to make gasoline (which isn’t the case) there would still be losses from the refining process itself.

As it turns out the EIA* actually publishes weekly data on refinery capacity margins (or “percent operable utilization” as the EIA calls it). I downloaded the series to create the chart below. Note that with the exception of Katrina (September 2005) that refineries have run at 80-98% capacity over the last few years (most typically from 85-95%). Note that there is also a seasonal pattern: utilization usually declines in winter and peaks in summer. This would imply less elastic supply in summer. Note also, however, that refineries are entering this particularly summer with the lowest capacity utilization rates we seen in spring in awhile, around 85% instead of 90-95%.

What would I conclude from all this?

1. If you wanted to maximize the portion of this tax ‘refund’ that went to oil companies, you should make the gas tax holiday during summer, when supply is most inelastic.

2. Compared to previous years, producers would probably benefit less from the gas tax holiday this year, since capacity margins are down.

3. Despite the factual errors and the incorrect implication that summer gas supply is fairly elastic, Tim is probably right when he says, “maybe the tax holiday might have some effect on both consumers and producers.” Why is that? Remember, demand for gas is also very inelastic. In other words, which world are we in? I say the bottom right case in this chart.

This guy sums it up pretty well when he says,

the gains of the tax cut will be split evenly between producers and consumers… I’m not saying that the gas tax cut is a good idea. In fact, I think it’s horrible pandering that wont help anyone in the long-run.

*Public service announcement: when using energy data about the U.S. to back up any argument, please avail yourself of the EIA. If you can’t find what you need, look again. Still not sure? Check a third time. The EIA is amazing. Use it.

How, exactly, Iowa controls the world

Although this is first and foremost an environmental economics blog, I’ve decided that it is my duty as a native Iowan to address the upcoming Caucuses. The need for such a post became evident to me when several discussions with highly politically literate friends revealed a widespread ignorance of the mechanism by which approximately 250,000 Midwesterners will significantly alter the course of U.S. politics. Preview: it’s completely crazy.

Bloomberg is audaciously hopeful

In his speech at the Bali conference, Michael Bloomberg described a cap-and-trade system as vulnerable to “special interests, corruption, and inefficiencies,” and called for a tax in its stead. There have been numerous posts here at CT weighing the merits and deficiencies of taxes against those of a cap-and-trade system, so I’m not going to try to expand or improve upon those.

However, a major argument raised against a carbon tax is that of political intractability. Bloomberg attempted to address this major weakness of his policy:

He said most experts would agree that carbon taxes are “a very difficult political lift,” since they would probably boost costs for energy consumers. “But that’s what leadership is all about, and we need leaders around the world who get things done,” the New York City mayor said.

First off, a cap-and-trade, unless full auctioning occurs, is also likely to raise costs for energy consumers. Second, is it just me, or do politicians put far too much stock in their own ability to lead America to greatness? Obviously we need to elect people who have vision on important issues, but choosing realistic policies is also a big part of being an effective leader. Regardless, with Chris Dodd largely out of contention, it would be interesting to see Bloomberg jump in the Presidential race. He could inject the cap-and-trade vs. carbon tax debate into national politics. Jumping right to that dicussion in a general election (especially one in which two major candidates are discussing it) might cast mandatory carbon mitigation as an inevitability.

H/T: Mankiw.

Reagan was an, um, environmentalist

In John McCain’s new “Environment” issue brief video he channels the legacy of Teddy Roosevelt and Ronny Reagan. (Actually the clip is funny because he says “Teddy Roosevelt was a great environmentalist, Ronald Reagan was a (verbal pause) environmentalist.”) Now usually I try to avoid politics on CT, but I thought this was a good time to bring up Ronald Reagan’s legacy on renewable energy. This may be old news to many of you, but I just learned recently that Ronald Reagan literally ripped the solar panels off the roof of the White House when he became president.

In the 1970’s the US faced an energy crisis due to the oil embargo. Under the Carter administration the US embarked on an unprecedented effort to reduce our dependence on foreign energy. One of the more ambitious areas of focus was on solar power, and, in addition to funding a massive amount of R&D and substantial tax credits for solar installation, Carter installed solar hot water heaters on the roof of the White House a sign of the nation’s intent.

Enter the actor from California. Reagan came into the White House and quickly cut funding for solar research and revoked the the solar installation tax credit (Evan has a good story about Reagan’s effect on the National Labs). Then, as a signal of his intent, he pried the solar panels off the roof and put them in the dumpster. 25 years later, we’re frantically scrambling to increase our national renewable capacity. Meanwhile, countries like Germany who invested heavily in solar in the past are acheiving impressive levels of renewables penetration.

Today, we’re lucky that Dutch’s old state, California, and companies like Google are picking up the slack. Nevertheless, Reagan’s pettiness and lack of foresight on this issue should be a source of embarrassment, not inspiration, for the current GOP candidates.

A highly scientific study

Total pages pertaining to energy/environmental policy on candidate websites:

Hillary + Obama + Edwards = 33

Giuliani + Romney + McCain + Huckabee = 6.

The Economist weighs in on green protectionism and Reggie

Here’s the first link. Unsurprisingly the magazine opposes any sort of green trade restriction. As I said earlier on this page, I’m pretty skeptical as well. My opposition was further solidified by all the anti-free trade rhetoric at this week’s Democratic debate. Not sure what happened to the Democrats over the past 7 years, but it sounded like most of the candidates on stage in Nevada would gladly levy us back to the Hawley-Smoot days. No need to give them more ammo on this front.

Also in this week’s Economist is a short piece on the Regional Greenhouse Gas Initiative (RGGI). The main point is that RGGI is going auction all its permits (good), but that there may be too many of them (bad). On the former point, I actually don’t know if this is settled in all ten states. On the latter, this is something PointCarbon published two months ago. Given that electricity usage is so dependent on the weather and emissions are so dependent on fuel prices, pegging reduction targets to a baseline year will always lead to some over- or under- allocation. Yet banking should mitigate the damage of this over time. Of course none of this would even matter if Congress ever got around to passing a reasonable climate bill. RGGI’s initial cap isn’t that strict, so a more ambitious national policy would probably prove binding, and the price of RGGI permits would go to zero.

Celebrate clean coal, come on!

I’d just like to point out that last night’s Democratic debate was sponsored by the coal industry. That might help explain this exchange:

WOLF BLITZER: All right, Senator, until there’s some new technological breakthrough, as you would hope and all of us would hope, where do you send the [nuclear] waste?

BARACK OBAMA: Well, right now, it is on-site in many situations. And that is not the optimal situation, Wolf. But don’t keep on assuming that we can’t do something. I mean, this is about the third time where you said, assuming we can’t do it, what’s our option?

BLITZER: Well, until we can…

OBAMA: But — but — but I’m running for president because I think we can do it. I reject the notion that we can’t meet our energy challenges.

BLITZER: All right.

OBAMA: We can, if we’ve got bold leadership in the White House that is saying we are going to do something about climate change, we are going to develop renewable energy sources. That’s what I intend to do as president.

BLITZER: Let…

OBAMA: And we shouldn’t, you know, be pessimistic about the future of America.

Nuclear is dangerous? Renewables are an audacious pipe dream? In such dire times, to whom can the American people possibly turn?

Taking off my foil hat for a second, I’d say the “highlight” of the evening was a clean coal commercial set to “Celebration” by Kool and the Gang. I’m considering advocating an immediate $500/ton carbon tax just so I never have to see that ad again.

Obama and King Coal

The tar sands article I just posted about also briefly mentioned the Coal-to-Liquid Fuel Promotion Act, introduced earlier this year by Jim Bunning and Barack Obama. This act would provide tax subsidies and loan guarantees for plants to invest in CTL. I knew that Obama was big on coal (he’s from Illinois), but I had forgotten about this specific bill when I posted on the energy platforms of the 08 front runners. While I’m all for letting the market decide which fuels we use once carbon restrictions are in place, subsidizing CTL now is insane. Especially given that there is still tremendous uncertainty as to if and where we’ll be able to capture and store carbon.

For me, this bill significantly undermines Obama’s green credentials. To steal a phrase from former Canadian Environmental Minister Charles Caccia, pledging to fight global warming on the one hand while subsidizing CTL on the other is “attempting to ride two horses galloping in opposite directions.”

Edwards’ ethanol guarantee

John Edwards continues to develop his energy platform in his new “Plan to Build One America“. Specifically, he comes a step closer to advocating full auctioning of permits (quote from page 52):

Edwards will cap emissions of greenhouse gases and reduce them by 20 percent by 2020 and at least 80 percent by 2050. He will auction the right to emit any greenhouse gases after a short transition period.

His overall plan retains many of the vague gimmicks noted by Rich in his earlier, more comprehensive post on the Democratic front runners, such as establishing a Green division of Americorps. He also still loves his command-and-control measures, many of which have questionable value:

Require oil companies to install biofuel pumps at 25 percent of their gas stations and require all new cars sold after 2010 to be “flex fuel” running on either gasoline or biofuel.

One policy I found particularly interesting is a plan to offer loan guarantees to new ethanol refineries. Under such a scheme, the government essentially co-signs a loan. There are two sides to this policy. On the one hand, by overcoming information asymmetries in the credit market, the government can help allocate credit to unproven but promising projects. This theoretically releases societal benefits that would have otherwise gone untapped. On the other hand, there is the issue of moral hazard; those partnering with the government are more likely to take on excessively risky projects.

Loan guarantees have been used to underwrite coal gasification, ethanol, and geothermal projects in the past with varying levels of success. Of the three ethanol projects, two defaulted and were sold for salvage, while one defaulted but became a major ethanol producer after extensive refinancing.

However, the point of a loan guarantee is to fund a large project with a huge amount of associated risk. At this point, are ethanol plants really the sort of thing the government ought to be cosigning on? They seem to be a pretty proven investment at this point (especially if Edwards mandates that all cars be able to use E85 after 2010 and oil prices continue on their way up). Perhaps loan guarantees would be more appropriate for truly risky, potentially revolutionary technologies such as CCS coal or tidal energy.

You keep on using that word. I do not think it means what you think it means.

Presidential candidate Hillary Clinton has released her energy and climate plan. I expect one of my co-bloggers will be along at some point with a more comprehensive analysis that will serve as an update of his previous analysis of the leading candidates’ energy plans. I want to deal in this post with reaction in the blogosphere to her promise to auction of 100% of the emissions allowances in a cap-and-trade program. Over at Gristmill David Roberts says:

I was just on a conference call with the Clinton campaign’s energy advisors, who were answering questions from the press. …

[The advisors said,] “the cap-and-trade program would produce assistance for energy-intensive industries.”

Now, as you know, the criticism of giving away permits under a cap-and-trade system is that it would produce windfall profits for polluters. By auctioning all permits, Clinton has seemingly avoided this criticism. But if she takes the auction revenue and then … gives it to polluters, well, she’s just hidden the windfall profits, not eliminated them.

Let me state first off that in general the idea of auctioning allowances rather than giving them away is a very good one. Auctions generate government revenues which can (hopefully) be put to good use, and by auctioning allowances rather than giving them away you diminish the opportunities for rent-seeking.

BUT… this term “windfall profits” has gotten thrown around a lot since the EU gave away most of the allowances in its Emission Trading Scheme (ETS) and the electric power companies subsequently all made a lot of money, and there seems to be a lot of fuzzy thinking about what windfall profits are, who might get them, and what the implications are for allowance allocation. The upshot is that while using an allowance auction is generally a very good idea, it will likely be helpful to freely allocate some allowances to a few industries which face strong international competition.

Dodd cites the Pigou Club at debate

Chris Dodd just used N. Gregory Mankiw to shame his opponents for not supporting a carbon tax.

Energy/ Environmental platforms of the ‘08 front-runners

Last weekend Barack Obama released a long, detailed energy/ environmental platform to much political fanfare. After reading it I decided to finally check out Hillary and Edwards’ plans for comparison purposes. If you’re of voting age and read this blog then I definitely encourage you to read each plan for yourself. In the meantime however, I’ll summarize some of the highlights and potential lowlights below.

** Note that this post only looks at the Democratic front runners. I went to the websites of Giuliani, Thompson and Romney and let’s just say that environmental policy clearly isn’t a “key issue” for the GOP at this point. Giuliani has come out in the debates as being pro-nuclear. Other than that, any mention of energy policy is in the context of energy security, and usually amounts to simply opening up untapped domestic oil.