A group of Republican elder statesmen have recommended that the US adopt a $40/ton carbon tax as the “most efficient and effective way of reducing CO2 emissions”. This post reviews the potential economic impacts of such a tax on the US energy sector. It concludes that the impacts on the oil and natural gas sectors would be comparatively minor but that the impacts on the coal sector would be severe. Electric utilities with a high percentage of coal in their generation mix could well be driven into bankruptcy.
The Carbon Tax Proposal:
This is contained in a document entitled The Conservative Case for Carbon Dividends, written under the auspices of the Climate Leadership Council, “an international research and advocacy organization whose mission is to mobilize global opinion leaders around the most effective, popular and equitable climate solutions.” It contains little in the way of detail, but its main provisions are:
…. a gradually increasing tax on carbon dioxide emissions, to be implemented at the refinery or the first point where fossil fuels enter the economy, meaning the mine, well or port ….. All the proceeds from this carbon tax would be returned to the American people ..… outright repeal of the Obama administration’s Clean Power Act and the elimination of most if not all onerous EPA regulations
And the rationale for the tax is:
Economists are nearly unanimous in their belief that a carbon tax is the most efficient and effective way to reduce carbon emissions. A sensible carbon tax might begin at $40 a ton and increase steadily over time, sending a powerful signal to businesses and consumers, while generating revenue to reward Americans for decreasing their collective carbon footprint
How would a $40/ton (I assume a 2,000lb short ton) carbon tax affect energy prices for CO2-emitting sources, specifically oil, natural gas and coal? To calculate this we need CO2 emissions data for these energy sources, which the EIA supplies in its January 2017 Monthly Energy Review (all of the data used in this review are from this source unless otherwise specified). Figure 1 plots running 12-month averages of monthly CO2 emissions from oil, gas and coal between January 1990 and October 2016, the last month for which EIA gives emissions data. For the most recent 12-month period for which data are available (November 2015 through October 2016) oil was responsible for 45% of total CO2 emissions from the US energy sector, natural gas for 29% and coal for 26%:
Figure 1: Running 12-month averages of monthly CO2 emissions from oil, gas and coal between January 1990 and October 2016
Impact of carbon tax on oil prices:
According to EIA the US petroleum sector, including the burning of gasoline, diesel, aviation fuel etc. and the manufacture of other refined products such as lubricants, asphalt and plastics, emitted 2,542 million tons of CO2 over the November 2015-October 2016 12-month period. Multiplying this by the $40/ton carbon tax yields $101.7 billion in tax revenue. With oil consumption over this period at 7.14 billion barrels this represents an increase of $14.24/bbl, or about 25% relative to the present ~$56/bbl price of Brent crude.
(It should be noted that calculations performed using published heat content values give significantly higher numbers. The EPA’s blanket estimate of 0.473 short tons of CO2/bbl , calculated using a heat content of 5.80 million btu/bbl for “average” crude, gives 3,377 million tons of CO2, tax revenues of $138 billion and a price increase of $18.92/bbl. I’ve not been able to find out why the EIA estimates are lower but have assumed they are the more reliable source of data.)
Impact of carbon tax on natural gas prices:
According to EIA the burning of marketed natural gas emitted 1,477 million tons of CO2 over the November 2015-October 2016 period. Multiplying this by the $40/ton carbon tax yields $65.2 billion in tax revenue. With natural gas consumption over this period at 28,432,240 million cu ft this represents an increase of $2.29/million btu, almost doubling the November 2015-October 2016 average spot price of $2.38/million btu at the Henry Hub, which is presumably where the carbon tax would be levied.
(Again, calculations performed using a gross heating value of 1,050 btu/cu ft and 117 lbs of emitted CO2/btu for natural gas give higher numbers. Tax revenues increase from $65 to $70 billion and the Henry Hub price goes up in proportion.)
Impact of carbon tax on coal prices:
According to EIA coal burning emitted 1,477 million tons of CO2 over the November 2015-October 2016 12-month period. Multiplying this by the $40/ton carbon tax yields $58.7 billion in tax revenue, with the tax applied at the mine mouth. With coal consumption of 733 million tons over this represents an increase of $80.13/ton, which almost triples the weighted average US coal price of $40.97/ton paid by electric utilities, the dominant coal consumers, in November 2016.
The increase will also fall disproportionately on low-btu coal. Table 1, based on data from Quandl, approximates the price increases that each of the US’s five major coal-producing regions will experience. (Note that the tons CO2/ton coal values are adjusted to an average of 2.0 to conform with the value estimated from the EIA’s emissions numbers):
Adding a $40/ton carbon tax increases mine mouth coal prices for higher btu coal by a factor of about three. The mine mouth price of low-btu Powder River Basin coal, however, increases by a factor of six.
Table 2 shows the results when the EIA’s estimates of between 205.7 and 215.4 lbs CO2 emitted per million btu of coal are used instead of the EIA’s emissions numbers. Mine mouth prices for higher-btu coal triple or quadruple and the price of Powder River coal increases by a factor of over seven:
Summing the oil, gas and coal tax estimates listed above gives 102+65+59 = $226 billion/year. This is within the $200-300 billion/year range estimated in the carbon tax proposal.
Impact of carbon tax on electricity prices:
A $40/ton carbon tax will inevitably drive US electricity prices up, and the amount by which they increase will depend on the generation mix, with those states with a heavy dependence on coal, and to a lesser extent natural gas, the most affected.
Figure 2 provides a graphical summary of the percentage of electricity generation contributed by oil, gas and coal in each of the fifty US states. The percentages are estimated from data provided by the Washington Post that cover January through May 2015, so they will tend to overstate the present contribution of coal and userstate the contribution of gas. Note also that these are in-state generation data that do not allow for exports of electricity to or imports from other states. Data on electricity consumption by generation source and state are not readily available.
Figure 2: percentage of electricity generation contributed by oil, gas and coal by state, January through May 2015
Between January and May 2015 39 of the 50 US states generated half or more of their electricity from fossil fuels. Only Hawaii and Alaska still used a significant amount of fossil oil to generate electricity.
The electricity price increases resulting from the carbon tax were estimated by dividing the total cost of the tax by total generation. This gives the following results for the November 2015 through October 2016 period (note that oil costs are based on a small amount of generation and are therefore approximate.)
We can evaluate the impacts of these added costs in three ways. The first is by adding them to power plant operating costs, which were estimated by EIA at $37.26/MWh for a fossil steam (i.e. coal) plant and at $33.24/MWh for a CCGT plant in 2015 (no estimate is given for oil-fired plants). Adding $40/MWh to the coal plant operating cost roughly doubles it from $37 to $77/MWh and adding $18/MWh to the CCGT plant cost results in a ~50% hike from $33 to $51/MWh.
The second is by adding tax costs to the levelized costs of electricity for new plants, which are estimated by EIA at $95.1/MWh for a conventional coal plant and at $75.2/MWh for a CCGT plant coming on line in 2020. It’s not clear exactly how a carbon tax would figure into an LCOE calculation, but simply adding the cash cost increases the LCOE from $95 to $135 for a coal plant and from $75 to $93 for a CCGT plant.
The third way is by adding the cost of the tax to electricity rates. I’ve done this for retail rates on a state-by-state basis by weighting the cents/kWh tax costs listed in Table 3 by the generation percentages shown on Figure 2. The state-by-state results in cents/kWh added are summarized in the left graphic in Figure 3. The overall impact is to increase average US retail rates by 2 cents from 12.75 to 14.75 cents/kWh, or by about 16%:
Figure 3: Left: impact of carbon tax on retail electricity rates by state, cents/kWh. Right, impact of carbon tax on retail electricity rates by state, percent increase.
The right graphic shows the percentage increase in retail electricity rates necessary to offset the carbon tax increase, once more assuming that it’s passed on to consumers at cost. In both cases, states with a high percentage of coal generation are the most seriously affected.
A $40/ton carbon tax would have the impact of increasing the US price of oil from its current level of around $56/bbl to about $70/bbl and increasing the Henry Hub natural gas price from $2.38 to around $4.67/million btu. These price increases will be inflationary and will also tend to depress economic activity. However, $70 oil and $5 gas are well within the range of historic oil and gas prices, and we can therefore expect that while they would have an adverse impact on competitiveness they would not cause the US to go into an economic tailspin.
Coal is a different matter. A $40 carbon tax roughly triples the price of US coal, taking it to levels not previously seen except briefly during the 2008/9 recession, and coal-dependent utilities in particular would need rate hikes to offset the impacts of the tax on their operations. As shown in Figure 3 these rate hikes are not small. Five states would require increases of 40% or more (Virginia more than 50%), twelve would require increases of 30% or more, 24 increases of 20% or more and 38 increases of 10% or more.
And herein lies the problem. US utilities are ruled by state public utility commissions, or their equivalent, that are either elected or appointed by the state governor. No state public utility commission would dare approve a 40%, a 30%, a 20% or maybe even a 10% retail electricity rate increase to keep coal plants in business – they would risk getting lynched. What would most likely happen is that the utilities would be told that this would be an excellent time to accelerate the conversion from high cost coal to “low-cost” renewables, particularly in the 30 US states that have adopted mandatory renewable capacity goals. The outcome would be that coal-dependent utilities would slowly, or in some cases rapidly, go bankrupt. The only solutions would be to repeal or greatly reduce the carbon tax on coal or a federal bailout of the coal industry, either of which would defeat the purpose of the exercise.
In summary, a $40/ton carbon tax could, and quite likely would, doom US coal-fired generation to extinction within a fairly short period, and since coal still supplies about 15% of total US energy consumption the consequences would be disastrous. Luckily, however, the proposers of the tax do not expect that the concept will be well received by the Trump administration.