Negative externalities

There is a widespread opinion that renewable energy is only alive because of the subsidies. As if to confirm the point a few days ago US president Barack Obama proposed a new 10$ per barrel tax to be levied on the american producers and importers of oil “to upgrade the nation’s transportation system, improve resilience and reduce emissions”.

Actually, alternative energy is not doing so bad. From 2009 to 2015 the cost of wind power dropped by 60%, and solar power by 80% – the sort of progress we normally see only in the information technology industry. Automotive industry is adapting to the emerging reality. BMW announced plans to develop electric version (PHEV) of every major model. Mercedes will introduce 10 new electric (PHEV) models by 2017. Toyota is making a huge bet on its version of the electric vehicle (FCEV). Market capitalisation of Tesla – a recent electric vehicle (EV) start-up – is half that of Ford and General Motors.

Increasing taxation of the incumbent is a form of subsidy to the renewable energy industry. Why do it now when renewable energy (including transport based on renewable energy) is finally becoming cost competitive with the fossil fuels?

Certain resources are priced at zero as they are considered infinite and easily available. Like air. For a long time the capacity of the atmosphere to take emissions – a by-product of fossil fuel combustion – has been treated like such type of a free and unlimited resource. But ecological problems, accumulated over XX-XXI centuries, have led to realization that such capacity is actually finite. It can be likened to the total parking space in the center of a megapolis. Charging for a limited resource (parking space, or capacity to take emissions) allows, if the price is right, find the right balance.

Barack Obama’s initiative is not the first of this sort. The European Union Emissions Trading System was launched in 2005 to establish a market in the carbon dioxide emission quotas. Parameters of the scheme were set before the 2008 economic crisis, and turned out to be inadequate for the new reality where the economies would grow slower than initially expected. Plenty of emission quotas were offered, so the equilibrium was found at the low price levels not changing the behaviour patterns of the market participants. The idea was right, but the fine-tuning of the parameters was not.

Presence of a viable alternative provides a new dimension in the logic of the argument. When there are no alternatives demand for certain goods does not depend much on the price. Oil at 140$ was a price for a lifestyle – something difficult to give up. But today as the alternative is emerging there are two products offered in the market – energy bundled with unwanted by-products (combustion emissions), and clean energy. The two should naturally be priced differently. The proposed oil tax is effectively an attempt to put a price on the by-products, and thus establish price differential between the two sorts of energy. In the world of two different sorts of energy one can keep the usual lifestyle without damaging the environment being the dark side of it.

We are used to seeing the oil producing countries imposing oil taxes to extract the natural resources rent. Such taxation does not impact the market price formation, but rather results in the profit redistribution within the industry from the producers to the state. On the contrary, additional taxes imposed by the oil consuming countries increase the costs of all the producers and lead to a higher market price. But higher market price is not the same as welfare loss. Quite the opposite. Some of the costs paid by the society, such as shorter lifespan and worsening quality of life due to ecology, are not monetary. Higher oil price (monetary cost) would lead to disproportionately larger decrease in non-monetary costs for the society.

If the proposal is approved, in the present form or another, the main result will be the acceleration of transition to clean electric transportation. The liquid fuel will become somewhat more expensive and the cost of renewable electricity will only continue to go down, adding to the economic attractiveness of the electric and hybrid vehicles. Approval of the initiative will accelerate arrival of the “peak oil”. Peak oil demand though, not peak supply.

There are political and economic sides in the president Obama’s proposal. On the political side there is an ongoing presidential campaign, and there is Congress controlled by the republicans (who are likely to block the proposal in its present form). Some of the skeptics view the whole initiative as a political bluff, or at best a bargaining chip. But strong economic logic make it an ace in the hands of the democrats amidst the ongoing presidential campaign.