January 30, 2006

Eileen Wenger Tutt
Special Advisor to the Secretary
California Environmental Protection Agency

Dear Ms. Tutt,

Please find herewith my written comments (KenJohnsonComments2.pdf) relating to the Climate Action Team’s Dec. 8, 2005 draft report to the governor and legislature.

I also have some additional comments on several points that came up in the Jan. 23, 2006 Climate Action Team Economics Workshop. These comments are provided below as a supplement to my formal written comments.

Ken Johnson
kjinnovation@earthlink.net


Comments regarding Mr. Dean’s presentation, “Inputs to Macroeconomic Analysis of Climate Change Strategies,” and Mr. Feizollahi’s presentation, “Macroeconomic Impacts of Climate Change Strategies”:

The CEC’s projected fuel prices are overly optimistic and do not reflect energy security risks. Gasoline prices are assumed to be $2.12/gal in 2010 and $2.19/gal in 2020. But as of Jan. 16, 2006, regular gasoline was averaging $2.42/gal in California, up 20 cents from the beginning of the month (http://www.energy.ca.gov/gasoline/index.html). Prices could be up or down another 10% next month, but will likely be significantly up in the 2010-2020 timeframe. Natural gas prices are assumed to be $5.70/MMBtu in 2010 and $8.00/MMBtu in 2020 (see p. 3 in the draft “Documentation of Inputs to Macroeconomic Assessment …”). But as of Dec. 1, 2005, natural gas prices in California were already in the $10-11/MMBtu range (http://www.energy.ca.gov/naturalgas/update.html).

Higher fuel prices would have two effects, which should be realistically reflected in the economic analysis: First, the value of fuel savings associated with emission reduction would be higher. Second, the proportion of savings attributable to regulatory policy would be smaller because the market would be more motivated to reduce fuel consumption in the baseline “business-as-usual” scenario. Sufficiently high fuel prices may motivate the market to achieve regulated emission limits even without regulatory intervention, in which case regulations would provide no emission reduction beyond business-as-usual. However, under this scenario it may be the case that more stringent regulations would not only be justified by the long-term environmental requirement (80% emissions reduction from 1990 to 2050), but could also provide even greater near-term economic benefits.

A realistic economic analysis should not simply assume fixed values for fuel prices, but should consider at least a couple or several scenarios with different fuel price assumptions. In rating regulations’ economic performance, the analysis should consider both the higher fuel cost savings and the lower baseline fuel consumption (due to fuel’s price elasticity) in the high-price scenarios.

The economic analysis is structured to rate the performance of regulations in terms of their net costs (or savings), given an assumed emission target (and assumed market conditions). However, the analysis should also evaluate performance from the converse perspective of assuming a given cost limit, and estimating what emission level would be achievable in the context of the cost constraint. For example, a zero-net-cost threshold could be stipulated, and a range of policy alternatives could be modeled to estimate how much emissions reduction would be achievable at zero net cost. The maximum achievable reduction level would define a benchmark for rating the emissions performance of specific policy proposals. The analysis should also evaluate policy “robustness” in terms of how well regulatory instruments are able to control costs and reduce emissions under a broad range of possible market conditions.

It is important to focus on cost-constrained (as opposed to emission-constrained) analysis for the following reason: The near-term (2010 and 2020) emission targets, unlike the 2050 target, are based on cost and feasibility constraints and not on environmental requirements. The 2050 emission target, which is based on an environmental sustainability limit, requires average annual reductions of approximately 9MMt from a 2005 baseline over the next 45 years, but the 2010 and 2020 targets fall short of this goal because the cost-acceptability constraint is more limiting than the environmental requirement. Thus, near-term policy objectives are based on a cost constraint, not an emissions constraint (i.e., regulatory emission limits are determined primarily to satisfy the cost constraint, not the environmental sustainability requirement). In order to ascertain regulatory policy effectiveness in relation to the cost-constrained policy objective, regulations should be rated in terms of their cost-constrained emissions performance.


Comments regarding Ms. Tutt’s presentation, “Overview of Meeting”

The function of Cap and Trade was characterized as achieving maximum emissions reduction at least cost. This is a mischaracterization – the function is more accurately described as capping emissions at least cost because Cap and Trade provides no incentive to reduce aggregate emissions below the cap level. Moreover, the policy objective of “achieving maximum emissions reduction at least cost” is ill-defined, in that it does not recognize or reconcile the conflicting policy objectives of reducing emissions and reducing costs. Some emissions reduction may be achievable at zero or negative net cost, but emissions reduction on the scale required for climate stabilization will likely entail positive costs, in which case it will not be possible to simultaneously reduce emissions and reduce costs.

A coherent regulatory policy requires clear priorities. If environmental objectives take priority over costs, then emissions should be capped at a level commensurate with the goal of climate stabilization, and policy instruments should function to achieve climate stabilization at least cost. If cost control has higher priority, then costs should be capped at an acceptable limit and regulatory policy should function to minimize emissions to the extent possible within the cost limit.

In practice, GHG emissions are never capped at environmentally adequate levels because cost acceptability always takes priority over environmental objectives. This is evidenced by the Climate Action Team’s policy prescriptions, which are primarily – if not exclusively – limited to options that have zero or negative net costs, neglecting regulations’ environmental benefits and making overly generous allowance for predictive uncertainty. By contrast, the 80% emissions reduction target for 1990-2050, which is the Climate Action Team’s only target based on environmental requirements, is described as a “stretch goal”. This apparently means it is only a “political” goal that is not taken seriously and is basically ignored. For example, the Overview presentation implicitly ignores the 2050 target in its assertion (on p. 8) that “… Implementation of These Strategies will Achieve the Governor’s Targets”.

It should be recognized that Cap and Trade’s policy objective of capping emissions at least cost is incompatible with both the environmental objective of minimizing emissions (not merely capping emissions at environmentally unsustainable levels) and the economic objective of capping (not just minimizing) costs.


Comments regarding the Public Goods Charge

One of the other commenters, representing taxpayer interests, strongly objected to the prospect of a 2 ¢/gal public goods charge on transportation fuel, suggesting that it would create undue economic hardship. But this assumes that a 2 ¢/gal charge would result in a 2 ¢/gal increase in retail fuel prices, which is not necessarily the case. If the charge revenue is applied as a subsidy to biofuel, then competition from subsidized biofuel would put competitive pressure on fossil-fuel prices, resulting in price decreases that would tend to offset the charge. Moreover, if the subsidy stimulates accelerated production and commercialization of biofuel, then fuel supplies would be less constrained and the reduction in future fuel prices resulting from relaxed supply constraints could far exceed the minuscule 2 ¢/gal charge. The economic analysis should attempt to model the real-world price changes and fuel substitution resulting from such charges and subsidies under a range of possible market scenarios.