Wednesday, January 30, 2013

Fat-Tailed Uncertainty in the Economics of Catastrophic Climate Change

Oh no, it's by someone from Harvard!

I seriously suggest that you read the paper.  It is really more of a philosophy piece attacking economics than an economic paper, but it is very convincing.

Although Weitzman was skeptical of the low discount rate and high cost of carbon from the Stern report, he sought to justify a higher cost of carbon on the premise that the uncertainty can increase the risk of a low-probability catastrophe.  His first argument is that we have already exceeded the maximum carbon dioxide levels in the last 800,000 years.  Conventional climate economics yields an optimal policy of stabilization at around 700 ppm while the previous high was 300 ppm.  This could potentially be very dangerous.

Of course, vastly increasing carbon dioxide does not necessarily mean that global temperatures are going to be unmanageable, but the greater the concentration, the greater the risk.  The IPCC had only modeled warming up to 4.5 degrees Celsius.  Depending on the type of curve projecting warming, the probability of low-probability events can be significantly different.  Using a pareto (power) distribution, the probability of high-warming is significantly greater than using normal distribution.  This lies in the "fat tail" of a power distribution that yields higher probability for extreme events.

There are real reasons for having concern for catastrophic warming.  A big concern among climate scientists is the possible release of massive amounts of methane.  We have large methane deposits stuck in permafrost that may slowly leak out methane as the permafrost melts from higher temperatures.  This positive feedback could be potentially devastating.  This article was written before the shale gas revolution, but there is concern now about methane leakage from natural gas deposits negating the lower carbon dioxide emissions from natural gas relative to coal.

Another concern is that the damages of catastrophic warming are underrepresented in standard models.  For William Nordhaus' damage function, 10 degree warming in only supposed to lead to a 19% decline in world output.  Over 200 years, this would mean only an average of 2% decline in output per year, not quite world-ending.  Weitzman posits that some standard assumptions for economic modeling may not hold with extreme warming.  He mentions that substitutability of goods.  I am not quite sure that I understand, but there is a difference between utility being multiplicatively separable and additively separable.  For example, material wealth is not easily substitutable for biodiversity.

The final concern is the discount rate.  Weitzman says that the choice of discount rate is largely normative (not scientific).  Discounting future value means that damage in the future is not as important as damage today.  If you don't know what I'm talking about, think of putting $50 in the bank today.  You expect it to be worth more in 50 years, so its future value in 50 years is much higher.  We will probably have a stronger, more robust economy in 50 years that is better able to deal with climate change, so there is economic sense in not doing everything today.  How much we should discount though is the difference between saying that we should do nothing to having a carbon price of $300 per ton of carbon dioxide, which I think is about $3 per gallon of gas.

Weitzman's analysis also divulges into a discussion of infinity.  Essentially, the possible damages from catastrophic climate change can be thought of as unbounded (eg complete destruction).  Thus, people's willingness-to-pay to avoid climate change can also approach infinity (or at least a very large number).  Weitzman has a "dismal theorem" on the importance of fat tails-if the probability of catastrophy is increased even slightly, then the WTP increases significantly.  Some other jargon is VSL or value of a statistical life (willingness to pay).

He concludes that the risk of inaction is great if his "fat-tail" assertions are correct.  Carbon dioxide emissions languish in the atmosphere for hundreds of years, so if we put ourselves on a path of destruction there is no turning back.  This means that we should be more willing to start reducing emissions now if there is a higher chance of catastrophe than current estimates.  Overall, a little dense, but mostly understandable and highly provocative.

Tuesday, January 29, 2013

Stern Review

Note that this report came out in 2006.  It was reading for my class, but a pretty important (and controversial) body of work.  I'll try to be brief in going over some of the highlights and criticisms.

I think most of you know the basics of climate science, so I will not harp on that nor try to convince anyone of the reality of climate change.  According to the Stern Report, there is between a 77% chance and 99% chance of 2 degree warming.  Just recently, Stern has said that the chances of limiting our losses to only 2 degrees are much lower; we should prepare for closer to 5 degrees Celsius warming.  Here are some of the economic costs mentioned:

  • Melting glaciers and rising sea levels will lead to greatly increased flooding (200 million permanently displaced by mid-century!)
  • Food production will go down due to warming, leading to increased malnutrition
  • Diseases like malaria will become more prevalent
  • Possible mass extinction, destruction of ecosystems (including hurting fishing)
  • Possible collapse of ice sheets
One tragic consequence is that climate change is going to affect poor people more.  The very poor depend more on farming and cannot afford to adapt to rising temperatures. This means that climate change will exacerbate global inequality.

The Stern Report predicts future GDP losses of 0-3% with less than 2 degree warming and 5-10% with 5-6 degree warming.  It warns that we need to take into account potentially catastrophic warming that will completely devastate the planet (keep this in mind for a later post).  Some would say that the projected impact is overblown.  Stern takes it further by stating that "estimates, based on modelling a limited increase in this responsiveness, indicate that the potential scale of the climate response could increase the cost of climate change on the BAU path from 5% to 7% of global consumption, or from 11% to 14% if the non-market impacts described above are included." This is taken even further to 20% if inequality is included.  

A second major contentious point lies in Stern's estimate of the cost of drastic emission reduction.  He states that in order to stabilize carbon dioxide at 550 ppm, GHG emissions would have to be 25% lower than today by 2050 (and 70% lower to achieve 450 ppm).  There are four ways of reducing emissions: reducing demand, increasing carbon sinks (reforestation instead of deforestation), increasing energy efficiency, and increasing clean energy.  Stern estimates that only 1% more of GDP must be spent on emissions-reduction in order to stabilize at 550 ppm.  He states that "[t\he power sector around the world will have to be least 60%, and perhaps as much as 75%, decarbonized by 2050 to stabilize at or below 550 ppm CO2e."  Even though solar energy is getting much cheaper, I don't think that it will be easy to make a fairly rapid transition to a mostly zero carbon economy.  Unfortunately, a resonating note is a warning as to the impact of inaction. The longer we wait to do something, the more it will cost us.  Stern mentions benefits to technological change and lower emissions, including energy security and health benefits due to likely lower air pollution.

Stern estimates the 2006 social cost of carbon to be $85 per ton of carbon dioxide (or about $300 per ton of carbon), far more than most economic literature.  Famed environmental economist William Nordhaus puts the cost of carbon at closer to $30-$40 per ton, about 1/10th of Stern's estimate.  Stern argues that uncertainty means that we should use a higher carbon price than the estimated average due to uncertainty in risks.  

Stern's basic policy proposals are fairly noncontroversial among economists: "Policy to reduce emissions should be based on three essential elements: carbon pricing, technology policy, and removal of barriers to behavioral change."  Stern recommends a massive increase in incentives for innovation, 2 to 5 times the ~$30 billion spent in 2006.  He appears to endorse efficiency standards and labeling as effective tools for behavioral change.  An important section is given to the need for adaptation, as some impacts are unavoidable.  We need to plan for climate warning (unlike North Carolina, which just outlawed sea level rise) and develop in a sustainable manner.

The rest of the report focuses mostly on international cooperation.  We need a global carbon market, global regulations rather than varying regulations by country, aid to developing countries for mitigation and adaptation, and removal of trade barriers to low carbon technology.  (Oops, Obama imposed a tariff on Chinese solar panels just last year.  Another example of the fruitless pursuit of preserving American jobs at the expense of the global economy and the environment).

Monday, January 21, 2013

Inauguration Speech and Climate Change

I didn't really intend to watch the inauguration, but Obama did talk a little about climate change, so I will devote some time to giving my analysis of it. Of course, it was lacking in specifics, but it did hint at some future actions and I am not too impressed.

We really need a price on carbon and Obama hasn't shown a willingness to expend political capital on pushing for it, even saying that carbon taxes are only an option if Republicans push for them. I am also disturbed by this quote: "But America cannot resist this transition; we must lead it. We cannot cede to other nations the technology that will power new jobs and new industries – we must claim its promise." Climate change is not a jobs issue or something that should lead to us trying to defeat China. We should welcome cheaper emission-reduction technology and clean energy no matter where it comes from, not ensure that every policy must increase US jobs.

Bottom line: it is good lip service to the issue, but I don't see any indication that he'll force legislation through a hostile Congress, even though it could lead to fewer regulations and lower taxes than his current economic proposals.  Instead, he seems willing to push for increased spending on clean technology and linking it to employment, increased regulations from the EPA and new efficiency standards, and increasing trade regulation with China.  Of course, the last policy will increase costs and increase emissions, like this tariff on Chinese solar panels.  If Obama is serious, he won't pay as much attention to where the technology is coming from as to how we can reduce emissions in the least-costly way possible.

Sunday, January 20, 2013

Viewpoints: Cap and trade should look to broader goals
This is another discussion of California's cap-and-trade program that I think I have read a while back.

Although it is great that California is a leader in reducing carbon dioxide emissions, no one should kid themselves into thinking that AB 32 will make a difference in limiting climate change.  I think that someone at the conference said that California and Australia produce the same amount of GHG emissions, just over 1% of the world's total.  Even eliminating our emissions would barely make a dent.

There is not much substance to the piece; it is mostly a call for conservatism and moderation.  If California shows that it can significantly reduce GHG emissions while maintaining a thriving economy, then perhaps the rest of the world will be more willing to undertake market-based climate policy (eg a carbon tax or cap-and-trade).  In addition, California can collaborate with other nations and develop a collaborative carbon price.

The key here is that other countries need to follow our lead in developing a policy that will reduce emissions. If California screws up and cripples its economy or just creates massive leakage, there is little prospect in advancing the case for action.  Fortunately, there did seem to be a realization at the carbon pricing conference at the need for cooperation.  Hopefully California will be fairly successful, although even the best-designed carbon pricing schemes have (British Columbia's revenue-neutral carbon tax) failed at getting majority support.

California Law Tests Company Responses to Carbon Costs

Sorry (Naor), but it might be a while before I type up a good response to the carbon pricing conference (don't worry, I have tons of notes, so unless I lose my notebook, I won't forget anything).

I believe that I read this in December, but I might as well summarize it here anyway.

California's climate change bill AB 32 went into effect January 1st, so businesses needed to start preparing earlier.  After a relatively dispassionate effort at repealing the bill (little support from oil companies even), companies had to find a way to comply.  Unfortunately, there are some unavoidable consequences of such a far-reaching bill, namely the prospect of leakage.  Some companies may cut production or move elsewhere as higher energy costs lead them to lose competitiveness.

In order to make the transition to lower emissions easier, large polluters have been given free permits at the beginning in the hope that they would be able to pay for energy efficiency upgrades and other pollution-reduction measures and remain profitable.  The article highlights Morning Star, a tomato processing company subject to the cap-and=trade regime.  It expects costs to rise and needs to spend $75,000 in the next few years to comply with the law.  For now, California controls most of the tomato-processing market in the US, but China may take over if companies like Morning Star have to raise prices too much to stay in the US.

Overall, this was a good summary on the prospect of leakage from regional climate-change regulation efforts. There was just one sentence I had a problem with: "But many economists said they think such a cost-centric analysis ignores the jobs and economic activity that the law could generate." I don't think that environmental economists view this as a benefit.  Actually, more jobs means that compliance is more expensive.  Clean jobs are a byproduct of increased environmental protection, not an explicit goal.  Of course, any environmental legislation will destroy "dirty" jobs and increase "clean jobs," but the projected effect on employment should not dictate policy.

Tuesday, January 15, 2013

Carbon Pricing Conference-Brief Thoughts

I will have a more detailed post later, but here are some quick observations:

  • There was no mention of a possible nationwide carbon pricing scheme in California
  • There were very few economists; also most didn't seem to view a carbon price as the centerpiece of climate change legislation, only a supplement to traditional regulation.  I am curious what the economists think of that assertion.
  • Fran Pavley, author of AB 32, mentioned lowering energy prices while increasing efficiency and increasing jobs.  I wanted to question her more about this, because I feel strongly like environmental legislation should focus on helping the environment (at least as long as the marginal social benefit is worth the cost), not on necessarily increasing jobs.
  • There was some interesting discussion of linking different carbon trading schemes.
  • There was a clear support of cap-and-trade over a carbon tax.  The people were mostly regulators, lawyers, investors, and it's interesting that none seemed to be more strongly supported of a clear price.
  • Carbon offsets and accounting for offsets was an interesting topic that I actually did learn something about.
  • There was a lot of support for government spending, but this might have been skewed because of the people present (regulators, investors, government officials).
Overall, I am worried that there is not enough of a sense of energy and not nearly enough support for a global price on carbon, which is really necessary in order to limit our contribution to climate change.

By the way, this was the agenda: .  Again, more to come later.

Monday, January 14, 2013

US- Australia Dialogue on Carbon Pricing Agenda

Super exciting. I actually signed up to go to a conference on carbon pricing that I'm going to tomorrow:  I'm pretty nervous since there are going to be a bunch of diplomats (Australia, Canada, US) and actual policymakers talking about carbon taxes, cap-and-trade, and more.  Perhaps I'll even be able to ask questions.  I will be sure to take whatever notes I can.

Utility Buys Town It Choked, Lock, Stock and Blue Plume

This was before Citizen's United by the way. It is eye-catching to read that American Electric Power literally bought the town it was polluting for $20 million.  Residents had had enough with the local coal power plant when it started expelling blue smoke on occasion. This is an interesting real-world application of the Coase theorem.  After likely causing permanent damage to the livelihoods and health of the residents of Chesire, Ohio, the utility literally kicked them out, payed them handsomely, and made them promise never to sue.

The people got about three times the original value of their homes ($150,000 per home).  Some thought that it was a good deal, while a minority thought that the company got off easy.  The utility was certainly a lot better off than it would have been had it been sued for health damages.

The power plants in questions actually had been cleaned up significantly to meet environmental standards, but still posed a health hazard.  A large part of the reason is that it still used high-sulfur coal, which is much cheaper (but dirtier) than the alternative.  Rather than fight a legal battle the town agreed to (literally) sell out to the utility.  This probably left everyone better off (except lawyers) than if a legal battle had ensued.

While this is a case that no doubt validates the premise of the Coase theorem, it is a rarity that companies and citizens will come to an agreement like this.  In fact, this was the largest deal of the sort ever, with 221 people involved.  Most cases involving unwanted externalities involve many more people and companies that might be willing to go through litigation and fight it.  So while it may be ideal to spur regulations and taxes for bargaining, it is usually not practical aside from a few small, local cases. It certainly will not happen with something as big as climate change.  I fear that establishing property rights will just lead to more conflict and more lawsuits.  Like many economic theories, the Coase theorem is idealistic and works in a vacuum, but the right conditions for it to be beneficial are too rare for it to make much of a difference.

Sunday, January 13, 2013

Markets and the Environment Chapter 4: The Efficiency of Markets

I purchased the book, but I won't be getting it in time to read this chapter.  Fortunately, the majority of it is again available for viewing online, this time with Google Preview.

In an ideal scenario, the market would take care of environmental issues.  There are some on the right who say that if the environment were a concern at all, the free market would take care of it.  There are some idealistic individuals (like Armory Lovins) who say that companies would boost profits by growing green.  Clearly this is not always the case.  Unfortunately, there are many times where the most efficient outcome is not achieved--that is, marginal social cost is not equal to marginal social benefit.

I don't think I learned anything new in terminology, but it couldn't hurt to review that markets are an exchange  of goods, not an auction.  They are decentralized (unlike an auction) and not government-controlled.

The rest of the chapter just goes over basic supply/demand and consumer/producer surplus.  Some common environmental economics jargon: the demand is marginal benefit is the price consumers are willing-to-pay and supply is marginal cost is the price producers are willing-to-sell.

Recall the three necessary tenants for an efficient market: perfect competition (no ability to manipulate prices, marginal benefit equals marginal cost), perfect information (everything freely available for consumers to see), and the market must be complete (all costs and benefits accounted for).  I presume that we focus primarily on the last condition; problems arise when not all environmental costs are included in the price of goods.

Wednesday, January 9, 2013

Markets and the Environment Chapter 1

I think that this book is a fairly basic overview of environmental economics, but perhaps I could use a better primer on the topic.  Just FYI, if you're seeing an ECN 125 label, the post is mostly for my energy economics class.

I don't have the book yet, so I didn't get through all of the first chapter.  It doesn't appear that the book is math-heavy.  It's probably not worth the $20 it costs to buy, but I might get it anyway.  Of course, the central premise of environmental economics is how we can use economic approaches to mitigate environmental issues.  The basic idea is to measure the costs and benefits of various policy options and choose the best one.  Easier said than done of course.  One big contrast between environmentalists and environmental economists is their differing views on free markets.  Environmentalists say that markets are the problem leading to so much pollution today.  Economists counter that the problem is that there is no market for pollution/environmental destruction.  If companies actually could profit solely by improving the environment, then they would.  Generally, markets are thought to be more efficient at achieving the same goals than increased regulation.

There is one interesting point mentioned about climate change economics. Keohane and Olmstead propose that climate change abatement is a public good-that is, something that is freely enjoyed by everyone regardless of their contribution.  This means that countries that don't reduce emissions will still benefit while other countries may sacrifice economic benefit for environmental gain.  Of course, this creates a prisoner's dilemma where the Nash equilibrium involves no attempts to mitigate climate change, making everyone worse off.  Unfortunately, the reality is that few countries are willing to make the effort necessary to significantly limit warming, and the countries that are doing their part are not going to offset the increased emissions from the rest of the world.

World Energy Outlook

Again, this is going to be a lot of summary.  The big takeaway is that our current growth is unsustainable, led mostly by developing countries.  However, even here and Europe, energy use and water use is going to rise if we do not take drastic policy measures to conserve.

If you've read some of my previous posts on energy, this shouldn't come as a surprise.  China, India, and the Middle East are projected to grow fast and use a lot more energy, mostly from fossil fuels.  In developed countries, coal is giving way to natural gas and renewables, but coal is still projected to be a major source of energy in 2035.

Lo and behold, the US is projected to be a net energy exporter by 2030.  So I was wrong, right?  Ah, the next paragraph clarifies.  Of course there's no way we'd actually be energy independent: "there is no immunity from global markets."

Energy efficiency is going to increase, but not nearly enough in most places.  The authors recommend more regulations and incentives for energy efficiency.  I'm not sure if that's more from engineers or economists.  Interestingly, I am also taking a class on building energy performance/efficiency, so I will be looking at booth perspectives.  Unfortunately, the prospect of limiting climate change to 2 degrees (Celsius) is looking bleak without huge changes very soon.  "No more than one-third of proven reserves of fossil fuels can be consumed prior to 2050 if the world is to achieve the 2 °C goal, unless carbon capture and storage (CCS) technology is widely deployed."

Oil use is expected to increase largely because of trucking (road freight) and some because of more cars.  I didn't realize that trucking would increase that much.  Another interesting tidbit: "Non-OPEC oil output steps up over the current decade, but supply after 2020 depends increasingly on OPEC."  Unless we (and other countries AKA China) do a lot to reduce demand, we're going to rely on evil Middle East dictators for global energy supplies.  Iraq is actually projected to become a huge supplier of oil (to the tune of 8 million barrels a day in 2035).

Natural gas of course is going to be an increasing part of the pie, largely due to fracking.  Unfortunately, China and India are going to use a lot more coal first.  Nuclear energy is still expected to increase, but at a much lower rate than projections pre-Fukushima.  Renewables are expected to be about 1/3 of the electricity mix, but largely due to subsidies to the tune of $240 billion.

Poverty is expected to remain high by 2030, with 2.6 billion people lacking clean cooking and 1 billion lacking electricity.  Of course, if this ends up being lower, then we'll be using even more energy!  Perhaps a bigger concern is water: water demand is supposed to double.  Many of our water resources are already scarce and many people lack clean water.

The Lie Factory

 “Sure, those quotations were irrelevant,” Baxter later said. “But we had one objective: to keep him from becoming Governor.” --the crux of political smear campaigns

To get things started, we delve into an insightful piece on the beginning of modern campaign firms.  For all of you who remember US History, the victim is Upton Sinclair, famous author of The Jungle, that book about working conditions in factories that you always heard about but never read.  Apparently he also wrote a fictional account called "I, Governor of California", which became the basis for his actual campaign for governor.  He successfully garnered the nomination for the Democratic Party.  It was an interesting time in 1933 in the middle of the Great Depression-there was not a single Democrat in statewide office.

Anyway, Sinclair, a socialist ran an anti-poverty campaign (End Poverty in California).  He easily got the nomination, but got walloped in the general election, spawning a truthful essay, "“I, Candidate for Governor, and How I Got Licked.”  The brunt of the blame is tied to the ominous-sounding Campaign Inc led by Clem Whitaker and Leone Baxter.  Now, Sinclair had had his clashes with the big corporations of the day (eg Standard Oil).  Naturally, Baxter and Whitaker happened to be publishers for the California League Against Sinclairism. The Democratic Party did however begin its ascendance in California politics in winning seats in the state legislature, so maybe two people weren't enough to buy every election.

Of course, the drama in California didn't end there.  Campaign Inc was later hired to fight an early start at social security ($30 a week to people over 50 AKA Ham and Eggs Referendum).  “In a typical campaign they employed ten million pamphlets and leaf-lets; 50,000 letters to ‘key individuals and officers of organizations’; 70,000 inches of advertising in 700 newspapers; 3,000 spot announcements on 109 radio stations; theater slides and trailers in 160 theaters; 1,000 large billboards and 18,000 or 20,000 smaller posters.”  Ouch.  They also ran an advertising firm and printed editorials that could be mistaken for news columns in some papers.  They made hundreds of thousands of dollars way before that was cool for anyone other than the best baseball players, if them.  I'll let them speak for themselves and you can see if you like this:

“We assume we have to get a voter’s attention seven times to make a sale,” Whitaker said. Subtlety is your enemy. “Words that lean on the mind are no good,” according to Baxter. “They must dent it.” Simplify, simplify, simplify. “A wall goes up,” Whitaker warned, “when you try to make Mr. and Mrs. Average American Citizen work or think.”
“We need more partisanship in this country,” Whitaker said. Never shy from controversy; instead, win the controversy. “The average American doesn’t want to be educated; he doesn’t want to improve his mind; he doesn’t even want to work, consciously, at being a good citizen,”
Whitaker and Baxter were not always popular, even among their clients.  Earl Warren, famed liberal Supreme Court head, was once a Republican.  He wanted universal health care for California, and of course this was unacceptable then just as it is now.  They ran a blitzkrieg campaign against it, including a postcard saying "That system was born in Germany—and is part and parcel of what our boys are fighting overseas. Let’s not adopt it here."  Later, they tried to impeach him from the Supreme Court.

Then there was this gem opposing Medicare: "Hitler and Stalin and the socialist government of Great Britain all have used the opiate of socialized medicine to deaden the pain of lost liberty and lull the people into non-resistance."  Sound familiar?  Baxter and Whitaker were pioneers in political consulting, and by Nixon's time, everyone was in the game.  The duo dismissed their campaigns as "grassroots organizing", perhaps foreboding the "grassroots" Tea Party movement of today.

I personally would like public campaign financing, which does a lot to even out the playing field.  Unfortunately, SuperPACs have taken hold and unless Citizen's United can be reversed multimillion dollar campaigns will remain the norm.  Lest you think though that during the 1950s, everyone cooperated and politicians didn't lie so much to get elected, that was not true at all.  Mudslinging has been happening ever since the first democracy and extremist rhetoric has always been commonplace.  Anyway, this is certainly an interesting read and my summary/assortment of quotes is not comprehensive.  Plus, it's The New Yorker.  Great Stuff.

Sunday, January 6, 2013

Get Ready for a Flurry of Posts

So I am taking a class this quarter called "Energy Economics" that will require me to read a lot of articles.  I think I will summarize and analyze everything I read here, mostly for my own benefit, but feel free to follow along.  Also, I will hopefully be attending a conference on carbon pricing with representatives from Australia, Europe (cap-and-trade), CARB (AB 32), and Chevron.