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Reduction of CO2 in Wyoming

 

Gregory Nolan Thomas

 

Natural Resource Economics 4410

Dr. Thunstrom

November 18, 2016

(Word Count 2790)

 

 

 

 

(Abstract)

This paper will examine the issues surrounding CO2 emissions in Wyoming, and provide

technical details about the nature of the problem, explain why government must intervene to

solve the problem, explore possible policy options, forecast impacts on the actors in the

economy, and recommend implementation of a carbon tax to reduce CO2 emissions.

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1. Introduction and the Nature of the Problem

The economy of Wyoming remains heavily dependent on carbon based industries, as a

result Wyoming continues to emit heavily, and speed up the negative impacts of climate change

statewide. Wyoming in terms of total emissions falls toward the middle of the pack, but

Wyoming also emits more energy related CO2 then more populated states such as Arkansas,

Utah, Massachusetts, and Maryland. See Figure A. below. (EIA, 2013). In terms of per capita

energy based CO2 emissions, Wyoming leads the nation by a healthy margin. See Figure B.

below. (EIA, 2013). The state of Wyoming also remains the most heavily carbon based

economy in the United States, with an intensity nearly six times that of the national average.

(EIA, 2013). In addition to suffering from damaging boom bust cycles and the resource curse,

this heavily energy based economy emits CO2 heavily, continuing to deplete the ozone, and

accelerate the negative externalities associated with climate change.

Climate change exists as a negative externality in production associated with Wyoming’s

energy industry. Global warming creates dynamic change to Wyoming’s forests, Wyoming’s

rangelands, and Wyoming’s economic growth. Wyoming remains quite well known for its’

outdoors and breathtaking landscapes, however, climate change continues to increase both the

survival and frequency of Mountain Pine Beetles (MPB). The MPB actively degrades

Wyoming’s forest by killing large numbers of pine trees, this occurrence continues to become

more common for two reasons related to climate change. Firstly, cold winters remain the

number one source of mortality for MPB, as winters become shorter and warmer, more MPB

survive and ravage the forests. (Régnière and Bentz, 2008). Secondly, pine trees rely on

precipitation for vigor and survival, as the climate becomes increasingly warm; trees lose the

ability to defend themselves against attacks from the MPB. (Régnière and Bentz, 2008). The

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ravages of the MPB epidemic will only continue to get worse as CO2 emissions, and therefore,

climate change accelerate.

Another negative effect of climate change involves invasive plant species. Invasive plant

species actively degrade both wildlife habitat and agricultural lands. Climate change appears to

accelerate the spread of invasive species such as Canada Thistle; “Data from the current field

study indicated that the growth and root to shoot ratio of Canada thistle may be improved in a

future, elevated [CO2] environment.” (Ziska, Faulkner, and Lydon, 2004). Invasive species

proceed to outcompete native vegetation and in turn reduce forage for both livestock and

wildlife. According to the Wildlife Society Bulletin; “Changes in vegetation composition can

affect food quality or availability for some native animals.” (Litt and Pearson, 2013). The

presence of invasive plants continues to alter wild landscapes and reduce forage for wildlife.

The effects are also felt by Agriculture, according to Sarell, Dyer, and Scott; “Economic loss to

farmers and ranchers is over $400,000 annually in equivalent hay production.” (1997). Though

dated, this data shows the economic losses that may result from invasive species spread. Making

the spread of invasive plant species an issue that effects both agriculture and Wyoming’s

rangelands.

The last externality associated with global warming involves economic growth. As

shown prior, Wyoming remains a heavily carbon based economy. The latest statewide recession

continues in part due to carbon emissions, with coal firms struggling to earn profits, labor

becomes the first cost cut. According to the Wyoming Economic Analysis Division, Wyoming

lost 4,000 mining jobs between September 2015 and 2016, this matriculated throughout the rest

of the economy, with Wyoming seeing an overall loss of 9,200 jobs. (EADIV, 2016). These job

losses mean lost wages, less money for consumption, and an overall economic slowdown.

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Climate change also creates constraints on Wyoming’s economy, according to the Obama

Administration; “Rising temperatures are leading to increased demand for water and energy. In

parts of the region, this will constrain development, stress natural resources, and increase

competition for water among communities, agriculture, energy production, and ecological

needs.” (Office of Press Secretary, 2014). Wyoming continues to live by carbon and die by

carbon economically, it remains only a matter of time until these climate change realities face

Wyoming unless policy measures are undertaken.

2. The Necessity of Government Intervention

Carbon emissions exist as a classic externality, carbon emission come from a multitude of

goods and services, but prices fail to capture the true costs of carbon emissions. Externalities

arise from unregulated markets and will inevitably continue to be pervasive unless government

intervenes. According to Carl Dahlman; “However, there is also one more strong implication of

the analysis: private contracting in markets will not lead to the elimination of the negative

influences of externalities.” (1979). Economic theory backs this position, in the case of an

externality in production, marginal social costs (MSC) will exceed marginal private costs (MPC),

this means a private market equilibrium will occur where the price of emissions fails to be

captured in private prices, and the quantity of emissions exceeds the social optimum. See Figure

C. below. (Hyman, 2011). Unless government intervenes, the externality will both continue in

existence, and create societal deadweight loss. With the necessity of government intervention to

correct externalities established, the question becomes; what policy alternatives exist? The next

section of this paper will examine three policy alternatives: a flat per unit carbon tax, a Cosean

tradable permit scheme, and command and control regulation.

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3. Policy Options, Economic Theory, Case Study, and Projections for Wyoming

Three policies exist for lawmakers, a tax, a permit scheme, and traditional command and

control regulation. Each comes with pros and cons, each will impact actors in different ways,

and only one will provide optimal results. Using the underlying economic theory and real world

observations, this paper will run a cost benefit analysis of each policy, and ultimately argue for

the implementation of a carbon tax. While all measures will achieve CO2 reductions, all policies

are not created equal.

The economic intuition of an externality correcting tax fall along the lines of; quantify the

externality, create a tax in the amount of the externality, and apply to the market. This approach,

also known as Pigouvian taxation shifts the MPC curve up by “T” and forces the MPC curve to

coincide with the social optimum. See Figure D. below. (Policonomics, n.d.). By shifting up

the MPC curve, the deadweight loss becomes zero, and the externality becomes internalized, as

well as reducing emissions. In reality, quantifying the externality proves difficult, meaning the

tax may be set too high which will stifle economic growth, or too low meaning less then optimal

emissions reductions, showing the empirical problems of partial equilibrium analysis.

In the real world, Australia implemented a $24.15 tax on carbon a year after the 2010

election. (Robson, 2013). The results showed both positives and negatives for both consumers

and firms. One negative effect involves consumer prices; “The main direct effect on consumer

prices has been through electricity prices, as well as natural gas prices. These price increases are

expected to continue over time as the carbon tax rises.” (Robson, 2013). Based upon the

Australian experience, Wyomingites will likely see increases in the prices of products with a

carbon tax attached. The tax will also reduce firm’s profits and workforce, for example, the firm

CSR reported 150 lost jobs at their Ingleburn and Wetherill Park facilities, as well as an

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additional $500,000 in annual costs at their Ingleburn facility. (Robson, 2013). Wyoming’s

businesses will likely see increased costs and will reduce their employment to cut costs.

However, the policy also came with some positives, the policy does raise revenue, the Australian

Department of Treasury and Finance estimated each $1 increase in the tax would add between

$160 million and $220 million to the bottom line. (Robson, 2013). It also accomplished

electricity emissions reductions of 12%. (Robson, 2013). One could then extrapolate a carbon

tax will both increase Wyoming’s government revenues and reduce emissions.

The second policy option, a Cosean tradable permits scheme, involves government

creating a quantitative limit on emissions and allowing firms to freely trade permits once

purchased by firms. This policy option appears attractive in theory, mainly due to the fact

regulators maintain direct control over emissions quantity, as opposed to manipulating price with

a tax and hoping emissions will decline. See Figure E. below. (Mankiw, n.d.). A problem

appearing in the normative theory of a tradeable permit scheme would be increasing permit

prices, this costs increase yearly, and could be passed down to consumers or serve as a barrier to

new entrants.

Few real world examples of emissions trading exist, and this approach remains a

primarily American approach to controlling emissions. Some examples of tradable permit

schemes involve; lead-in-gasoline (1982-1987) and acid rain (1993-present). (Tietenberg, 2000).

Under the first act, producers were given a fixed allowance, any unused permits were to be

traded amongst firms, estimated benefits of the program in terms of lessened health risks were

estimated to be $36 billion at a cost of $2.6 billion to refiners. (Tietenberg, 2000). Wyomingites

in theory could increase societal benefits at a reduced cost to firms. In the acid rain program,

firms were given rights to emit Sulphur, permits carried into the next year if unused, they could

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be traded, this program reduced emissions to four million tons less than the 1980 levels prior to

implementation. (Tietenberg, 2000). In implementation this policy will reduce Wyoming’s

carbon emissions drastically, if implemented similarly to the acid rain program. The tradeable

permit schemes also possess their own unique complications. The acid rain program saw

significantly less trading and lower permit prices than expected. (Tietenberg, 2000). Any

tradeable permit scheme will need a market with low transaction cost and brokers to allow trade.

Market power also presents problems for tradeable permit schemes, according to Tietenberg;

“The first type of market power involves the ability of participants to manipulate prices

strategically in the permit market either as a monopolistic seller or a monopsonistic buyer.” And;

“Firms could conceivably use also permit markets as a vehicle for driving competitors out of

business.” (2000). Implementation of a tradeable permit scheme in Wyoming could see large

firms utilizing market power to buy up the entirety of schemes to manipulate prices and extort

rents from other firms, or hoard permits and refuse to sell in order to run competitors out of

business. Another downside of tradeable permit schemes involve volatility, due to the

inelasticity of the supply curve, rapid changes may occur in permit prices, as occurred in

California in 200 under the RECLAIM scheme; “As a consequence, NOx allowance prices rose

from about $400 per ton to an average in the year 2000 of over $40,000 per ton (with the average

allowance price reaching $70,000 in the peak month of 2000).” (Goulder and Schein, 2013).

These rapid price changes could also be exacerbated by Wyoming’s erratic weather, for instance,

a massive unexpected blizzard will spike demand for electricity and hence demand for permits to

emit carbon to produce the demanded electricity. Wyoming’s firms could expect extremely

volatile permit prices.

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The last policy, command and control regulation, remains the tried and true go-to policy

of lawmakers. Lawmakers or an agency such as the EPA command firms to comply with set

environmental standards. While this approach remains quite deplorable in the eyes of economist,

the multiple Clean Air Acts from the U.S. did provide some quality net benefits. The EPA

estimated in 1990 their legislative action provided benefits of $1.2 trillion, the legislation grew

increasingly efficient between 1980 and 1990, and between 1981 and 1989 ambient air pollution

fell by an average of 22.6%. (Cole and Grossman, 1998). If Wyoming were to follow in the

footsteps of prior command and control regulation, lawmakers would be able to guarantee

emissions reductions, perhaps maintain efficiency, and maximize societal benefit. The more

mainstream view of command and control regulation describes the inefficiencies. A glaring

problem with command and control regulations, and for that matter most centralized planning is

that government cannot act dynamically in the market place. Firms rely on prices to make

instantaneous decisions, whereas, lawmakers must first identify a problem, pass a law after much

debate, and implement it over several years. This means Wyoming’s lawmakers will likely fail

to act quickly to solve emissions problems. In addition, administrative costs will certainly be

higher under command and control, government officials must oversee businesses, more

business to government contact will mean more market distortions and more bureaucrats with

paychecks. Another negative aspect of government oversight is the lack of freedom amongst

firms, as stated by Friedrich Hayeck; “The more the state "plans" the more difficult planning

becomes for the individual.” (Goodreads, 2016). Firms will no longer have options to operate

strategically based on their own choices, they will need to abide by preset laws. Also, if one

believes government to be a self-serving creature, command and control provides the ability to

firms and government to collude in cronyism, and engage in rent seeking behavior. Wyoming’s

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firms will likely experience difficulty operating under extensive red tape, government personnel

may expand, and if corruption exists, cronyism and rent seeking behavior amongst firms could

damper competition. The inflexibility, regulation, and inefficiency show the superiority of

market based mechanisms such as cap and trade or taxation.

4. The Argument for a Carbon Tax

Clearly market based mechanisms will be more efficient and respond dynamically to

market conditions. A carbon tax, however, will provide more benefits and lower costs. Firstly, a

tax can be implemented with relative ease and with less stipulations, for instance, a cap and trade

act, the Lieberman-Warner Climate Security Act of 2008 weighed in at 300 pages, while the

leading carbon tax bill in 2008 was only 17 pages. (Avi-Yonah and Uhlmann, 2001). This

occurs because a permit system requires the creation of an entire market, deciding whether or not

to “grandfather firms in”, deciding to auction or distribute permits directly, and provisions must

protect against the abuse of market power. Whereas, a tax simply needs to be set at a per unit

price. The relative simplicity of implementing a tax makes it a more attractive policy measure.

Taxes also appear to raise more revenue. A tax of $10 per ton is estimated to generate

$50 billion in revenues, in theory cap and trade may also create revenue, but in reality many

permits are simply given away for free, for example, the EU cap and trade regime gave away

95% of allowances for free. (Avi-Yonah and Uhlmann, 2001). This occurs due to politicians

giving back to their constituents and financial supporters, i.e. engaging in rent-seeking behavior.

The increased tax revenue could provide Wyoming’s government with more funds for

investment in economic diversification, education, and social programs to ease the recession.

Carbon taxes could also be revenue neutral, for instance Wyoming could use the revenues from

carbon taxes to cut taxes elsewhere, perhaps cutting sales tax for consumers to get prices back to

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pre-tax levels, or reducing property taxes on mineral lands in order to compensate the largest

emitters for their newly incurred costs from a tax.

Any trading scheme also faces uncertainty in pricing. As previously mentioned, the

inelasticity of supply in a carbon trading scheme promotes volatile prices, this will make

planning difficult for firms. For example, if a firm were to undertake a massive abatement

investment and the price of permits went rock bottom, then the firm just made a very poor

investment in terms of net present value, or if a firm declined to invest then faced a massive hike

in permit prices they would need to reduce output or spend massive amounts of cash on permits

to lawfully operate. Contrast this to a state per unit, constant tax; “This enables businesses to

plan ahead, secure in the knowledge that raising the tax rate beyond any automatic adjustment,

which can be planned for, requires another vote in Congress that they can hope to influence.”

(Avi-Yonah and Uhlmann, 2001). The price certainty makes taxes more favorable for business

and protects them from the volatility that inevitably follows any market with an inelastic supply.

Taxes remain a simple measure in implementation, taxes raise more revenues in practice as well

as providing revenue neutrality in theory, and provide a consistent cost firms may plan for

instead of an uncertain and often volatile price.

5. Conclusion

In conclusion, this paper described the carbon dependent nature of Wyoming’s economy,

the negative externalities associated with climate change, provided policy options in theory and

in practice, predicted impacts on Wyoming’s economy, and argued for a carbon tax on the basis

of simplicity, revenue, and certainty of pricing. Wyoming, the U.S., and the globe faces

increasing uncertainty against the backdrop of climate change. Unless lawmakers implement a

carbon reducing policy, ideally a tax, the costs of climate change will only continue to increase.

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6. Figures Referenced in Text

A. (EIA, 2013)

B. (EIA, 2013)

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C. (Created using excel) based on negative externality diagram (Hyman, 2011).

Negative Externality in Production

MBPMCMSC

Quantity

Price

Q*

PFM

QFM

The negative externality exists as a wedge between MSC and PMC, the social optimum denote P* and Q*, has both a lower quantity of pollution and a higher valuation of pollution then the free market outcome denoted PFM and QFM

Figure D. Made using excel based on (Policonomics, n.d.)

Negative Externality in Production

MBPMCMSCPMC+T

Quantity

Price

Q*

The Pigouvian Tax shifts up PMC by “T”, and intersects MB at the social optimum, denoted P* and Q*.

P*

P*

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Figure E. (Mankiw, n.d.)

Permit Market

DD'

Quantity

Price

In a tradable permit scheme, a regulatory agency decides on a supply of permits, denoted S, this is also the quantity traded as this is where demand intersects supply. S’ represents a reduction in supply of permits as regulators reduce emissions, this increasing relative scarcity leads to an upward shift in demand and a price of P’.

P’

P

Q’/S’ Q/S

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