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 E2 Chapter Director Tony Bernhardt
At the Ecosalon of March 28 Ray Kopp of Resources for the Future told us that a tax of $25 per ton of CO2 would raise about $125 billion in annual revenues and that, if spent wisely, these revenues would benefit the economy far more than the cost of higher energy prices.

The purpose of this article is to illustrate the impact that a CO2 tax of $25 per ton would have on primary energy prices that we all experience - natural gas, electricity and gasoline - without reference to economic benefits that might accrue from the revenue it generates. 

The point that I hope to make is that this price, in and of itself, has only a small impact on the economy compared to the changes that we have seen in energy prices in the recent past.  This will be illustrated graphically for each energy source in the charts that follow.

$25 per ton of CO2 is in line with price expectations of world markets.  Point Carbon has surveyed expectations for carbon prices in 2020.  That is a good year to consider because markets are just starting up now in Europe and California and by 2020 they will have come into equilibrium (e.g. almost all allowances will be auctioned rather than given away). The Point Carbon 2011 survey indicates a price expectation in California of $17-50/ton in 2020.  Their survey shows a 'global reference price' expectation of $35-40/ton in 2020.

Effect on natural gas prices: A CO2 tax of $25 per ton corresponds to an increase of $1.37 per thousand cubic feet ($1.37/tcf) of natural gas[1]. As the chart below shows, wholesale natural gas prices have fallen in the last year from $4/tcf to $2/tcf, due to shale gas production.  Futures contracts for natural gas indicate that by this summer prices will be back to $3/tcf, where they are expected to level out.  The chart also shows that natural gas prices were around $6/tcf for most of the period from 2003 to 2009 with two spikes to much higher prices. At $3/tcf, natural gas still costs half of what it was during that period and even with our tax the price would be 27% less than it was from 2003 to 2009. 

In the last decade we have had an overall price range of almost nine times the value of the suggested tax.  Just in the last year we had a drop in price of 150% of the tax and in the next few months we will have a rise of 73% of the tax.  A carbon tax of this magnitude will affect our economy much less than market swings.

Importantly, the US holds a large competitive advantage over other industrialized countries in terms of the cost of natural gas.  Unlike oil, natural gas is not transported around the world in sufficient quantities to establish a world price.  For decades there has been talk of establishing a fleet of liquified natural gas (LNG) ships and terminals to take natural gas from low cost sources to high cost markets and this may yet happen but for now the US is the low cost market. Europe pays in excess of $11/tcf and Japan and Korea pay more than $15/tcf.  In India, natural gas costs about $14/tcf.  In two provinces in China where the government is allowing market pricing to replace state-controlled pricing, natural gas costs about $12.50/tcf. Thus a $1.37/tcf tax in the US does not significantly reduce the US advantage in its cost of natural gas.

Effect on electricity prices:  A tax on carbon will raise the cost of electricity in the US.   Approximately half the electricity in the US is generated from coal and a carbon tax will add almost twice as much to the price of coal-generated power as it does to natural gas generated power.  Of course, hydro, geothermal and renewable power sources are affected by a carbon tax only in the cost of materials for construction of new facilities (e.g. cement and steel).

A carbon tax will increase the already strong incentive of electricity producers to switch from coal to natural gas as the lowest cost generation option.  45% of coal power plants are more than 40 years old.  Natural gas is cheaper than coal as a fuel even without a tax on carbon.  Thus, for many utilities, it is more cost effective to build a new natural gas plant than to perform the maintenance and modifications required to meet recent EPA regulations governing the emission of SO2, NOx, particulates, mercury and coal ash.  Indeed the low cost of natural gas power will also inhibit the construction of nuclear power plants.

The effect of a $25/ton tax on CO2 is shown below is the map of the U.S. that Ray Kopp discussed on March 28th.  The numbers on the map show the price in cents per kilowatt hour (kWh) of electricity in each area outlined.  The color of each area indicates the increase of the price of electricity due to the tax.  In areas where coal is the major fuel source the price increases 2-3 cents/kWh. In areas where little coal is used the cost is less than 1 cent/kWh.  For example, in Washington state, where 66% of electricity comes from hydro and only 8% from coal, the price of electricity only goes up by 0.35 cents/kWh.  In California, where 52% of power is generated from natural gas but most of the rest is from hydro, nuclear, geothermal, wind and solar, the price goes up by 0.81 cents/kWh.  In Illinois where 47% of power comes from coal the price increases by 1.1 cents/kWh and in Kansas where 68% of power comes from coal and 20% from natural gas, the price increases by 1.9 cents/kWh.  Of course, the price of electricity from coal-intensive utilities will come down when they switch to natural gas. 

In the last decade wholesale prices in electricity markets across the country moved in a range of about 3 cents/kWh to 9 cents/kWh.  The chart below shows the daily price data from the Northeast, the Pennsylvania-New Jersey-Maryland (PJM) and California (Palo Verde West) markets. Prices from mid 2001 to mid 2008 generally followed an upward trend from about 3 cents/kWh to about 8 cents/kWh.  Then the recession hit and prices fell back to about 4 cents/kWh where they have remained. Disregarding the 2000-2001 electricity crisis in California and spikes of less than a month in duration, there have been four periods of around six months duration in which prices rose or fell by about 4 cents/ kWh.

A carbon tax will have a more noticeable effect on electricity prices than on natural gas prices.  For regions where most electricity is produced from coal the tax is as much as half the medium term market price fluctuations and the longer-term price trends.  For most other regions the effect is less than a quarter of such market swings.  For Kansas, the effect of the tax can be reduced by taking advantage of that state's prodigious wind resources and shifting to natural gas as coal plants reach the end of their useful lives.

Effect on gasoline prices:  $25 per ton of CO2 translates to an increase in gasoline prices of 28 cents per gallon.  The graph below shows the price of regular unleaded gasoline since 2000.  The price has risen from $1.50 per gallon to over $4.10 per gallon in mid 2008, back down to $1.60 per gallon at the end of 2008, back up to just under $4.00 per gallon in mid 2011, back down to $3.40 in December and looks to be heading back to $4.00 per gallon next summer.  As in the case of natural gas, price changes since 2008 are 9 times the magnitude of the tax. 

A price of $25 per ton of CO2 is in the range of what markets expect for the year 2020.

• The main effect of pricing carbon is in the electricity sector where it will accelerate the process of fuel switching from coal to natural gas. 

• States that make heavy use of coal in their electricity generation will be most affected by the tax. Nevertheless, electricity price swings are more than twice the tax in such states. 

• The effect of the tax on natural gas will be to raise its price to 27% less than it was in the period from 2003 to 2009.

• Natural gas and gasoline consumers are far more affected by market price swings than they will be by this tax.  People who have been driving for 5 years have experienced prices of $4 per gallon and $2 per gallon, and everything in between several times.  Would a tax of 28 cents per gallon have very much impact by comparison?

[1] The price of natural gas is also quoted in $ per million Btu ($/mmBtu).  Fortunately a million Btu of energy corresponds to within 10% to the energy in a volume of 1000 cubic feet of natural gas, so $2/tcf  equals $2/mmBtu


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