Time to Choose

Last week's finding by the US Environmental Protection Agency that greenhouse gas emissions "threaten the public health and welfare of current and future generations" should not have come as a surprise. It has been virtually inevitable since the Supreme Court decision in Massachusetts v. EPA two years ago, and it was rendered imminent by the election last November of Barack Obama, who made responding to climate change a centerpiece of his presidential campaign. Whatever you might believe about the risks of climate change, we no longer have a choice between addressing them or ignoring them. Representative Edward Markey (D-Mass.), who chairs the Select Committee on Energy Security and Global Warming, responded to the finding by saying, "It is now a choice between regulation and legislation." I don't think that's quite accurate, particularly since his own proposed climate legislation includes many strong regulatory features. Instead, I believe the choice lies between relying primarily on an explicit price for emissions to nudge consumers and businesses away from emissions-intensive activities, and employing a more prescriptive approach using mandates, "standards", and air pollution-style rules on smokestacks and tailpipes. Long-time readers won't need to infer my position on this matter from the way I've described that choice.

I've argued the case for cap & trade numerous times on this blog and in front of various audiences, corporate and public. I've also expressed my misgivings about the imposition of a strict cap & trade system in the middle of a recession, particularly if the government intends to use the revenues from cap & trade to fund a dog's breakfast of non-energy programs, rather than returning the bulk of it to taxpayers. I've even suggested that under some circumstances a simple carbon tax might be preferable to cap & trade, since both serve the purpose of establishing a price for emissions, to which our market economy must respond by shrinking emissions-intensive sectors and growing low-emissions ones, including the renewable energy sector with its vaunted "green jobs." I've spent less time, however, examining the regulatory approach, perhaps because I regarded it as self-evidently inferior, particularly if it looks more constraining than the version of cap & trade that might accompany it. It is abundantly clear that many others do not share that view.

The main appeal of the regulatory path is that it would build on long experience in managing other environmental impacts--including many from energy systems--under existing federal and state air and water quality regulations, the federal Renewable Fuel Standard (RFS), and numerous state-level renewable electricity standards (RPSs) and other regulations. But these programs also illustrate some of the severest drawbacks of this approach, in the complexity and overlapping nature of these rules. Regulating emissions that are not incidental to, but rather a fundamental consequence of the use of our principal energy sources would add further layers of complexity without subtracting any, as cap & trade might eventually be expected to. We already have trading in Renewable Energy Certificates (RECs) for state RPS compliance, Renewable Identification Numbers for compliance with the federal RFS, and sulfur and nitrogen credits for compliance with the Clean Air Act's rules for criteria pollutants. And because the GHG emissions from motor vehicles are determined largely by how much fuel they consume, efforts at regulating tailpipe emissions become de facto fuel economy regulations, in conflict with the federal Corporate Average Fuel Economy regs. (This is the matter on which California eagerly awaits a waiver from the administration to pursue its legislated Low-Carbon Fuel Standard.) With all due respect to the dedicated professionals at the EPA, anyone contemplating leaving the regulation of greenhouse gas emissions to that agency should be required to pass a test demonstrating that they understand the EPA's notice implementing the RFS for 2009, which involves the comparatively much simpler task of setting the required ethanol percentage in gasoline for the year.

We are now at the point that I have long feared we would be, if we mislabeled carbon dioxide as a pollutant. While the consequences of excess CO2 and other naturally-occurring greenhouse gases certainly live up to the terms the EPA has applied in its finding, unleashing a pollution mentality to solve climate change will be counter-productive and unnecessarily expensive, when dealing with a phenomenon for which a ton of CO2 emitted, captured or avoided in Boston is exactly equivalent in its climate impact to a ton emitted, captured or avoided in Beijing. We would have been much better served if the Supreme Court had paraphrased the Hitchhikers Guide to the Galaxy and found that CO2 was "almost, but not quite, entirely unlike" pollution, yet here we are.

By next year's Earth Day, the 40th anniversary of the first one, I expect that we will have made our choice between these competing approaches. We see signs of this in the apparent determination of the administration to arrive at the Copenhagen climate conference this December having taken concrete steps here, and in the competing cap & trade bills making their way through the Congress. I can understand that opponents of strict legislation on climate change might regard the EPA's endangerment finding as a high-stakes game of chicken. But whether it serves as an implicit threat or merely an insurance policy against protracted legislative delay, it--rather than inaction--represents the new baseline. Anyone who has been sitting on the fence must now decide which approach is likely to be more effective in dealing with the US contribution to global warming, while simultaneously doing less harm to our economy. After long and careful scrutiny of the options, and after spending a career in an industry that has already been regulated to the gills, I find pricing emissions by far the most attractive solution. This is anything but a trivial decision, though it is one that must be made, and soon, before the default option becomes as inevitable as the endangerment finding was.

The Back Door on CO2

When the Supreme Court ruled in Massachusetts v. Environmental Protection Agency that carbon dioxide was a pollutant, the implications were clear. Rather than waiting for the Congress and President to agree on federal climate change policy, presumably built around an economy-wide cap & trade system or a carbon tax, the Court told the EPA that it had all the authority it needed under the Clean Air Act to order emitters of greenhouse gases to cut back--regardless of the wider repercussions. Now a lawsuit filed by the Attorneys General of New York and eleven other states seeks to force the EPA to implement this ruling on emissions from US oil refineries. But unlike a comprehensive approach, such a selective effort would greatly worsen the nation's energy security, while having very little impact on overall US greenhouse gas emissions.

The US emitted a net 6.2 billion tons of CO2-equivalent greenhouse gases (GHG) last year. Reducing those emissions has become a high priority, and pending a federal response along the lines of the Boxer-Lieberman-Warner cap & trade legislation that failed to pass the Congress earlier this year, the states have largely taken the lead. New York's suit to force the EPA to implement the High Court's ruling on CO2 as a pollutant is just one example of this trend. But in singling out oil refining, the states have chosen a target with enormous negative leverage on US imports of petroleum products--and thus on US energy security. Moreover, oil refining contributes a very small share of total US GHG emissions. California, which joined New York in filing this suit, is home to nearly 12% of US refining capacity, but its refineries account for only about 3% of the state's emissions, despite processing some of the nation's most challenging crude oil. 3% is small beer, compared to the 39% of US emissions attributable to electricity generation, or the 30% associated with our use of all transportation fuels. (Input from a chemist at the Air Resources Board suggests that refinery emissions may be closer to 7% of the state's total, although that includes co-generated electricity, some of which is sold.)

To appreciate why the cost/benefit ratio of this effort is so poor, you have to understand where GHG emissions occur along the petroleum value chain. End use, not processing, is the biggest source by a long shot. With their raw material priced over $100/bbl, and their other main energy input, natural gas, costing about half that on a barrel-equivalent basis, refiners have ample incentives to be efficient. Every BTU they burn in the course of making gasoline, diesel, jet fuel and other products is a BTU they can't sell. The latest analysis by Argonne National Laboratory found that the average oil refinery operates at 88% efficiency. Since emissions follow energy use, that means that while burning a gallon of gasoline in your car releases 19.4 lb. of CO2, only 2.6 lb. were emitted refining it. Reducing refinery CO2 emissions by 20% would have no more impact on climate than improving the fuel efficiency of the average car by 0.5 miles per gallon--less, in fact, because the US already imports a million barrels per day of gasoline and gasoline blending components. And there's the rub.

Because CO2 emissions from refineries are tied directly to their energy consumption, the only way refiners have to reduce those emissions is to process less oil, or to process it less intensively. Either option reduces their output of the high-quality transportation fuels the US demands--think reformulated gasoline and ultra-low-sulfur diesel--and forces us to import more of them from overseas, from refineries that won't be subject to the EPA's regulations on emissions. Sure, refiners can buy some renewable electricity, but that won't produce any net GHG reductions for the economy. With most US electricity still generated from fossil fuels, they would just compete with whoever is buying that output today, and drive up the premium on green electrons. And with the economics of wind and solar power still depending more on incentives than on the price of electricity, it would be hard to argue this would lead to additional renewable electricity capacity being built.

No one expects the refining industry to be handed a Get Out of Jail Free card on its greenhouse gas emissions. However, singling out refineries for enforcement of air-pollution-style regulations on their emissions will yield minimal net CO2 reductions and merely shift its emissions offshore, while further eroding the employment and profits of this strategic manufacturing sector. In addition, increasing US imports of refined product would worsen our trade deficit by their margin over crude oil. In the case of diesel fuel, which is in short supply globally, that has averaged $22 per barrel so far this year. The suit by New York, California, and the other states thus reflects a poor grasp of both energy economics and environmental priorities. If we want to reduce the GHG emissions from our use of petroleum, we must focus on squeezing demand for it, not the US companies that process it into fuels.

By the way, The Economist is hosting an interesting debate on whether existing technologies are sufficient to solve our energy problems.

Tectonic Shift on CO2

It's ironic that such a major development on an issue to which I am so attuned would occur while I was on vacation. Somehow, the Supreme Court's landmark decision on regulating greenhouse gases escaped my notice, in the small amount of news I read or watched between stops on our driving vacation out west. But without exaggeration, the Court's ruling in Massachusetts v. Environmental Protection Agency was as important as any in recent years, with the possible exception of the resolution of the 2000 election. By a narrow majority, the justices affirmed that greenhouse gases, including the carbon dioxide given off by every car and fossil fuel power plant--as well as every animal--on the planet, are pollutants. In the process, they have made it much harder for the federal government to continue its current approach to climate change on the basis of incentives and voluntary measures.

I recall my Public Policy professor in business school making quite a point about the number of votes behind a Supreme Court decision, in evaluating the precedent it sets. 5-4 decisions usually set weak precedents, because the shift of a single vote, either through a distinction in circumstances or the retirement of a justice, can undo it the next time a relevant case comes before the court. But in today's political context, that 5-4 looks more like a 7-2 in its likely durability. Had this decision been rendered in 2005, when the Administration and Congress agreed on climate change--and before Hurricane Katrina and "An Inconvenient Truth" raised the public's concern--my main message would have been one of caution. In 2007, however, the stars are lining up for a stronger response on climate change, and the Supreme Court has added its authority to the side of prompt action.

The court's ruling doesn't change my concern that defining CO2 as a pollutant will lead us down the wrong path, but that no longer matters. What counts now is the impact of this decision on US climate policy, and by extension, the global response to climate change. A world in which the US and EU are generally aligned on reducing emissions will look very different from the period that is now drawing to a close. Even developing countries should take notice of the Court's finding, because it implies they will ultimately have to fall into line, as well.

Although this decision may pave the way for action by the states, particularly in forcing the EPA's hand in allowing California and other states to regulate CO2 from automobile tailpipes, the ruling appears much less prescriptive than, say, Brown v. Board of Education or Roe v. Wade. It still remains for the Congress and the White House, whether this one or the next, to map out the actual means of limiting emissions. The biggest long-term impact of this ruling may be in foreclosing many of the legal challenges that will surely follow any such legislation or administrative rule-making.

For the last decade it has looked increasingly likely that the cost of carbon emitted to the atmosphere would not be zero for much longer. Since the 2006 election, that likelihood has increased to a high probability, and with Mass. v. EPA it now looks like a certainty. Based on the views expressed by most of the major candidates for President, by 2009 all three legs of the federal government will agree on the need for urgent action. It now falls to the current Administration to decide whether to work with the Congress to draft climate change legislation that addresses the President's legitimate concerns about international competition and the domestic economy, or to defer action for another two years, setting the stage for tougher regulations, later.