Your Cost of Carbon

It appears that the Obama administration is getting closer and closer to implementing some sort of GHG cap and trade system, since the WSJ and others are reporting that the proposed budget is counting on revenues from the sale of allowances.

You may read these articles and see numbers in the 10's or 100's of billions of dollars thrown around, and you may wonder "what is this really going to mean for me?". Let's do some math and find out.

We'll start with the impact of driving a car, which is pretty straightforward. Independent of your vehicle, driving style, etc, gasoline generates just shy of 20 pounds of CO2e per gallon. With around 2200 pounds in a metric ton, that means there's about 110 gallons per ton of CO2e. With carbon at $20 as suggested in the article, if the cost of carbon is passed straight to the consumer (more on this below), then added cost per gallon from the carbon cost is $0.18. This is an interesting number for those of us here in Massachusetts, since its close to the $0.19 increase in state gas taxes that the Governor is considering, and would put the total "tax" on gas in Mass at $0.60/gallon.

At $2.00/gallon, the $0.18 is just shy of 10% "tax". Based on this result you can see that a $40 price of carbon would be a tax of $0.36, and a $10 price at $0.09. Note again that these results hold anywhere in the US.

Next we'll look at the effect on your electricity bill. This isn't quite so simple, since the CO2e varies by location, as well as the cost of electricity. Let's look at Massachusetts as an example, and we'll use the EPA eGrid data, along with the local cost of electricity as reported by the EIA. Using the file eGRID2007V1_1_year05_SummaryTables.pdf from the eGrid site, we find that the output emission rate for GHG for the New England region is 1350 pounds per MWh, or 1.35 lbs/kWH (about average for the US). With 2200 lbs/ton, this results in about 1630 kWH/ton of CO2e. At $20/ton, this is about $0.012 per kWH.

On the price side we'll use the residential cost in Massachusetts, which is $0.177/kWH (in the top 5 highest rates nationwide, btw). With the high price of electricity and the low GHG emissions, this is only bumped up by 6.8% or so to $0.189. Again, $40/ton is twice this, and $10/ton is half this if you want to see a couple of other simple points on the curve.

As a quick comparison, at $20/ton Colorado works out to a $0.018/kWH hike on an average rate of $.099/kWH for an increase of 18%.

Now remember that all of this assumes that the price difference passed on to the consumer is exactly the price that the utilities or refiners pay for the allowances. It's hard to believe we'd pay less, and likely more. In Germany it was reported by the WSJ in 2006 that the consumer prices rose much higher than the allowance costs (full article by subscription only, unfortunately).


As well the cost of the direct emissions and any "administrative" mark up that the suppliers decide to charge, the price of gasoline needs to include the cost of CO₂ emissions in its production, manufacture and transport. This will apply to all goods, of course; that's the point, after all.

Posted by Ed Davies on February 27, 2009 at 10:00 PM EST #

Ed, I agree with your comment from the perspective of an ideal, conceptual model, but in reality these extra costs will only be included to the extent they occur in parts of the world that put a price on carbon. There are discussions of "carbon tariffs", but they don't seem very loud and its not clear they'd be politically viable globally or at home.

Posted by David Douglas on February 28, 2009 at 02:07 AM EST #

Great analysis. I think this would be the high-end of the cost, right, because if the initial credits were grandfathered in (as opposed to auctioned off at these prices) then emitters would only need to buy credits (i.e. increase cost) for amounts over the cap. Now presumeably the caps would decrease over time (or grow slower than power consumption/output) which would increase the "tax" but that mechanism would ease in the cost (as opposed to a big 10% hit in Year 1.

Posted by FN on February 28, 2009 at 10:28 AM EST #

That depends if they decide to give energy companies free credits for awhile. My question is what's the point of having a price of carbon if you give away a large number of credits? Isn't the price of carbon supposed to change investment and consumption patterns? How does that work if you artificially lower the price?

Also, the administration says it will bring in $645B in revenue between 2012 and 2019. We currently generate just shy of 6B Mtons/yr, so in 8 years that means the average carbon price is $13.45 over the whole time to bring in that much money.

Posted by David Douglas on February 28, 2009 at 03:11 PM EST #

If they auction all the credits, then they would generate the vast majority of the revenue in year 1 (2012). Probably on the order of $600BB of the total projected. The revenue in year 2 and beyond would be generated because companies could not abate GHG emissions internally at a lower cost (so they buy credits). This would be the similar to how the FCC auctions off spectrum. It would be a huge shock to the utilities and is unlikely to be passed (in my view). More likely is some sort of partial grandfather of credits in exchange for a steep cut in future caps that would ramp credit prices quickly from zero to something in the $50+ range. If you look at the McKinsey study on GHG abatement opportunities, the really interesting projects become viable in the $25+ range. The whole goal of the cap-and-trade scheme is to make those projects viable.

Posted by FN on February 28, 2009 at 03:25 PM EST #

FN -

Couple of points:

I'm not sure what numbers you're using. The US inventory is around 7G tons/year. So one year's worth at $20/ton is $140B.

I'm not sure why its a huge shock to the utilities, they are going to pass every $$ an more on to their users. I'm more concerned that they pass on higher amounts.

There's growing evidence that cap and trade schemes alone done make the necessary projects viable. They only provide a market mechanism to enforce a cap.

The administration has been quoted as saying two things: 1) no allowances, and 2) they want to raise about $B/year (carbon price of $12 or so at current levels, those they are dropping some due to recession)


Posted by David Douglas on March 01, 2009 at 01:20 AM EST #

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