from Energy, Security, and Climate and Energy Security and Climate Change Program

The Carbon Price Equivalent of Blocking Keystone XL

February 20, 2013

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Fossil Fuels

Climate Change

In an exchange about the Keystone XL pipeline earlier today, NASA’s Gavin Schmidt made an important point: “Many things can raise the effective carbon price: tax, cap-and-trade, regulatory action (mercury standards, pipeline decisions etc)”. (I’ve taken the liberty to expand some twitter abbreviations.) That’s true. So what carbon price would blocking the Keystone XL pipeline be equivalent to?

It’s a trickier question than one might think; there are actually no clean analogies. But here are two useful ways to think the issue through. (And a preemptive note: I understand that one can’t boil the Keystone fight down to a little cost-benefit calculation. I’m just picking up on an issue that others have raised.) I’d be eager to hear from others who have issues with these approaches, or who have other ideas -- the broader challenge of thinking through "carbon price equivalents" for regulatory and other non-price measures is an important one for domestic and international climate policy alike.

What level of carbon price would be required to have the same impact on pipeline development as simply rejecting the thing?

It’s easiest to look at this by first focusing on a concrete price.  Take $100/tCO2, which is many times in excess of the shadow price that the U.S. government applies in its regulatory decisions. Producing and refining a barrel of oil sands crude entails about 100 kilograms of carbon dioxide emissions. That translates to $10 a barrel in extra charges. At the same time, applying the same carbon charge to U.S. oil use would add about $40 to the cost of using a barrel of oil. Demand elasticity for U.S. oil is low. Increasing the price of U.S. oil by this increment (let’s assume a base price of $120) would eventually lower U.S. demand by perhaps 15 percent (again I’m being generous). U.S. oil is about a fifth of the global market, so that would lower total global oil demand by about 3 percent. The IMF estimates that elasticity of world oil demand is around -0.072 in the long run; the net result should be about a 34 percent decline in the oil price. (This is a very, very conservative lower bound, since OPEC members would cut back investment, and other countries would pick up some consumption, but let’s run with it.) Assuming that we start $120/bbl oil, that takes us down to $79 oil. (Again, in reality, probably not nearly so far.) Most oil sands producers can make their investments work – even after paying the extra $10 – at this price.

How high a carbon cost would be required to negate other positive externalities from oil sands development?

Oil production doesn’t just cause damages that aren’t accounted for by market prices – it also brings benefits. Let’s focus on just one: more production pushes down oil prices. That creates benefits for all U.S. oil consumers. What level of carbon damage would be required to fully offset this?

Imagine that you boost net world production by one million barrels of oil a day. (This could be one million additional Canadian barrels; it could be five million additional Canadian barrels and four million barrels of offsetting OPEC cuts. The absolute magnitude of the number doesn’t matter – all of what I’m about to do scales linearly. That’s one of the things I particularly like about this line of analysis.) Let’s stick with the same IMF estimates of demand elasticity. The resulting price hit is a bit less than $20 a barrel. Now apply that to the roughly 7 million barrels of oil the United States imports each day. You’re talking a total cost of about $130 million a day. Climate damages need to be around $130 dollars a barrel – approaching $300/tCO2 – just to get even.

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