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The Cost of an Overheated Planet

by: Steve Lohr    12 December 2006

The iconic culprit in global warming is the coal-fired power plant. It burns the dirtiest, most carbon-laden of fuels, and its smokestacks belch millions of tons of carbon dioxide, the main global warming gas.

So it is something of a surprise that James E. Rogers, chief executive of Duke Energy, a coal-burning utility in the Midwest and the Southeast, has emerged as an unexpected advocate of federal regulation that would for the first time impose a cost for emitting carbon dioxide. But he has his reasons.

"Climate change is real, and we clearly believe we are on a route to mandatory controls on carbon dioxide," Mr. Rogers said. "And we need to start now because the longer we wait, the more difficult and expensive this is going to be."

Global warming is not only an environmental hazard, but also a great challenge for economic policy. Without economic incentives, analysts say, the needed investments in industrial cleanup, innovative low-carbon technologies, fuel-efficient cars and other ways of reducing energy waste will not occur.

Mr. Rogers's stance is far from universal within the power industry, but it has surprising support, particularly from those, like him, who also produce electricity from carbon-free nuclear reactors.

And despite the Bush administration's adamant opposition to any limits on fossil fuel emissions, the idea is beginning to pick up momentum in the American political arena as well. Already, California has adopted a policy aimed at reducing the state's contribution to global warming by 25 percent in the next 14 years.

In Washington, several influential lawmakers, including Senator John McCain, a leading Republican contender for president in 2008, have introduced legislation intended to limit the nation's carbon dioxide output.

But how would those goals be achieved? Global warming can be seen as a classic "market failure," and many economists, environmental experts and policy makers agree that the single largest cause of that failure is that in most of the world, there is no price placed on spewing carbon dioxide into the atmosphere.

Yet it is increasingly clear that there is a considerable cost to carbon dioxide emissions, especially to future generations, as climate specialists warn of declines in farm output in poor tropical countries, fiercer hurricanes and coastal floods that could make many people refugees.

Price List for Polluting

"Setting a real price on carbon emissions is the single most important policy step to take," said Robert N. Stavins, director of the environmental economics program at Harvard University. "Pricing is the way you get both the short-term gains through efficiency and the longer-term gains from investments in research and switching to cleaner fuels."

Some academics see an analogy between a global warming policy and the pursuit of national security in the cold war. In the late 1950s, American military spending reached as high as 10 percent of the gross domestic product and averaged about 4 percent, far higher than in any previous peacetime era. A Soviet nuclear attack was a danger but hardly a certainty, just as the predicted catastrophes from global warming are threats but not certainties.

"The issues are similar in that you pay now so things are less risky in the future it's an insurance policy," said Richard Cooper, a Harvard economist. "And in the cold war, we taxed ourselves fairly highly to mitigate that threat."

What makes such a view more than a conceptual argument is that executives like Mr. Rogers, who is also chairman of the Edison Electric Institute, a utility trade group whose members provide 60 percent of the nation's electric power, are also pushing for a carbon dioxide-pricing policy to reduce the risk to their companies.

They say that only with some sort of federal policy in place which would probably take the form of a tax on carbon dioxide waste from any source, or a "cap and trade" regulatory system will it become clear what carbon cleanup or fuel-switching moves their companies may have to make, and on what sort of timetable.

Investors in alternative energy projects also emphasize the need to set policy priorities.

"We need a policy framework for the long term," said Vinod Khosla, a leading environment-oriented venture capitalist. "Fifteen years is the minimum horizon of stability that we need."

Beyond incentives for business, a national global warming policy should include increased federal spending on research on futuristic technologies to curb carbon emissions, advocates say.

Combating global warming, they say, will require over-the-horizon breakthroughs involving safe nuclear energy, hydrogen power and advanced carbon sequestration or technologies that have not yet been imagined.

But even today, there are sizable opportunities, by insisting on more efficient energy use, that are not being seized, according to the McKinsey Global Institute. In a new report, the institute, a business-oriented research group that is part of McKinsey & Company consultants, estimated that the yearly growth in worldwide energy demand could be cut by more than half through 2020 to an annual rate of 0.6 percent from a forecast 2.2 percent, using current technology alone.

Available steps that would yield a more productive, and efficient, use of energy include compact fluorescent lighting, improved insulation on new buildings, reduced standby power requirements and an accelerated push for appliance-efficiency standards.

All these moves, McKinsey said, would save money for consumers and businesses. "We were really surprised by these huge straightforward opportunities that are not being taken," said Diana Farrell, the McKinsey Global Institute's director. "In some senses, there is a big market failure."

Energy efficiency can help slow the pace at which the risk from global warming risk increases, but it cannot reverse the trend alone. In the very long term, environmental experts say, the world's economy needs a technological transformation, from deriving 90 percent of its energy from fossil fuels today to being largely free of emissions from fossil fuels by 2100, through cleanup steps or alternative energy sources.

Science and Uncertainty

Given all the uncertainties, the scientists and economists who design and run simulations of global warming policy acknowledge that their work is at best a tool for thinking about climate change issues.

Still, they tend to agree that over the next 50 years, the cost of slowing and eventually reversing carbon emissions growth will be 1 to 2 percent of global economic output. They assume the focus over those years will be mainly on efficiency and cleaning up electricity generation.

In later years, their cost projections become more varied, ranging from 1 percent to as high as 16 percent of global output, depending on assumptions about how difficult it will be to wean the world's vehicle fleet from fossil fuels, and to make other technological leaps.

"Going past 2050, the cleverness really has to kick in," said John M. Reilly, an economist at the M.I.T. Joint Program on the Science and Policy of Global Change.

A global warming policy would be shaped first by science and social values, before economics. A sensible goal, according to many environmental specialists, is to try to avert a doubling or more of atmospheric concentrations of carbon dioxide in this century.

"This is not something that goes on inside a computer, but a grand political calculation," said Stephen H. Schneider, a climate expert at Stanford University.

Yet even in realms of social policy, where uncertainty is high, there is an implicit calculation of costs and benefits. In the case of global warming, the cost of society's insurance policy may well be worth it, measured in the damage averted.

But it will not be cheap. Take the experts' consensus estimate that curbing carbon dioxide emissions over the next 50 years will, on average, cost about 1 percent of global economic activity annually.

It seems a modest figure. Yet in today's terms, 1 percent of the United States economy is more than $120 billion a year, or $400 a person.

Put another way, $120 billion is about equal to the Bush administration's tax cuts in 2001; it is also roughly the amount spent on the Iraq and Afghanistan wars this year.

"There's no easy way around the fact that if global warming is a serious risk, there will be serious costs," said W. David Montgomery, an economist at Charles River Associates, a consulting group.

A price on carbon dioxide emissions, most economists agree, would be the most efficient way to combat global warming. And the price, they say, should start small to give industries time to adapt, then ratchet up over the years to encourage long-term investments in energy saving, carbon cleanup and new technology.

The two methods of pricing carbon are to charge a tax on each ton of carbon dioxide emitted into the air, or to place a cap on total emissions and then let polluters trade permits to emit a ton of carbon dioxide.

Economists like William D. Nordhaus of Yale and Mr. Cooper of Harvard advocate a tax as the clearest price signal to the energy marketplace, and less susceptible to political tampering and market manipulation than a cap-and-trade system. It could also be used to raise revenue to offset other taxes.

In a recent paper, Mr. Cooper suggested an initial tax around $14 a ton of carbon dioxide emitted, which he calculated would translate roughly into a 100 percent tax on coal and add 12 cents to each gallon of gasoline. Such a tax would raise as much as $80 billion a year in the United States.

"There's nothing sacred about the number," he said, "but you need to get a significant price into the system to create the incentive for people to go out and look for solutions."

A Quota or a Tax?

Economically, a cap-and-trade system has the same goal as a tax, putting a price on carbon dioxide emissions, but goes about it differently. A limit would be placed on overall emissions, with polluters allocated permits. Then, companies able to go below their emission targets would be allowed to sell their unused "permits to pollute" to companies that could not.

A cap-and-trade system also has some political advantages. It can deflect the anger over higher costs and enable governments to use their allocations to essentially buy political support, since permits are the equivalent of cash. Big polluters, who will have to invest most to clean up, could be granted extra allowances in the early years of the program to subsidize their investments.

In the United States, caps and trading have a record of success in combating acid rain, which is caused by sulfur dioxide emissions from fossil fuel power plants.

"People said it was a crazy idea, too complicated and too regulatory," said Richard L. Schmalensee, an M.I.T. economist who was an economic adviser to the first President Bush when the sulfur emissions program was designed. "But the lesson learned was that a cap-and-trade system can work."

The global warming legislative proposals before Congress including one sponsored by Senator McCain and Senator Joseph I. Lieberman of Connecticut, and another by Senator Jeff Bingaman of New Mexico envision cap-and-trade systems.

But the challenge of controlling carbon emissions is far greater than sulfur. Carbon dioxide is a pervasive byproduct of the economy, and the polluters are many and varied. Once emitted, carbon dioxide is vexingly long-lived in the environment.

The early struggles of the European Union's carbon emission trading system, set up last year, point to the administrative and political difficulties. The European governments, responding to lobbying by domestic businesses, handed out permits that exceeded the emissions that most companies were already putting into the air. When that became clear in April, the market price of carbon dioxide emissions fell by half.

Senator Barbara Boxer of California, who will soon take the chair of the Senate environment committee, has pledged to push Congress to impose a price on carbon dioxide emissions, as the Europeans have done.

Yet without coordinated international action, even if the United States the largest source of carbon emissions reined them in, this would have only limited effect on global warming. China is on track to surpass the United States as the leading emitter of carbon dioxide by 2009, according to a recent report by the International Energy Agency.

"Unless China and India are brought in, it won't matter much what the developed world does," said Scott Barrett, a professor of environmental economics at the School of Advanced International Studies of Johns Hopkins University.

But developing nations like China and India, energy specialists say, would certainly avoid joining any international effort on global warming without an emphatic move by the United States.

"Every year we delay, we contribute to another year of delay in China, India and elsewhere," said Jason S. Grumet, executive director of the National Commission on Energy Policy, a bipartisan group of energy experts. "The ecological and economic imperative is to start now."