31 may 2018

It’s time to think seriously about cutting off the supply of fossil fuels

A new paper makes the case for supply-side climate policy.

By David Roberts Updated May 31, 2018,

There is a bias in climate policy shared by analysts, politicians, and pundits across the political spectrum so common it is rarely remarked upon. To put it bluntly: Nobody, at least nobody in power, wants to restrict the supply of fossil fuels.

Policies that choke off fossil fuels at their origin — shutting down mines and wells; banning new ones; opting against new pipelines, refineries, and export terminals — have been embraced by climate activists, picking up steam with the Keystone pipeline protests and the recent direct action of the Valve Turners.

But they are looked upon with some disdain by the climate intelligentsia, who are united in their belief that such strategies are economically suboptimal and politically counterproductive.

Now a pair of economists has offered a cogent argument that the activists are onto something — that restrictive supply-side (RSS) climate policies have unique economic and political benefits and deserve a place alongside carbon prices and renewable energy supports in the climate policy toolkit.

“In our experience,” the authors write, “the climate policy community has for too long been excessively narrow in its preference for certain kinds of policy instruments (carbon taxes, cap-and trade), largely ignoring the characteristics of such instruments that affect their political feasibility and feedback effects.” I have written the same thing many times, so I think a climate policy argument that takes politics seriously deserves a close look.

To understand it, it helps to have a framework for classifying climate policies.

The four quadrants of climate policy

Climate policies can apply to the supply side (production of fossil fuels) or the demand side (consumption of FF), and they can be restrictive or supportive. That creates a grid with four quadrants:

* Restrictive supply side: policies that cut off FF supply, including declining quotas, supply taxes, and subsidy reductions
* Restrictive demand side: policies that restrict demand for FF, including carbon prices and declining emission caps
* Supportive supply side: policies that support the supply of FF alternatives, like renewable energy subsidies and mandates
* Supportive demand side: policies that support demand for FF alternatives, like subsidies for purchase of energy-efficiency appliances or favorable government procurement policies

As the authors — Fergus Green of the London School of Economics and Richard Denniss of the Australia Institute — point out, virtually all climate policy discussion and analysis has focused on quadrants 2 through 4. In surveys of the toolkit available to climate policymakers, quadrant 1 is almost always omitted entirely.

On its face, this doesn’t make much sense. In other areas of policy, demand- and supply-side policies are routinely mixed and considered mutually reinforcing. As an example, Green and Denniss focus on attempts in Australia to reduce smoking.

Those efforts, which have won acclaim around the world, are a wide-ranging mix of tactics. Supply is restricted through taxes, licensing requirements, and prohibitions on advertising and sponsorships. Demand is restricted through consumption taxes, public education campaigns, and warnings on packs.

It isn’t a single, clean instrument, an “optimal” policy, but a portfolio approach. And it isn’t considered a muddle or a redundant mess, but a sensible way to approach a complex problem. And it has worked.

In fact, portfolios of demand and supply measures have worked in plenty of policy areas, including environmental policy (lead in gas, chlorofluorocarbons, etc.).

So quadrant 1’s absence in climate discussions is, the authors say, “anomalous.” And they argue that it is impoverishing the discussion, because restrictive supply-side policies have unique economic and political benefits.

Let’s start with the economic benefits.
Cutting off fossil fuel supply has unique economic benefits

Green and Denniss list four economic benefits of restrictive supply-side policies.

1) RSS policies are easier to administer.

“Both carbon taxes and cap-and-trade schemes,” they write, “require detailed and complex rules, procedures and regulatory institutions for the monitoring, reporting and verification (MRV) of greenhouse gas emissions at facility/installation level (e.g. power plants, steel mills), often across hundreds or even thousands of facilities/installations.”

All this complicated monitoring and reporting reduces economic efficiency, creates an informational asymmetry (facilities will always know more about their emissions than regulators do) and thus incentive to game the system, and generally restricts such systems to major emitters, leaving substantial swaths of emissions unregulated.

By contrast, RSS policies target a relatively small number of sources, rely on data that is already gathered for other purposes, and by definition cover all downstream consumers. They are much easier to verify, which makes them politically potent both domestically and internationally (see below).

2) RSS policies cover the weaknesses in demand-side policies.

Climate wonks and economists are very taken with the fact that, in theory, the “least cost” way to reduce emissions is to pass technology-neutral, sector-neutral pricing policies that cover the entire global economy, allowing distributed, profit-maximizing actors to find the cheapest ways to cut CO2.

In the real world, considerations like MRV costs and “leakage” (any jurisdiction that passes a pricing policy threatens to drive some consumption to neighboring jurisdictions) mean that pricing policies are never economy-wide or entirely neutral.

Pricing policy that isn’t universal — like all current and foreseeable pricing policies — threatens, by lowering demand for fossil fuels, to also suppress FF prices and thus increase consumption outside policy barriers. Areas that aren’t covered by pricing policy will use more fossil fuels and the industrial shift to clean energy will be slowed.

“Restrictive supply-side policy has an important role to play in limiting countervailing price effects” from non-universal pricing policies, the authors write. “The combination of supply-side and demand-side policies will thus hasten the industrial transformation required to meet climate mitigation objectives.”

3) RSS policies can avoid infrastructure lock-in.

I will let the authors explain “lock-in”:

When production processes require a large, upfront investment in fixed costs, such as the construction of a port, pipeline or coalmine, future production will take place even when the market price of the resultant product is lower than the long-run opportunity cost of production. This is because rational producers will ignore “sunk costs” and continue to produce as long as the market price is sufficient to cover the marginal cost (but not the average cost) of production. This is known as “lock-in.”

Basically, once a big piece of fossil fuel production infrastructure is built, it keeps producing in perpetuity (or until it runs dry), even if subsequent developments render the original investment foolish. Even if the original owner goes bankrupt, someone will buy the fixed asset and use it to produce “so long as the market price covers the marginal cost of production.”

That means every build-or-don’t-build decision for a piece of FF infrastructure is an inflection point, a “lump” of future FF supply that becomes almost guaranteed even in the face of substantial reduction in demand.

Given the danger of lock-in, complementary RSS policies send a signal to investors to “avoid inefficiently high levels of investment in the production capacity for goods of which policymakers are determined to reduce consumption in the future.”

4) RSS policies can short-circuit the dreaded “green paradox.”

The threat of policy growing more stringent over time (as in a rising carbon tax) is that it will push producers to move up their production schedules — to get while the getting’s good — which could suppress prices and boost short-term consumption. Restrictive supply-side policies passed now can help avoid this so-called “green paradox.”
Cutting off fossil fuel supply has unique political benefits

While economic arguments are familiar in climate policy circles, analyses that grapple with politics — the political economy in which policies are generated, supported, and implemented — are quite rare. (I have lamented this before.)

That seems to be changing a bit lately, though. Green and Denniss commend “the emerging literature on policy instrument interactions that ‘endogenizes’ political constraints.” In non-nerd-speak, “endogenizing” political constraints means making them internal to the analysis, recognizing that political constraints affect policies — and, crucially, that policies can in turn affect political constraints. (Policies that drive down the price of renewable energy, for instance, make higher renewable energy targets more palatable.)

One thing that recent political science has highlighted is that “overcoming political constraints to ambitious climate mitigation is best done by sequencing policies in such a way as to engineer feedback effects that expand the politically feasible set of climate policies over time.”

Rather than jumping straight to, say, an economy-wide carbon tax, it might be better to use more targeted policies to build the case against fossil fuels, improve the economics of key technologies, get the public more familiar with alternatives, and thus prepare the ground for more ambition. (I wrote a post about that too.)

Green and Denniss argue that RSS policies have some unique political benefits that should earn them a place early in that sequence. They cover three.

1) It is easier to organize public support around RSS policies.

This is the key argument. As the authors acknowledge, a great deal of recent study has gone into what kinds of features the public prefers in climate policies, but there’s not been much analysis of public preferences regarding “whether the instrument targets the supply side or the demand side.”

Attempting to fill that gap, the authors argue that supply-side policies will often be more conducive to building public support.

Political science has traced support for climate policies to, roughly speaking: “(i) the perceived benefits of the policy, (ii) the perceived personal and public costs of the policy, and (iii) the perceived distributional fairness of the policy.”

On all three scores, they say, RSS policies do well. First, where demand-side policies typically foreground carbon reductions, the benefits of which are widely spread in time and space, RSS policies target fossil fuel reductions, with a wider range of benefits — air and water pollution reductions, health improvements, and punishment for big fossil fuel companies, which are politically unpopular.

This broader portfolio of benefits is more likely to mobilize public support. It “enables proposals to be framed in ways that are more resonant with voters and more resilient to counter-attack by opposing interest groups; facilitates alliance-building among diverse groups with wide-ranging concerns about fossil fuels; and facilitates network-building among groups at different advocacy- and policy-relevant scales.” All those effects build political strength for future battles. (I’ve written about this too.)

Second, where demand-side policies tend to place the costs visibly on consumers, the perceived costs of RSS policies fall on fossil fuel companies themselves. Of course, those costs are at least partially passed downstream to consumers eventually, but they are relatively more “hidden” that way, and thus more politically palatable. “Accordingly,” Green and Denniss write, “we would expect that people would perceive the costs to themselves of supply-side policies to be lower, or the distribution of the costs to be fairer, or both — and thus support for such policies to be higher.”

2) RSS can divide fossil fuel companies against one another.

As a sector, fossil fuels are well-organized and well-funded. United, they will almost always overpower civil society groups and politicians.

But they can be turned against one another. RSS policies can divide them along temporal lines — set incumbents against new entrants, for instance, with a ban on new extraction — or by “sub-industry” lines, say, coal from natural gas. “Rational fossil fuel producers perceiving a risk of a tightening carbon budget constraint,” they write, “will support policies that require emissions reductions from other sectors, including other fossil fuel sub-industries, but which exclude their own sector.”

As climate policy becomes more stringent, fossil fuel companies will adopt the philosophy of the campers attacked by a bear — you don’t have to be faster than the bear, just faster than the other campers.

Given the difficulty of building a winning coalition behind climate policies, the potential to win over FF sub-industries is a mark in RSS policies’ favor.

3) RSS policies can aid international cooperation.

The globally harmonized, independently verified, legally binding climate policy framework that climate activists have been dreaming about for decades has never materialized, and the Paris climate agreement marks the death of that aspiration. The Paris framework makes very little attempt to harmonize demand-side policies across countries, and most verification is done via self-reporting. That creates a different kind of policy environment and a different set of challenges for international cooperation. Green and Denniss argue that RSS policies are well-suited to the task.

First, economics tells us that if the “price elasticity” of a fossil fuel — the ability of consumers to find alternatives if prices rise — is higher than the “supply elasticity,” then demand-side policies would produce more “leakage” than supply-side policies. In those circumstances, “unilateral domestic supply-side policies would be more effective at reducing global emissions than their demand-side equivalents.” (Coal arguably fits this bill.)

“The emergence of international cooperation on fossil fuels is likely to be contingent on a coalition of early-movers taking unilateral steps to limit or reduce fossil fuel supply,” Green and Denniss write. “Low international leakage rates associated with supply-side policies would encourage the necessary unilateral action.”

The second feature that encourages international cooperation is the relative ease of measuring and verifying RSS policies relative to demand-side policies (as described above in the economics section). Transparency builds trust and makes further cooperation easier.

“Since the Paris Agreement’s success is predicated on states’ gradual escalation of their commitments over time,” they write, “commitments to implement supply-side policies offer major advantages as a ‘currency’ of international climate cooperation.”
It’s time to apologize to activists and make FF supply restrictions part of the climate policy toolkit

As Green and Denniss say over and over, no one is arguing that RSS policies are better than demand-side policies, or a substitute for them. The exact economic and political effects of any set of policies will always depend on context-dependent factors; different portfolios will be appropriate for different times and places.

But RSS policies are an excellent complement to demand-side policies, with economic and political strengths that help fill in the gaps. They are simple, transparent, easy for the public to grasp, and unmistakable signs of good faith in international climate negotiations.

It’s easy enough to understand why the political establishments of most countries are leery of RSS policies, given the ubiquitous influence of the fossil fuel industry. But it’s time for climate analysts and wonks to get past the sneering attitude they’ve traditionally had toward such policies and the activists who support them.

Yes, at this point, everyone gets it: An economy-wide, steadily rising, fuel- and technology-agnostic price on carbon is the optimal policy. But we don’t live in an optimal world, so yacking on about it isn’t much help. We live in this world, where a variety of political constraints means that no such policy has passed or seems likely to pass anytime soon. In this world, limited (thus suboptimal) demand-side policies need supplementing.

In this world, it makes sense to draw on all four quadrants — to use the portfolio approach taken for granted in so many other areas of policy. Climate change is a big problem. We can’t afford to leave any tools in the toolbox.

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