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Forget Cap and Trade, A Carbon Tax Is Better

Congress got hot under the collar in early June as it debated national climate change legislation. The Warner-Lieberman bill went down in flames, however, because Democrats couldn't muster the 60 votes needed to break a Senate filibuster. But this isn't really bad news because the whole idea of a national cap and trade isn't very good to begin with, considering the new economic reality surrounding energy.

Oil reached US $135 a barrel in late May and has stayed above US $120 since then. Many analysts are predicting US $150-200 oil within two years. Natural gas prices have surged to records not seen since Hurricane Katrina and Rita locked in significant Gulf of Mexico production. Coal prices are at records and have doubled over the last year. Utility bills will soon follow as utility companies are forced to pay far higher prices and pass those prices along to ratepayers. Gasoline keeps rising and has breached US $4/gallon nationally and is over US $4.50/gallon in places like California (and over US $4.70/gallon at some stations in my hometown of Santa Barbara). Diesel prices are even higher, topping US $5/gallon.

What does all this spell for our future? In a word: conservation.

Lo and behold, gasoline demand is not inelastic, as economists have stated for years. People do in fact respond to higher prices. Prices just had to rise high enough to provoke a significant response. US $4/gallon seems to have been the magic number.

In May, auto companies released their sales figures and they were remarkable: SUV and light truck sales have dipped 30-60% (depending on the brand) over the last year. Small car sales are up almost as much. At the same time, total "vehicle miles traveled" dipped for the first time since 1979. Behavior is changing — and rapidly — in light of higher prices.

Markets are in fact working. The question is: will prices remain high and will these behavior changes persist even if prices dip again? Looking to history, we can see that after an impressive ten-year period of conservation and declining petroleum demand after the oil shocks of the 1970s, the U.S. consumer returned to her profligate ways. We forgot the lessons of the past.

Will the same thing happen this time around? Don't count on it.

The difference this time around is that the higher prices are prompted mostly by fundamental supply and demand issues. We may already have reached a global peak in oil production, and even if we haven't, it will likely be here in the 2010-2015 timeframe at the latest. When global peak oil production is reached, we can count on far higher prices than today's records.

At the same time, we have already witnessed declining global oil exports. While global production has been on a plateau the last three years, global oil exports from the top 15 exporters declined 2.7% in 2007 (according to EIA data). In 2008, this trend has accelerated, with imports to the US from Venezuela and Mexico, two of our five largest suppliers, down 32% on an annual basis. This may have been a factor in price increases over the last few months, as US inventories are declining.

So high oil prices are very likely to persist, with some possible dips along the way. And the most likely outcome of these dynamics is far higher oil prices between now and 2020.

Far higher prices will lead to very significant demand destruction in the US and throughout the world as consumers change their behavior and countries that subsidize oil prices are forced to lift subsidies as their treasuries buckle under the weight.

This brings us back to cap and trade. Any legislation that could be passed by this Congress this year and not vetoed by President Bush will have far less impact on consumer behavior than market forces are already achieving. Republicans in Congress have a decent point when they say the last thing consumers need right now is even higher prices due to federal legislation (though higher prices in the short and mid-term would likely lead to longer-term cost savings for consumers as alternatives came online in a big way).

A better course of action would be for Congress to adopt a modest carbon tax, such as those proposed by Stark or Dingell, and use the revenue to fund petroleum reduction planning efforts at the state and local level, and to fund alternatives to the status quo. For example, a ten cent per gallon carbon tax (on top of the current 18 cent per gallon federal gas tax) could fund billions in planning efforts and renewable technologies around the country. Ten cents per gallon is small enough that it wouldn't be a huge burden on most consumers. For lower income consumers that may be harmed by an additional tax, Congress could provide for annual or semi-annual rebates, eliminating the regressivity of such a tax.

A carbon tax is also easier to administer than a cap and trade system, and is less vulnerable to gaming and extreme price volatility. More information is available at www.carbontax.org. The carbon tax idea has support from countless economists, the American Petroleum Institute, Al Gore, and many other leaders and policymakers. It should be considered superior to cap and trade in many ways.

Good government policies can do much in times of normal energy prices. But with energy prices sky high, market forces will do far more to reduce greenhouse gas emissions through reduced fossil fuel consumption. So government policies should, in such times, simply try to guide consumers toward better long-term options. A carbon tax that is used to fund state and local planning efforts, and alternative energy technologies, would be the right solution at this time.

Tam Hunt is Energy Program Director and Attorney for the Community Environmental Council in Santa Barbara. He is also a Lecturer in renewable energy law and policy at the Bren School of Environmental Science & Management at UC Santa Barbara.

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