Keystone Pipeline and the Carbon Tax: A shotgun marriage that can work

We recently learned that Senators Pat Toomey (R-Pa.) and Dianne Feinstein (D-Calif.) suggested amending a bill that approves the building of the Keystone pipeline and abolishes the corn ethanol mandate. This is a very unwise proposal. If Congress needs a face-saving way to approve the Keystone pipeline, it should be done in a way that enhances the national interests rather than erode them.

I suggest an alternative amendment of a 50 cent gasoline tax (or better, an equivalent carbon tax) with the proceeds going towards infrastructure, reducing the burden of student loans, and/or reducing the burden of other taxes. In other words, keep the mandate and tax greenhouse gases.

There are interesting linkages between the Keystone pipeline, biofuel, and a carbon tax in my proposal. The Keystone pipeline that carries Canadian crude oils to the Gulf of Mexico is obviously unappealing. It provides a mechanism to move carbon-intensive petroleum and increases the profitability of producing oil from tar sands, and its existence is likely to enhance greenhouse gas emissions.

However, it is quite clear that the fuel will be utilized with or without it, and it will be shipped by means that are even ‘dirtier’ and more dangerous if it is not built. We recently witnessed a tragedy where 47 people were killed as a train full of fuel derailed in Quebec. The Keystone pipeline may decrease the likelihood of such events. Thus, from an environmental and public health perspective, the net benefit of the pipeline is questionable, even though I am quite sympathetic to those opposing it.

However it seems that if the pipeline is built to move, say, American oil produced from South Dakota to the Gulf, it probably would have been approved already. As I understand it, the legal system did not find the ‘smoking gun’ that justifies rejecting the pipeline, so the debate is political.

It seems that the U.S. environmental community and our administration are trying to impose standards on other countries that we cannot keep ourselves. We have to realize that we didn’t sign the Kyoto Protocol and the world remembers.

However British Columbia, a Canadian province, is the first region in North America that established a carbon tax, and we can learn from their example. Not supporting the pipeline might offend our Canadian neighbors for years to come. This stark political reality is likely to lead to an approval. The President has threatened to veto a proposed bill to allow the pipeline and he needs a face-saving way to justify not exercising the veto that will also satisfy the environmental community. But an amendment eliminating biofuel standards is the wrong choice. A carbon tax would be a real contribution to the health of the planet.

The investment in infrastructure to produce oil from tar sands, including the Keystone pipeline, was introduced because oil producers expected high oil prices. Such investments would be curtailed if expected future prices will be reduced–here is where the carbon tax becomes important. It will produce a wedge between the price consumers pay at the pump and price that producers receive, discouraging the expansion of GHG-intensive fossil fuels, and encouraging conservation and low-carbon alternative energy.

Corn biofuel has proven itself to be a viable alternative fuel. I was among the first who was alarmed by the food price effect of biofuel, and indeed food prices rose drastically around 2008. But, to their credit, corn producers adopted technologies that increased supply, and now with the mandate, the prices of corn have stabilized. If tomorrow the corn biofuel mandate is eliminated, the price of corn will plummet and politics will require introducing a heavy subsidy to the growers, and there will be new pressure to increase the price of oil.

Corn biofuel is not ideal from a GHG perspective (it reduced GHG emissions by 20 or 30% relative to gasoline), so it does not deserve a big subsidy, but still it makes a contribution. More importantly, the mandate encourages investment in renewable fuels because it is assured a market for the product, requiring oil refineries to use the fuel and potentially reducing their profits. Now there is evidence that the corn biofuel program has been effective and no longer needs an explicit subsidy, but the mandate provides protection against the producers of fossil fuels that represent their competition. While there is evidence that subsidies for some biofuels have been excessive, performance of corn ethanol assured investors that biofuels and renewables can be viable, and after a few years of support, they can stand on their own. I don’t expect the mandate to last forever, but it should be evaluated on its own merit within a larger context, rather than hastily written into a Keystone bill.

Because of biofuel and fracking, the monopoly power of OPEC has been reduced; this contributes to their reluctance to reduce oil production and to increase prices. When prices are low, there is no incentive to invest in production, but consumers may increase their demand, which will lead to an increase in future prices, spurring new investments in fossil fuels. A carbon tax will increase the price consumers pay, slowing their demand. Since consumers have become used to paying much higher prices for gasoline, their objection to a carbon price now will be much lower than if it was introduced during a period of high prices. Since cleaner fuel would be subject to a lesser tax (or be exempt altogether), it will give them an advantage in the market and encourage the energy sector to ‘think outside the barrel’.

If the country has to swallow the Keystone ‘pill’, we should use it as an opportunity. Some GOP lawmakers are rumored to support a carbon tax and tying it to the Keystone would provide additional political cover. So a bill approving the Keystone with a carbon tax amendment will maintain our friendly relations with Canada and benefit the environment.

Is 2015 the year for a carbon tax?

Last year, during the holiday season the price of gasoline was at $3.57/gallon, which restricted the financial choices of everyday Americans. Actually from 2005 we consumers gradually adjusted to higher prices of oil. The adjustment wasn’t easy. Many lower-income individuals who purchased new homes far from work realized that they could not pay their mortgages, and their fuel costs and high-energy prices contributed to the financial crisis. But the high-energy prices led to huge investments in new sources of fossil fuels as well as helped to establish the renewable fuel industry. This and new CAFÉ standards, as well as a stagnating economy, reduced demand for fuels and now I found myself paying $2.60/gallon as I drove to pick up my kids from the airport last week.

Some people see this ‘miraculous’ decline in the price of oil as a gift. I feel that the concerns about climate change in the general public might have subsided and the recent statement that climate change is going through a hiatus has also reduced the sense of urgency. But climate change still remains an immense risk facing humanity that requires a response. One lesson of the last few years is that high fuel taxes are not necessarily good for reducing greenhouse gases in the long run. It may lead consumers to consume less gasoline, but it can also lead producers to pursue more, sometimes ‘dirtier’, sources of fuels. Once they invest in the capacity to deliver the fuels, they will continue to sell it, even at low prices. If energy companies would receive low prices for fossil fuel and high prices on renewables, then they will shift from ‘drill, baby drill’ and force them to think outside the barrel. We need to develop a larger wedge between the price of received by the producer of a fossil fuel and the price paid by the consumer, and received by the producer of renewables.

It is common sense that the price of carbon can slow the human contribution to climate change. Politically, it is near impossible to think about this when energy prices are increasing as they were in recent years. As I recall, during the 2008 presidential campaigns, both Hillary and McCain advocated for the elimination of gasoline taxes, regardless of climate change and infrastructure needs. One reason that I liked Obama is that he did not share in this opinion. Now that prices are trending down, we have a good opportunity to prevent people shifting back to bigger cars, to sustain the biofuel industries and continue to search for alternative energy.

I speak here about a fuel tax as an example of a carbon tax. In the US, we have a federal tax of 18.4 cents/gallon for gasoline and 24.4 cents/gallon for diesel. The federal tax has not risen since 1993 when the price of gasoline at the pump was $1.11/gallon. Together with state taxes, consumers pay on average around 50 cents/gallon for fuel. Raising this average tax to $1.00 will, to a large extent, allow us to ‘catch up’ with the rising cost of fuels. I feel that a $1/gallon, which is below the recent decline in gasoline, would be quite reasonable. Renewable fuels will pay less, based on carbon emission so corn ethanol would have 40% less extra tax and sugarcane would have 60% less.

I know that politically this is not likely to fly. We are nearing a big election in 2016, and I don’t see any politician that is likely to approach the American people, who generally are averse to taxation, with such a proposal. But if we tax fuel, we could reduce other taxes and create jobs. In 2013, Americans consumed around 170 billion gallons of gasoline and diesel for transportation and if we taxed even 50cents/gallon, we have about 85 billion dollars. Of course, the tax revenue can be recycled. Part of it can go to towards tax relief but if it reduced income tax, it might be regressive, benefiting mostly the rich. An alternative use for the money is for infrastructure, an area where we have an ongoing crisis. The American Society of Civil Engineers estimate we need 3.6 trillion dollars of investment by 2020 to sustain our infrastructure. Let us suppose that they are self-serving and only half is actually required, then that is close to two trillion dollars. The extra gasoline tax might be a useful start towards making this investment.

A short blogpost can’t outline the exact design of the policy. For me, a tax on carbon emitting sources that is equivalent to about 50-75 cents/gallon on liquid fossil fuels can be a great start. I am sure that the extra revenue could be distributed among tax relief, infrastructure, developing renewable energy sources and other needs. Thus far, the people fighting to introduce incentives against greenhouse gas emissions faced a tough battle because they were working against rising energy prices. Now that prices are declining, we can take advantage and push for bold moves while the wind is on our back.