Is A Trans-Atlantic Environmental Race To The Bottom Next?

Environmentalists often pillory China, with its opaque city air, dirty water, and contaminated food as the leader of a race to the bottom. By spending as little as possible on pollution control, they say, it keeps production costs to a minimum and boosts exports. If Chinese producers had to bear the full external costs their pollution imposes on others, the critics go on, a good part of its competitive advantage would disappear. The environment would be cleaner and good jobs would return to the United States. So China’s behavior is an outrage, is it not?

Now, however, there is a looming danger of a new race to the bottom, this one with America as the leader and the Atlantic rather than the Pacific as the arena. Is this prospect any less outrageous?

Appropriate vs. affordable energy pricing
As I detailed in a three-part series earlier this year [1] [2] [3], economists across the political spectrum see appropriately high energy prices as a key to an efficient, environmentally sustainable economy. “Appropriate,” in this case, means prices that include charges for environmental harms—local pollution like smog and mercury emissions, groundwater pollution from fracking, climate change caused by greenhouse gas emissions, everything. Higher prices, in turn, would provide incentives for conservation and clean energy innovation.

Naturally, there are disagreements about the size of the appropriate pollution charges, but no serious analyst believes that zero is the correct number. Economists also differ as to whether stronger enforcement of property rights, cap-and-trade, or taxes are the best way to implement pollution charges, although for reasons explained in the earlier posts, pollution taxes seem to have the largest following.

On the other side of the debate stand representatives of energy producing and energy using industries who argue that the aim of energy pricing policy should not be appropriateness, but rather, affordability. “Affordable,” in this context, seems to mean as low as possible, the environment be damned. Taxes on energy are the ultimate anathema.

The American Petroleum Institute has always been a stalwart of the affordable energy brigade. As the API puts it in a recent ad posted on its website,

American energy is creating millions of jobs and fueling economic growth. It’s working. So as Washington considers reforms to our tax code, one thing is clear: Don’t raise taxes on American energy. It’s driving our comeback. Tax hikes on energy would halt our progress at just the wrong time. It could destroy jobs when we need them most.

Despite diligent lobbying by the API, American energy prices are not the lowest in the world. End-user prices are even lower in countries like Egypt, Venezuela, and Iraq that go beyond mere tax breaks to squander their scarce budget resources on direct energy subsidies. However, U.S. prices, depending on the form of energy, are the lowest or among the lowest in the OECD. They contain no explicit charges for environmental externalities, although EPA regulations do add to production costs in some cases.

When we combine producer-friendly pricing with the new supplies of oil and gas made possible by the recent fracking boom, it is fair to say that the United States has already won the race to the bottom in energy prices among the economies that border the North Atlantic. That is beginning to make affordable energy advocates in Europe nervous. In a recent op-ed in the Financial Times, Paolo Scaroni, head of Eni, the Italian oil and gas giant, laments that, “cheap energy gives the United States a huge competitive advantage.” Not surprisingly, he would like to see European policies that are friendlier toward oil and gas production, including fracking, but that is not enough. “Other potential components of the solution for Europe,” he writes, “are nuclear power, energy efficiency, better use of conventional hydrocarbons – in short, anything that can make energy cheaper and more readily available.”

Politicians seem to be listening
Politicians on both sides of the Atlantic seem to be listening to the affordable energy lobby. In the United States, Democrats and Republicans are united in an effort to defend low energy prices. Although both parties briefly flirted with a cap-and-trade approach to raising energy prices in the run-up to the 2008 presidential election, any such ideas have been off the table for some time now.

The new political development is that Democrats have given up their long-held position that energy companies should at least pay the same taxes as other businesses. This week the FT obtained a draft list of tax loopholes that Democratic negotiators want to see closed during the current round of budget negotiations. Perennial targets like tax breaks for hedge funds, private equity, and real estate investment trusts are on the list, along with lesser tax dodges for owners of yachts and corporate jets, but loopholes that benefit oil and gas producers are not mentioned.

As API spokesperson Brian Straessle told the FT, “There is growing bipartisan support for domestic oil and natural gas development and growing bipartisan opposition to tax hikes targeted at the industry that could decrease American energy production and job creation.” Award this round to the API.

Meanwhile, Europe is wavering in its one-time leadership in the use of pollution charges as a tool of environmental policy. The centerpiece of that effort has long been the EU’s Emission Trading Scheme (ETS), a cap-and-trade market for carbon emissions. The trouble is, the price of ETS permits has crashed to €5 or less per ton of carbon, far below the €25 to €30 thought necessary to reach emission reduction goals. In fact, carbon permits have become so cheap that European power plants are closing down relatively clean capacity fueled by Russian gas and ramping up production at power plants fueled by coal imported from America. As a result, total EU carbon emissions have been rising even as the economy as a whole stagnates.

European environmentalists have been pushing for a sharp reduction in the number of ETS permits in the hope of getting carbon prices up again, but they are having limited success. Instead, in the face of opposition to outright reductions from Poland, Germany, and other heavy polluters, the European Commission has come up with a relatively weak “backloading” scheme that would postpone the issue of some permits until 2020, without actually cancelling them. The Commission estimates that backloading will raise prices to a range of €8 to €12 per ton, but that is less than half what environmentalists had been hoping for.

Meanwhile, energy policy is setting country against country within the EU, and one social group against another within countries. The situation in Germany is especially acute. Germany has prided itself on being a leader in wind and solar energy, but there is a dirty little secret behind its support for renewables.

As Scott Belinski explains at OilPrice.com, the extra cost of subsidizing renewables has so far been loaded entirely on the electric bills of consumers and small businesses. Larger firms, including all the big exporters, have been exempt from renewable surcharges. German consumers have been anything but happy about this arrangement, and Germany’s export competitors within the EU have not looked kindly on it. Under pressure from Brussels, the German government is getting ready to shift more of the cost of subsidies for renewable energy to large industries.

However, German businesses are pushing back. As Belinski notes, they are becoming increasingly concerned that they may lose their privileged position. He quotes a representative of VIK industry, a lobby for heavy energy users, as warning that a loss of the exemptions could saddle companies with billions of euros in additional costs and “destroy Germany’s industrial core”.

On both sides of the Atlantic, then, the affordable energy lobby is out in force, and the race to the bottom is on.

Where to go from here?
There are two ways to go from here. One way would be to let the race to the bottom play out, allowing both U.S. and European energy prices to fall toward the bare costs of production, with little or no allowance for environmental costs. Doing that would leave the United States as the low-cost producer in many sectors, especially those dependent on natural gas, for which transportation costs are higher than for coal or oil. Still, if Europe reduced its support for renewables and let the ETS languish, it could minimize Trans-Atlantic cost differentials.

But caving to the affordable energy lobby, in my view, would be a mistake. “Affordable energy,” as I explained in detail here, has always been a myth. Low end-user prices for energy are “affordable” only in the sense that they shift the cost to pollution victims. Far from reducing total costs, the shift is a negative-sum game: the winners gain less than the losses suffered by those who are harmed.

The alternative would be a race to the top, in which all the major trading countries would raise energy prices to an appropriate level. Doing so in a coordinated fashion would not greatly disturb existing competitive relationships. Some sectors of the U.S. economy, like those based on gas and renewables, would gain, although coal users and exporters would probably suffer.

A sign that such a race to the top could actually happen is China’s growing disillusionment with life at the bottom, where the air is unbreathable and the water undrinkable. China has introduced an experimental carbon-trading scheme of its own—one that, according to early indications, will impose a carbon price somewhat higher than the currently depressed level in the EU.

China’s price-based efforts to control pollution face daunting obstacles, to be sure. Not least among them is the fact that the biggest polluters are state-owned heavy industries that are not especially responsive to market signals. China’s latest round of reforms is supposed to bring state-owned enterprises into the market economy, but even the reformers admit that will take a decade or more. Meanwhile, reformers have pledged to backstop the market-based environmental experiments with stricter administrative measures.

Still, China could show the way. In a true race to the top, the United States, Europe, and Asia could all agree to work jointly toward energy prices that incorporate realistic charges for damages from both local and global pollution. What a welcome outcome that would be.

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