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Renewable energy advocates like to point out that the cost of renewable fuels, like solar power, have dropped substantially in the last few years. The cost of solar power for instance has fallen by more than two-thirds since 2009. Yet for all the excitement about renewable power, the reality is that the entire energy sector has essentially been in a state of deflation for the last decade. The notable drop in oil prices over the last two years aside, costs of producing oil both in the U.S. and in many parts of the world have fallen dramatically. The phase out of coal in the U.S. has been driven not by government regulation, but rather by the economic forces associated with cheaper U.S. natural gas production. The cold reality for renewables is simply this; conventional fossil fuel costs are coming down just as fast.
A new study by economists at MIT and the University of Chicago confirms this reality. The authors show that technology driven cost reductions in fossil fuels will lead society to continue using those fuels for decades or even centuries under present conditions. The only way to force society off of that path, according to the study, is through a carbon tax. Such a carbon tax, called a Pigouvian tax in economics, is meant to curb the negative effects from fossil fuel consumption. There are serious questions about whether such a tax is politically realistic or implementable as even the authors acknowledge in this study and others.
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The study says that fossil fuel consumption is likely to continue despite a continued fall in the cost of renewable energy sources. According to the authors, neither decreases in supply related to the old concern about “running out of resources”, nor improvements in renewables technology alone will be enough to materially impact the use of fossil fuels for the foreseeable future. In particular, natural gas power plants and conventional gasoline retain large advantages compared to current and probable future renewables costs in the form of both solar power for electricity and battery packs for electric cars.
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The study finds that oil needs to average at least $90 a barrel for instance before battery powered cars make significant economic sense. Further, the result of externalities – the costs of pollution and carbon emissions – push that breakeven price required for battery powered cars to take off up to $115 per barrel even after assuming that U.S. Department of Energy forecasts improving battery technology prove accurate. Realistically then, in order to get consumers to make wholesale switches from fossil fuels to renewables would require a carbon tax of at least $43 per metric ton of carbon released.
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Unfortunately for advocates of such a policy, implementing a carbon tax in the U.S. alone would not be sufficient. U.S. emissions are only a small fraction of global emissions. Brazil, Russia, India, and China – the BRIC nations combined - already produce more than 2.5 times as much carbon as the U.S. does. In addition, carbon emissions are not the only source of global warming gases with methane and Nitrous Oxide both playing significant roles as well.
The overall conclusion one might draw from all of this is that even if a carbon tax were realistic in the U.S., it’s not clear that a $43 per metric ton tax would ever work here. And even if such a tax were passed, it’s even less clear that it would be feasible to get such a tax implemented in other parts of the world. That suggests that other solutions will likely be needed to help humanity deal with carbon emissions and any resultant global warming.
By Michael McDonald of Oilprice.com
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Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…