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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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The Largest Oil Lobby In America Is Now Backing A Carbon Tax

The American Petroleum Institute (API) now advocates a carbon tax? We had to read the API’s press release twice to make sure we were reading correctly. Whatever else this accomplished we believe at the very least they pulled off a public relations coup designed to delay carbon suppression behind a smokescreen of reasonableness. There is no shortage of informed opinion on this issue. Like any broad public policy it has advocates and detractors. Proponents hail its economic efficiency and that it pushes the government further away from the energy industry’s decision making. Detractors, which interestingly hail from both sides of the US political aisle, claim this policy only leads to incremental, non-systemic decisions and a piecemeal approach to a serious environmental issue. Rather than get embroiled in this debate, we would rather acknowledge it as an issue but instead look at two key bread and butter issues.  

First, energy demand is price inelastic. This is a fancy way of saying that demand for the product does not react much to change in price. In the case of energy, price elasticity is estimated at roughly -0.2 short term and -0.6 long term. In other words a 10% price increase in energy will only reduce demand for energy by 2% in the short term. In the long haul trucking business, for example drivers don’t simply walk off the job if gasoline or diesel prices shoot up dramatically. Although they might cut speeds a bit to reduce fuel consumption. Over the long term, however, a 10% price increase reduces demand by 6%. Staying with our present example, this suggests that longer term drivers and their industry may respond to higher prices by purchasing more fuel efficient vehicles once the present rig wears out. Thus it will take a big carbon tax to reduce consumer and industrial demand by a significant amount. And the likelihood that Congress will impose a big tax seems remote. 

Related: India: OPEC+ Decision Could Derail Oil Demand Recovery
Second, energy consumers may regard a prospective carbon tax simply as payment for a license to pollute especially if the tax starts out as a small one. As our example above shows this is not likely to meaningfully reduce energy demand or reduce the accompanying pollution. We can analogize to parking tickets that routinely appear on delivery van windshields in a busy urban area. The tickets may be a nuisance but in the end they are simply a cost of doing business. Warnings against penalties (such as taxation) as a form of behavioral regulation date back to Adam Smith. Basically, once people start to pay a regular penalty to do something deemed anti-social or immoral, they tend not to feel obligated to consider revising their behaviors.

The oil industry, like any industry facing some existential threat to consumer demand for its products, wants to avoid controls or timetables from the government that dictate to consumers specifically how much or what sort of energy they can use. (Our readers know that certain municipalities in California have already banned the installation of natural gas appliances in new construction.) At the same time, the oil companies, at least some of them, no longer want to be seen as climate change deniers. The industry’s goal here it seems is to portray itself  in a favorable light, sounding reasonable while delaying activities that significantly reduce energy demand.

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We expect in its defense the oil industry will claim, with much evidence, that governments make inefficient choices when directing technology like that of carbon attenuation. In addition, since the free market is a better resource allocator than an intrusive government, why not depend on the market? That will no doubt resonate with more conservative legislators. Institute a tax, but one that’s not too big because that would have negative economic consequences.

But there is a policy conflict here. We also expect the same energy companies whose business is being adversely affected by potential taxation and very uncertain demand trends, to happily invest to accelerate a carbon-free future. The optimal result for the oil industry at this juncture we believe would be  a minimal tax, a small reduction in demand, and plenty of time to keep drilling. Which brings up the cautionary comment by the late Saudi oil minister, Sheikh Yamani, that the stone age did not end because of a shortage of stones. To sum up, The API’s recent statement in favor of a modest carbon tax is a brilliant move. It at once shifts the discussion,  and makes the industry appear reasonable but we suspect  will ultimately fail to sway many policy makers. 

By Leonard Hyman and William Tilles for Oilprice.com

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