I’ve been thinking more about environmental economics since I blogged about retail carbon credits. I was surprised about how cheap (some would say unrealisticly cheap) wholesale credits are — about $2.20 per tonne of CO2. (Update: This price keeps changing. The U.S. price is clearly out of whack down to just 25 cents per tonne in 2009. The European price has declined too, from $20/tonne when I wrote this to $14/tonne in fall 2009.)
Today, many of my friends have bought a car like the Toyota Prius, feeling they are doing their bit to help the environment by burning less gas. The Prius costs around $3,000-$6,000 more than a comparable old-style engine car (in part because high demand keeps the price high), and the savings on gasoline don’t justify it on a financial basis unless you do nothing but drive all day. So the main reason to buy it is to help the environment and to make a statement before your peer group. The Camry Hybrid, which gets 32mpg instead of 23mpg costs about $5,000 more than the regular Camry.)
Problem is, there’s an argument that you’re hurting the environment, counterintuitive as that sounds. And no, it’s not just the unanswered questions about recycling the fancy batteries in the Prius when they fade, where fairly positive results have been returned so far. Read on…
The Prius gets about 44 “real” mpg, not nearly as much better than the similar Corolla or Camry models as EPA figures suggest. Consumer’s Union suggests a typical driver will save 176 gallons/year over a Corolla and 284 over a Camry. As the Prius-style non-hybrid is in between, call it 200 gallons or $450/year — $2800 present value over the predicted 8 year life of the battery. Not enough to cover the added cost of a Hybrid today (in part because high demand for Hybrids makes them more expensive) but it is nice to get. (Update: This number keeps changing with the price of gas. When it hit $4 the Prius was a win on saved gas, at $3 it’s a win but lesser.)
But what if you didn’t buy it and put the saved money into carbon credits? Well, you could offset 681 tonnes of CO2 with $1500 at the cheap 2005 U.S. price. That’s 77,000 gallons of gasoline!.
Yup. Buy buying the more expensive Prius rather than buying a cheaper similar car and putting the savings into carbon credits, it’s like burning 77,000 gallons of gas. That’s like driving an 10mpg Hummer 770,000 miles — around the world 30 times. Or like taking 10 Camrys that drive 20,000 miles/year off the road for the 8 year life of the Prius. At the European cost, which is more (I’ve seen quotes ranging from $11 to $25) it’s not so bad, $1500 buys only 136 tonnes, or 15,000 gallons of gasoline — only 6 trips around the world in the Hummer. At $25 it’s a more modest 6800 gallons offset by $1500 and only 2.7 circumnavigations.)
Ok, so this is just greenhouse gas and not the other pollutants, so we’ll need to do a bit more work on the numbers.
You might not believe in carbon credits. But you can also do something more direct, namely put the money into subsidizing other clean sources like wind and solar, especially thermo-solar rather than PV. However, they still pale in comparison to the pollution credits.
The interesting thing is that I expect that even if everybody did accept the validity of these numbers (and even I agree there are many factors to consider in getting the right number) I doubt people would line up to buy cheaper cars and put the savings into pollution credits, while they are lining up to pay more for a hybrid. The hybrid gives you a good feeling and something to show off. People have always wanted to show off their tastes with their car choice. The hybrid reminds you each day that you did something, in a very physical way, the credits are too abstract for most. Our brains seem to be wired that way.
Speaking of solar, people often desire to put up solar panels on their roof for clean electricity. Some fool themselves, by ignoring everything they learned about mortgage math, into thinking that solar panels can pay for themselves. They can’t yet, though perhaps someday they will. You can generally take the money you would have spent in the solar equipment, and put it in other investments and get back more than the panels save in electricity bills. Plus, while the panels sit there losing money, they also depreciate as they age. Nobody would normally buy an investment that returns 4% and where the principal depreciates to nothing over time.
However, it gets worse if you imagine what you could do putting the spare money into pollution credits. A 5kw solar system will cost about $20,000 even with the huge rebates offered in some areas. Buy $20K worth of carbon credits, and you could offset the greenhouse gas emissions not just of your own home but many more. $20K means 9000 tonnes, which translates into roughly 9 gigawatt-hours generated from coal, oil, gas and hydro mix. Your house probably uses 8 megawatt-hours in a year. That means you could offset the electricity usage of 80 similar houses over the 30 year life of the panels. (Assuming 6% interest and the price of credits remaining the same.)
How can this be?
How can making these well meaning choices be so bad for the environment, compared to the choice of buying carbon credits, which is to say bribing existing polluters to cut back their output?
The answer, right now, is that it’s far easier and cheaper to reduce pollution by cutting output at the big polluting factories and power plants. A dollar spent there does an order of magnitude more to cut pollution than a dollar spent on personal PV panels or a personal hybrid car.
We feel better about doing it personally, but we’re doing the wrong thing for the planet. At least for now. Over time, if the system catches on, the carbon credits will get more expensive. As the existing big polluters get more and more efficient due to laws and credits, it will be harder to squeeze more efficiency out of them, and it might begin to make sense to put our dollars into improving the efficiency of our own lives.
A working credit system (and I’m not ready to make the final claim that we have one) creates a market that focuses the money on the places where you can get the most bang for your buck in pollution reduction. A working credit system means you don’t work on your own house because you can spend the money getting somebody else’s far less efficient house in order first. Sometimes people justify their own solar panels or Prius by saying that they want to do something, and they can’t do anything about the big power plant. But with a credit system that’s exactly what they can, and should do — until the markets change and it makes sense to spend money on your own car.
Now, there are some counter arguments to the above thesis, though not at today’s margins. For one, while the custom parts of hybrid cars cost lots today, if the demand for them remains strong, the manufacturers will figure how to make them for less. Once the fuel efficient car costs the same as the guzzler (or even the same after gas savings are factored in) it is an obvious win.
Likewise, increasing demand, even if artificial, for PV solar and wind, can also drive the cost of these low enough that they make sense. Some argue that thermo-solar is already economical and some trial projects are underway in California. Perhaps, an argument goes, we should push these currently inefficient ways to reduce pollution in order to make them become economical in the future. Or, it could be argued, this should be the role of the government.
This debate will continue, and over time we’ll see various technologies get cheaper, and will probably see the cost of fossil fuels go up, all of which changes the equation. We may also see better economies in pollution reduction for big plants, which tips things in that direction. A proper pollution credit market automatically moves the money to the place where it can do the most good.
NOTE: Some figures in this posting have been modified since the original form, making the first comment seem out of context. That’s not the fault of the commenter.
In addition, let me sum up what I think are the best counter arguments, some of which come from commenters below.
- U.S. $2.20/tonne carbon credits are artificially low in price, because the U.S. has not signed Kyoto and there is not legal power behind enforcing them. Some suspect the sellers of U.S. carbon credits may be cheating and not getting caught by the CCX enforcement systems. Though presuming that’s not true one should perhaps buy them while they are cheap, though this might not be sustained. European market prices are higher. Wind power based Green Tags are about $30/tonne.
- Even if they accept the logic that carbon credits are a better way to help the environment than expensive hybrids or solar panels, people get only an abstract good feeling from the credits. A hybrid car reminds you every day of what you’re doing to cut gasoline usage. Because this makes people feel good, it’s better “marketing.” A poorer choice that people actually are willing to do can be arguably better than a mathematically better choice they would never do. People also feel better making a personal difference compared to paying somebody else to make a larger, impersonal difference.
- For similar psychological reasons, some people can’t mentally accept pollution credit trading, even if they rationally accept it is reducing emissions. As such they would never accept this approach. (Some go even further and argue that credit trading is not a good way to reduce pollution.)
- Some feel hybrids are already cost effective just on savings at the gas pump, or if not, they soon will be, so there is no choice because there is no “extra money.” Many Prius owners also love the non-gas-saving attributes of the car, though of course those could and probably will appear in other cars if they are popular.