Here’s what you need to know about the NDP program and gas prices.
The NDP cap-and-trade program would require “big emitters” including oil refineries and major producing sites including oil sands facilities to buy emission permits at auction, with a price floor at $45/ton. This will increase the costs of producing oil and refining gasoline. The maximum increase in gas prices would result if all of the increased marginal costs of production were passed through to consumers.
Production and refining emissions from gasoline production are about .875kg/l of gas for the average barrel of crude in North America, and closer to 1kg/l for oil sands. This means that marginal gasoline production costs would increase approximately 3.93c/l at $45/t.
While I agree with Dr. Mintz that an ideal system would place a carbon price on the entire 3.5-4 kg/l of ghg emissions embedded in gasoline, the NDP system does not do that. As such, there is no reason to expect that companies could pass through 10c/l of costs while incurring additional marginal costs of 4c/l .
Changed below for clarification – 9:00pm 4/29/2011
The proportion auctioned should not be expected to have any effect on the eventual gas price increase. With a 25% auction, the average cost increase on gasoline production (in the early years) would be closer to 1c/l. However, since the value of the permits at the margin (what a firm could sell a permit for if they opted not to produce the gasoline) would still be $45/t, the price effect would reflect that value in a competitive or monopolistic market. So, regardless of whether the NDP chose to auction 100%, 50%, 25%, or give all the permits away for free, you should expect similar gas price swings.
That’s what you need to know. If you don’t want to take my word for it, check in on Clare Demerse’s blog.
20 responses to “On the gas price impact of NDP cap-and-trade”
How could the oil production costs from cap and trade be passed on to the consumer when the price of oil is set on the commodities market?
Thanks for reading. Good question. This is why I put out a maximum cost-pass through. True that crude oil is priced to global benchmarks, but refining is much more localized, and even crude markets are not perfectly fluid globally. If you look at gas prices across the country, you clearly see differences…companies are able to pass costs through to consumers regionally. Also, Canada has a small and vertically integrated refining sector, so pass-through potential likely higher here than US.
See some great comments from Dave Sawyer below yours.
With evidence of a full cost pass through in gasoline markets (links below), the full value of the permits, whether obtained freely or not, will be passed on to the consumers. Opportunity cost matters, just like freely obtained hockey tickets that you scalp at the gate. To the extent permits are freely obtained, refiners will likely be over compensated as they pass on the opportunity cost of retiring a permit to produce fuel. This explains why the petroleum sector is excluded from EITE status under Waxman-Markey.
Translation = 4c/l likely is the full cost impact of the proposed policy.
Cost pass through: “Estimates showed that the price passthrough from the spot to the retail market is complete within two-and-one-half months”
Agreed, Dave. Should have been clearer that average cost impact to firm was 1c/l, cost pass through to consumers is 4c/l assuming (as one likely should) that all costs get passed on to gas prices.
Because demand for gas is inelastic which means consumers will pay more because they won’t change their habits… Canada and all of its urban centers were designed for automobiles. As a result, this is just another tax.
What makes you say that demand for gas is inelastic? In the short run, people can’t suddenly replace their cars with more fuel-efficient ones just because the price of gas is up. But over a five- or ten-year period, a lot of people do replace their cars, and with higher gas prices, they tend to buy smaller, more fuel-efficient ones. Mike Moffatt summarizes a couple of meta-studies: in the long run, a 10% increase in gas prices reduces consumption of gasoline by 5-6%.
Russil, thanks for commenting. While I will never defer to Mike on anything (we were grad school classmates), I agree with his numbers on this. Facts are though that we are talking about gas prices when the programs are imposed, and for perhaps a couple of years after. It’s an election campaign. Even in the long run, the gas production cost increase will still be there, although the dollars passed through may be smaller given the long-run inelasticity which you describe
Apples, oranges and fruit salad.
The Mintz and Olewiler paper (www.sustainableprosperity.ca/dl308) calculated a 10c/L tax to gasoline on the premise of imposing a carbon tax of $42 per tonne of CO2 on the emissions specific to the combustion of gasoline. There is no mention in the paper that the 10c/L is the cumulative impact of upstream CO2 emissions and, indeed, at an emissions intensity of 2.341kg/L (CO2-e per NIR emissions factor) a $42/t tax would result in a levy of 9.8c/L. (The Apple)
If the NDP proposal is to apply the $45/t floor to refineries and upstream, that’s a separate tax point-of-sale and would lead to your estimate 3.5-4c/L. (The Orange) Without the direct tax on the specific emissions for combustion of gasoline, the refiners don’t have the cost push to increase sale prices by 10c/L. (Which is to say, I agree with you last paragraph.)
The Mintz and Olewiler paper did not stop at the proposal to impose a CO2 tax. They proposed it as a replacement to other inefficient or ineffective taxes. Revenue-neutrality was a critical element of the proposal. In all likelihood, the way forward with CO2 taxes will require revenue-neutrality or at least a give-to-get reduction in other taxes. So while we can all postulate about tax impacts based on emissions intensities for each element of the supply chain, we are simply speculating on the ultimate economic impact to individuals without due consideration of the whole picture. (The Fruit Salad)
Let’s not loss focus. The environment isn’t getting any better if its business as usual.
Thanks for comenting. The post was all about getting information out there, not on optimal policy design. As you say, let’s not lose focus on the goal of these policies, which can be to both raise revenue and improve the environment. None of the parties is proposing business-as-usual (at least in their platforms!)
[…] and inadequate to meet his own emission targets. Layton’s proposals will in fact lead to moderate increases in gas prices, and if they don’t, they won’t be […]
Alberta already has an emissions charge – penalties go to research. Has ANY OTHER PROVINCE got any kind of control on their emissions. Not going to stand for another NEP to bankrupt this province.
BC has a broad-based carbon tax. It’s currently at $20/tonne, rising to $25/tonne in July 2011. It’s revenue-neutral: there’s offsetting cuts to income tax.
Yes, but again, not necessarily personally revenue neutral. High carbon users lose, low carbon users win. Also, did not cover process emissions…which will be covered under cap-and-trade.
While the math may work, we are starting from the wrong end of the equation. The NDP needs xx.x billions to meet spending plans, therefore we need to work back through the calculation to arrive at the correct assumption.
If the NDP forms the next government, the price increase in a liter of gasoline will be directly propoptional to the popularity of Jack Layton. And as he reminded us yesterday, if it exceeds that amount, he’ll simply regulate the price down to a more acceptable level.
It’s just that easy.
Agree that the regulatory approach was a bad soundbite. Unfortunately, all the politicians seem to be falling into gas price politics today.
Thanks to andrew for doing the math. I did the math and came up with the 1 – 4 cents as well (with the sensitivity on the auction %). Its a relief others agree. I was thinking to myself, this Dr. Mintz must be a respectable fellow, he’s got a quality CV, how’s he getting 10? What am I missing?
Well, in hindsight and given the extent to which he’s seems to have taken a hell-or-high water approach to the 10 prognostication, maybe there’s some political motivation related to it? After all, dropping bombs on the advancing enermy during an election gives you better odds of scoring a purple heart than it would in peacetime — a nice swan song appointment courtesy of those you helped, perhaps.
I don’t live in Canada by the way. I live in the US. You know, if this was an American election and some high profile economist made a statement like Dr. Mintz did that was subsequently repeated by a Presidential candidate, every network would have some talking head on within an hour disecting the number and offering their own number — in other words, you wouldn’t need to fact check it on some esoteric board in cyberspace.
Thanks for the note. Dr. Mintz made a very reasonable assumption that the downstream emissions would be included, and in his defense, we are all reading between the lines. I am assuming that the policy, which is said to exempt transportation, implies that only upstream emissions would be covered. As Dr. Mintz points out, a policy with only really big emitters is hard to reconcile with their revenue numbers. NDP revenue numbers are based on covering 350Mt with the cap-and-trade program, and to get this kind of volume, you would either have to cover all emitters over 25kt/yr, or you could also cover emitters over 50kt/yr plus transportation emissions of 160Mt. I really think it’s up to the NDP to clarify their policy. If they clarified that it corresponded to my assumptions, Dr. Mintz would agree with me. The reverse is true…if the NDP proposed to make the “big polluters” pay for the downstream emissions, Dr. Mintz’s number is the right one, or even perhaps a little lower than I would estimate.
We have (perhaps thankfully) fewer talking heads per capita in Canada, so not as many people talking about it, but I have heard my name mentioned a few times on the news today.
Thanks for reading.
[…] for purchasing permits for combustion emissions, and so you could should expect, as I outlined here, a price impact of about […]
Andrew — no need to publish this but thanks for the clarification on your inductive reasoning of the coverage. Why you are clarifying it and not he is another question. One plays with fire when they wade into a debate in a late stage election – its folly not to bring a fire extinguisher along.
There’s a lot of scare mongering going on in terms of the costs of carbon pricing — you tell a guy driving an F150 that his fill up is another 10 bucks and that’s a real vote swinger (grey policy or not). Misinformation on the costs killed C&T in the US (that, and the fact that most Americans are skeptical of the science). And when comments come from someone in Alberta — and from a school that has accepted lots of cash from the administration using your quote for political purposes — the reader has a knee-jerk reaction to assume you come from a different church than Paul Krugman.
[…] 10 cents per litre. (There was some debate on this point during the last election. Andrew Leach projected the increase at about four cents per litre. The Pembina Institute found […]