The case against restricting domestic fossil fuel supply

Shadow carbon pricing is a bad idea

The other day, David Roberts tweeted the provocative claim that the volume of American oil production has no impact on the global price of oil because global oil prices are set by the cartel-like activities of OPEC+.

David Roberts @drvolts

US domestic oil production has virtually no effect on the price of oil, which is determined in a global market dominated by a cabal of the biggest producers. US politics seems utterly immune to this very basic fact, but I like to repeat it periodically anyway, just to keep sane.

This idea is worth unpacking because I’ve heard it from a lot of influential Democrats, and I believe it is to some extent the conceptual glue holding together the economic policy wing and the green activist wing of the party.

The problem with this line of argument is that to the extent that it’s true, it makes the case for domestic production restraint even weaker because there are no environmental benefits at all to blocking American fossil fuel production if doing so doesn’t raise prices. If additional U.S. supply has no impact on the global oil price, then “keep it in the ground” is just a direct financial transfer from the United States to Saudi Arabia and Russia that serves no climate purpose at all.

My suspicion is that environmentalists actually do think American production impacts the global oil price and therefore there is an environmental purpose to constrained production. But I want to argue that to the extent this is true, it is an extremely costly way of reducing emissions in terms of human welfare and we should reject it.

The price impact of U.S. domestic oil production is hard to predict because OPEC behavior is hard to predict. Increased American output could bring prices down a lot or not, and there’s no real way of knowing for sure. What’s true, though, is that to the extent the price impacts are small, so are the environmental impacts. Whereas to the extent the environmental impacts are meaningful, the economic costs are large and regressively distributed. Either way, it’s a bad deal.

The out-of-reach baseline: tax the externality

Once upon a time, the consensus political goal of the climate advocacy community was to place a price (either via carbon tax or cap-and-trade) on greenhouse gas emissions and then work through the global trade and diplomatic process to make that price global. This effort has completely collapsed for a variety of political and logistical reasons, but it’s worth walking through the logic of carbon pricing because it’s a useful lens through which to examine supply constriction.

At the time I’m writing this, the price of a barrel of crude oil is $124, which represents the intersection point of a global supply and demand curve.

One barrel of oil is associated with 0.43 metric tonnes of CO2 emissions, so if you had a $20/ton carbon price, that would add $8.60 to the price of a barrel of oil.

As you will see in any introduction to microeconomics textbook, the impact of this kind of tax (the example they had in mind here was a cigarette tax) is to shift the supply and demand curves to a new point where the quantity consumed is lower.

If the thing you are consuming less of has harmful consequences, that reduction in quantities consumed can be good. Still, there is a problem represented on the chart by that little triangle of deadweight loss. Deadweight loss from a carbon tax is one guy sitting in New Hampshire being uncomfortably cold in his own house because he’s trying to save money on the heating bill, while another guy sits out of work in Texas because he was laid off after New Englanders turned down their thermostats.

The other problem is that taxing energy is somewhat regressive in its distributional impact.

That said, the tax also generates revenue. And while the carbon tax generates deadweight loss, so do all kinds of other taxes the government levies. And while the carbon tax is somewhat regressive, so are lots of other taxes. You can use the carbon tax revenue to blunt the negative impact.

This is why even though carbon pricing is deader than a doornail right now, I think it may make a comeback someday. There will probably be a moment of truth regarding the U.S. budget deficit at some point, and all of the options for closing the deficit involve inflicting pain. A carbon tax is painful, but it also accomplishes something useful, whereas cutting Social Security is pure pain. But whatever you make of that idea, it’s certainly not on the table right now and hasn’t been for some time.

For our purposes, the important thing about the chart is you can read it in the other direction if you want: with the tax, you raise the price which reduces the quantity, but you could also directly reduce the quantity, which would have the effect of raising the price.

Shadow carbon taxes are much worse than real ones

When we worked together at Vox, Roberts and I used to argue all the time about what he called “supply-side climate policies” where you try to use regulatory tools to directly block fossil fuel extraction.

Here’s how he characterized the disagreement in one 2015 piece:

There's long been a tension between climate activists and climate wonks.

Activists have found that their greatest successes — in terms of the people they can organize, funds they can attract, and media attention they can generate — come from supply-side battles, attempts to block or shut down fossil fuel extraction and transportation projects. These battles have key features that lend them to organizing: clear villains, diverse constituencies (because of the local land, water, and air damage such projects do), and unambiguous metrics of victory.

Climate wonks, however, tend to believe that supply-side battles are pointless, and that demand-side policy — reducing demand for fossil fuels through subsidies for alternative energy, carbon pricing systems, pollution regulations, energy efficiency standards, and the like — is the only kind that makes a difference in the long term. As long as demand for fossil fuels remains, they reason, shutting down supply projects is an endless game of whack-a-mole. Knock one down, another pops up.

Fossil fuel reserves vastly exceed what's necessary to push the climate into chaos, so there will never be a shortage of moles to whack. There's simply too much potential supply to block it all. In short, say wonks, supply-side victories can push emissions around (geographically and temporally), but they can't reduce emissions, not as long as demand remains steady.

That's the conventional wisdom. And that's why wonks and pundits often react to supply-side campaigns like the one against Keystone XL with condescension or scorn.

I think what’s important about Roberts’ 2015 article is that it shows how the activists try to have it both ways in terms of the point of these supply-side policies. When energy is cheap and people aren’t paying much attention, they say the wonks are wrong about diversion and that supply-side policies can be effective at reducing emissions. But then when prices are high and people are annoyed, they flip and say supply-side measures aren’t influencing prices.

But if they’re not influencing prices, then they’re not influencing quantities consumed, and if they’re not influencing quantities consumed, they’re not reducing emissions!

The other thing Roberts’ piece captures is that the real point of these supply-side campaigns was to create an engine for activism. Nobody likes being told, “just stay chill, vote for Democrats, and hope for the best.” If you run a climate group, you need to do stuff and then report back to your board and donors saying you are accomplishing things. By picking regulatory fights on issues that can be addressed through executive action, activists created difficult enough battles to attract attention to themselves, but ones that were also winnable.

The problem is that to the extent that these policies do anything at all to reduce emissions, the mechanism has to involve raising prices. Those price increases have all the downside of an explicit carbon tax (which is why when prices get high, environmentalists deny that there are any price effects) except that unlike a carbon tax, shadow-pricing doesn’t generate any revenue. What you do get is a financial windfall for foreign oil producers. All the deadweight loss and regressivity of a carbon tax is there, except instead of Uncle Sam getting the money, it goes to MBS and Putin.

The path of the subsidy

The great unheralded irony of the failure of the Obama-era effort at carbon pricing is that emissions ended up falling anyway by basically the amount Obama set as his target.

That was mostly for two reasons. One is that Obama’s efforts to promote wind and solar power were successful and led to falling marginal costs for solar in particular. The other is that there was a large increase in American natural gas production, and cheap natural gas is a great complement to renewable electricity. Natural gas plants that cycle on only when the sun isn’t shining obviously aren’t going to get you to a zero-emissions electricity grid. But they are great for getting you to a lower emission grid without the need for massive overbuilding.

And this success paved the way for what is currently the main element of the progressive climate strategy: subsidize more zero-carbon energy, hope that learning-by-doing will drive down costs, and then outcompete fossil fuels. This is a pretty good strategy, both because it is more politically palatable (it makes energy cheaper rather than more expensive) and because it does not require incredibly complicated international cooperation. If the U.S. government can make it the case that the best kinds of cars are electric and the cheapest form of energy is zero-carbon, then as Kenya gets richer, the people who live there will drive electric cars powered by zero-carbon electricity. By contrast, if you try to reduce emissions with taxes and fees, it’s going to be very hard to convince Kenya to go along with your strategy.

But I think once you embrace this strategy, it’s worth committing to it and genuinely giving up on the aspiration to sabotage the fossil fuel industry.

Consider that Ford is currently not accepting any more reservations to buy an electric truck — they’ve sold as many as they can build.

Similarly, Lucid Motors had to cut their 2022 production target by 40 percent not because of any lack of demand for electric cars but because of supply chain problems. Elon Musk is talking about how he might invest in lithium mines in order to make more batteries.

Elon Musk @elonmusk

@stats_feed Price of lithium has gone to insane levels! Tesla might actually have to get into the mining & refining directly at scale, unless costs improve. There is no shortage of the element itself, as lithium is almost everywhere on Earth, but pace of extraction/refinement is slow.

You can see long reports on these battery issues from McKinsey or from Roberts himself.

The upshot of this is that the high-level policy concept of shifting people to EVs is basically working; people are buying electric cars about as fast as they can be made. The relevant policy challenge is in addressing these supply bottlenecks — opening up more mines, more refineries, and more battery-making factories. But that also means recognizing that there’s no harm in letting people have the cheap gasoline they crave while we wait for the rollout. Is there harm in delay? Yes, absolutely; every extra bit of CO2 in the atmosphere is a problem. But a lack of price incentive to switch is not currently relevant to implementing the long-term vision. We just need to work on the vision.

Trust the process

The difficulty with the route to decarbonization based on innovation and deployment is that it’s an endless series of annoying technical problems.

Wind and solar are cheap now, but getting wind projects permitted and building interregional transmission lines to balance the grid is hard. Several different nuclear technologies seem promising but they are untested. Electric cars work well now, but we’re going to need to scale that up to larger kinds of trucks and other vehicles. Decarbonization of industry and aviation poses daunting technical challenges. Maybe we could make a lot of hydrogen, but then we’re going to need a ton of energy to make the hydrogen.

It’s hard. But we’ve made a lot of progress, and a lot of people are working on it, and a lot of the barriers at this point are actually not super-partisan or ideological.

The appeal of pricing has always been that since it’s so generic, it doesn’t require delving as deep into the details. You can just set the price and figure out the rest.

But exactly as the leftist critics of pricing have said all along, realistically there is only so much pain a government is going to inflict on people in pursuit of some neoliberal adjustment utopia. Unless you can change industrial policy to make certain things easier, the price is never going to get high enough or be comprehensive enough. What I think the left hasn’t gotten is that this exact same critique applies to supply-side policy. Most of what you manage to actually get done won’t make a significant difference. But to the extent that you do manage to use supply constriction to significantly reduce emissions, it’s going to be by inflicting tons of pain on people who will get mad and put climate denialists in office.

Judged as tax policy, pricing makes some sense because revenue is useful and there’s no politically painless way to raise revenue — so doing it in a way that has environmental benefits has a certain appeal. Someday, when we reach a fiscal fork in the road where all the options are ugly, maybe that will happen. But trying to secure the same price impact by stymying production is all the pain for a fraction of the gain.