What does it mean to include petrol prices in emissions trading?

Peter Martin discusses the lack of bipartisan support on whether petrol should be included in any emissions trading scheme. I have been trying to follow this debate for sometime and find myself completely confused. Indeed, my current guess is no one is being really coherent on this issue.

So let me give it a shot. 14 percent of emissions come from transport so to leave it out from any climate change strategy appears stupid. That said, the world economy is doing our work for us by doubling the petrol price anyhow. Ironically, the market has generated the best political solution thusfar. The problem is that is an illusion as it only reflects a change in the world-wide distribution of demand for petrol and hence, is not a climate change policy at all — except for the fact that an upward sloping supply curve for petrol, should it exist, means that we will have less consumption than we would otherwise have had if prices were lower. That said, this event is softening the public up for a change in relative prices.

But an emissions trading scheme need not include petrol at all. Leave aside refining, I have news for you, petrol doesn’t generate emissions, cars + driving + petrol does. If you have an emission permit, in principle, the price of petrol could be exactly the same, but the cost to the consumer of using that petrol is now the emissions trading price + the cost of petrol.

The problem is that sure, this is the way emissions permits should work but in practice how do we monitor whether someone who is observed to be emitting while driving indeed has the necessary permits? We pretty much can’t. So the idea is to say to petrol suppliers, if you want to supply petrol, you had better purchase a permit. And so what do we get, higher petrol prices at the pump.

But there is an alternative that, in my mind is potentially much better than this solution, road pricing. The other key input into driving is a road to drive upon. What we do is this. We eTag up the driving population and install monitors on all roads. Then we charge people for road travel. Now we could just set the road price or use congestion pricing and that would be a good outcome as we could internalise another externality — that caused by other drivers. But if you really wanted to you could have the road supplier purchase emissions permits based on the average emissions of drivers and allow them to set prices based not only on the emissions trading price but also on the particular emissions-rating of the car that is being driven.

There is, however, one caveat in the choice between permits for roads and permits for petrol. The road option doesn’t allow us to adjust prices to reward driving behaviour (predominantly, not speeding) that can also reduce emissions. A petrol price signal would do that. Regardless, this only highlights the challenges in adhering to an economy-wide emissions trading scheme initially. I must admit I would prefer a targetted sector-by-sector approach (which would include transport and energy first up) rather than a purist option than tries to get at it all.

[Update: Tim Dunlop links to this post and from the comments it seems I was less clear than I was hoping to be. My point is a simple one: the only thing we know from the government at the moment is that it wants emissions trading. That is a property rights scheme which means that people buy permits and get rights. The problem is that petrol doesn’t sit as neatly into that whole regime as people seem to think. If the government wants to leave petrol out and then increase taxes by 25 cents per litre to take care of carbon, that is one option. But if you want it part emissions trading, you have to decide where to do it. Legally, you can’t require petrol suppliers to hold emissions permits any more than you can require DVD makers to hold permits because you are going to use electricity. So there is a real system design issue here. My point is that we can have permits for use of petrol while driving (but I don’t know how it will be monitored) or we can permits for road use (which has a monitoring option but other issues). My preference is to either move to road pricing for all of the other reasons that would be a good idea or abandon emissions trading for transport and slap a tax on petrol. Hope that clears some matters up.]

18 thoughts on “What does it mean to include petrol prices in emissions trading?”

  1. The current petrol price rises mean only that drivers are paying for the shortage of fuel. They’re still not paying for the damage they cause us with their emissions. That’s where the carbon tax comes in.

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  2. This is a pretty weird idea Joshua.

    Sure, petrol doesn’t create emissions til you burn it in your car, but any petrol that’s being sold is going to be burned in the next little while and we know how much GHG will be emitted when it does so it’s not a big step to get the refiners / importers to buy permits for those emissions.

    With your proposal, you need to estimate average emissions per bit of road, presumably adjusting for how busy the road is and what kind of vehicles use it and when. Then divy it all up to road suppliers and make them buy permits based on estimated traffic. Hugely expensive, hugely complicated and resulting in prices that are only vaguely related to emissions. How is this potentially much better?

    I’m all for road pricing and/or congestion pricing but let’s do it to internalise the externalities of congestion and free roads, not to (very) indirectly attempt to internalise climate change externalities – it’s not the right tool for that.

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  3. An across-the-board emission pricing regime is probably the only one that would work, given the increasing crossover between automotive and mains power. Otherwise electric cars would be at a disadvantage, because their source of power (mostly coal) is subject to emissions pricing. Also how do you price diesel? It’s used for both power generation and transport.

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  4. I think petrol needs to be included at some point in the process, wherever it’s easiest to calculate. Apply the same per-uni-carbon charge as other emission sources, which can be adjusted across the board as needed.

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  5. I agree this is a really strange thing to get so confused about, as petrol is purchased to be consumed in the (relatively) near future therefore you may as well tax it at purchase. Also I think you are confusing the factors which have a big impact on the fuel consumption per distance travelled with the emissions generated by 1L of petrol being burnt. The only behaviour we need to influence (from a GHG point of view) is the amount of petrol burnt.

    So the simple answer is that petrol retailers should have to purchase emissions permits for the amount of petrol they sell, as the alternative arrangement of requiring drivers to purchase emissions permits before they drive would have infeasibly high compliance costs (and on a related note I presume you would have gas retailers purchase the permits for the natural gas they supply to households rather than requiring individuals to go out and purchase them themselves?)

    Finally, presumably when you said “an upwards slping supply curve means that we will have less consumption than we would otherwise have had if prices were lower” you actually meant a downwards sloping supply curve?

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  6. “We eTag up the driving population and install monitors on all roads.”

    The latter point would cost a lot.

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  7. So let’s see, if I sell petrol to someone I will need an emissions permit. What sort of property right is that?

    Look, I am not saying not to include petrol. Indeed, my Garnaut submissions says slap a tax on it and be done with it and then apply emissions trading selectively.

    But what is the government going to do if it just wants emissions trading? It will have to make a call — petrol or roads. How else will it be done?

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  8. Joshua, if you look sector by sector, transport is probably going to be amongst the costliest areas to decarbonize with present technology. Land use and industrial processes are probably the cheapest, broadly, stationary energy the next (particularly when you take into consideration the cheap conservation options), and transport the most expensive.

    So why do you want to do transport first?

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  9. Fair enough with regards to your submission: I’ll give it a plug on LP.

    Incidentally, there’s one (minor and largely inconsequential) error in it. Tree planting’s effect on climate doesn’t only relate to its effects on carbon; there is the also the effect on the Earth’s surface albedo. These effects apparently vary substantially from place to place.

    Back on to the main point: I’m still not clear how petrol represents as big a problem with the theoretical purity of the scheme as you claim. The fact is that, once it’s been refined, pretty much the only useful thing you can do with it is burn it. This results in a pretty easily calculable amount of CO2 released into the atmosphere.

    Furthermore, petrol is rarely stored for long periods without being burned. So there’s not very much temporal distortion either.

    While, theoretically, I can see that it’s a distortion in that we don’t trade the permits and the petrol separately, I can’t for the life of me see that this has any practical adverse impact. The payback is a vastly simpler scheme to administer.

    From the legal perspective, I’m no lawyer, but as far as I know the government is within its rights to require whatever permits it wants to sell petrol.

    I’m not arguing against road and congestion pricing, by the way; I think it would be an excellent replacement for registration fees, and would price in the adverse impacts of congestion on our cities. But if you’re going to design such a system, you’d better be damn careful to come up with something that isn’t a privacy nightmare.

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  10. Robert, it is the legal bit I am worried about. To deal with it legally you will have to legislate something special about petrol because as a property right it has nothing legally do to with emissions. So you need to be careful and that is my point here. If you aren’t careful some petrol company lawyer will have it in the courts for years. What is more, who know how many other issues of this kind are out there.

    Look I want us to manage climate change but we can’t ignore that we have to regulate to do it and that means rent seeking around those regulations. I just want us to get it right as quickly as possible.

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  11. The legal issue isn’t a problem. I agree that the permit is a property right and can be traded as such. However, under a cap and trade scheme the permit will cease to exist (or be acquitted) when it is aligned with a tonne of carbon emissions. This will probably be done through a returns system similar to our current tax return structure. The legal regime can simply deem the sale of fuel in the supply chain to be an emission of CO2 equal to the amount of emissions that will result from its combustion. The supplier will acquit the required number of permits to cover the emiossions that will result from the combustion of the fuel. The cost of these permits can be passed through to the retailer. In this way, a permit can be freely traded on the market and be purchased by either a fuel wholesaler or an energy user. Either of them could use it to offset their emissions (actual in the case of a coal power station and deemed in the case of the fuel retailer).

    This was dealt with in the original discussion papers on emissions trading released by the Greenhouse office (98-2000) which are worth a look if you can find them (I tried to find them to link to but couldn’t).

    One problem for the fuel sector is that if the permits are authoined, they will have less of an idea than actual emitters about the optimal cost of permits fr them. Emitters will know their marginal cost of abatement and bid uip to this point. Fuel retailers will just have to accept the market price and pass it through.

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  12. This debate illustrates the problem with Emissions Permits Trading and Carbon Trading. Everyone concentrates on the collection of money and no one talks about the spending of money. The emissions problem will only be solved through investment in renewable infrastructure in all its many forms. We need to concentrate on how to strengthen the existing market place of renewable infrastructure goods and services. One way to do it is to take the money collected no matter how it is collected and give it to many new buyers in the existing market place for renewable infrastructure. If there are buyers with money then the sellers will come.

    Here is a letter I recently wrote that points out how it can be done for petrol, almost overnight, in an equitable manner and probably with no legislative changes.

    “The Rudd government faces a dilemma. It is under pressure to reduce the price of fuel while under pressure to increase expenditure on renewable energy infrastructure. There is a solution. Instead of removing taxes on fuel give the tax money back to the motorist but require that the motorist spends the money on renewable energy resources. If the petrol companies can create a system to give us four cents a litre discount they can also create a system to give the taxes back to the motorist instead of the government. An electronic market place where people can spend their returned taxes is easy to create and those that do not want to spend their returned taxes on renewables can sell the tagged money to someone who wants to. The money could be spent on solar panels, windfarms, geothermal wells, solar thermal plants, plants to build hybrid cars, insulation, light rail, or any
    other infrastructure to reduce greenhouse gases. The effect of the system would be a reduction in the net price of petrol and instead of giving taxes to multinationals taxpayers would end up owning renewable assets.”

    The arguments against the proposal of tagged money is that it is “impractical”, that people will subvert the system, and that it is too hard to work out what the money can be spent on. These objections are countered by Woolies are already doing it with respect to groceries and petrol, the sellers of infrastructure volunteer to sell and if it is proved their infrastructure does not meet their greenhouse reducing claims they cannot accept tagged money and similarly if buyers cheat then they too do not get any taxes returned to them, and finally noone has to decide on what can be included only if the infrastructure spending will reduce greenhouse gases and the other sellers in the market place will soon point out the cheats.

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  13. On another topic brought up by Robert Merkel with respect to privacy while tracking car use. There are several technical solutions. Essentially the information about travel is kept in the car and only the aggregate is returned occasionally for charging purposes. There is also a technical solution for a car keeping track of where it is in an urban environment. http://www.locatacorp.com/

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  14. I would say it’s not unreasonable to legislate the requirement that to put petrol in your car, you must also purchase the emission rights to burn it.
    And given that realistically 99.99..% of all petrol sold by a petrol station is ultimately, burnt, then it’s not unreasonable to legislate the requrement that if you wish to sell petrol, you must also bundle it along with the emission rights to be burn it.
    Personally, I prefer a carbon tax, but if we’re going the direction of emission rights, then it doesn’t seem that difficult a problem really.

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  15. Perhaps what you’re really saying, Josh, is that emission trading is more complicated than carbon taxing.Complexity is a big negative when trying to sell something (relatively) new.

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