Will a Price on Carbon Make U.S. Industries Uncompetitive?

Posted on 20. Apr, 2009 by tsvanleeuwen in Climate Politics

oil-refinery

Anyone attending the Carbon TradeEx America conference in DC last week hopefully caught the forum on The Implications of Climate Change for Foreign Policy. Those who did were treated to a reality check from some climate policy veterans, including Stuart E. Eizenstat, former US Ambassador to the E.U. and chief U.S.negotiator on Kyoto (under Clinton), invaluable for their pragmatic predictions on how climate change legislation will emerge, scathed, from the political realities of our legislature.

Two comments stood out as particularly important to keep in mind:

1.) Part of the compromise needed to pass climate change legislation will be some form of trade sanctions that punish countries with lax environmental provisions.

2.) “Substantial” offset provisions will likely be included in any cap and trade bill — as cost control and a mechanism to engage developing countries.

Economists are likely to shudder at the trade distorting effects of the former and ETS skeptics at the dubious emissions reductions potential of the latter. However, the political realities of our legislature suggest that these will make it into U.S. climate policy. Central to the perceived necessity of both these provisions is the idea that a CO2 cap and trade system, by putting a price on carbon, will make U.S. industries uncompetitive. Especially in our current economic situation, this claim carries particular weight, and deserves further investigation before it is used as an excuse to postpone the implementation of a cap and trade system.

Will a Price on Carbon Make U.S. Industries Uncompetitive?

The short answer is: No. Most industries will not notice significant cost increases per unit of output because of a price on carbon. Exceptions include energy-intensive industries such as iron and steel production, petroleum refining and pulp and paper manufacturing.

Excellent quantitative support for this claim can be found in research performed by Resources for the Future (RFF), McKinsey and others (see here and here), which suggest that a price on carbon may have relatively minor effect on the competitiveness of many covered industries.

The key variable to consider here is the carbon intensity of affected industries, measured in emissions of CO2 per unit of output or dollar of revenue or profit. The higher this ratio, the more an affected firm will have to pay in a carbon constrained economy to produce its wares or maintain a sustainable revenue flow – and the more its competitiveness will suffer.

So, how much CO2 do industries emit to produce our goods? The answer is, for the majority of industries, not that much.

But first, a little background:

First, consider that most industries’ CO2 emissions originate from the electricity they consume (with notable exceptions like petroleum refining, iron and steel and cement industries). As such, industry carbon intensity closely follows industry energy intensity. Most of an industry’s exposure to cost increases from climate legislation will be through its energy use.

Under a cap and trade system, the price of electricity produced from fossil fuel (78% of the current supply) will increase as power producers are forced to buy permits to cover their emissions. Industries that use natural gas as fuel or feedstock (such as the bulk chemical industry) will also likely face higher prices, as some power producers will switch from coal to gas and drive the price of natural gas higher.

Now, how would a price on carbon affect various industries?

According to the RFF paper mentioned above, energy costs make up only 0.7% of the motor vehicle manufacturing industry’s total costs. A carbon price of $10/ton would increase the price of their cars by approximately 0.42% (including corresponding price increases from other intermediate inputs). Under this scenario, that $21,000 mustang you’ve been eying would now cost $21,088, unlikely to cause too much consumer heartburn, or too much of a problem for Ford.

Likewise for other non-energy intensive industries: the apparel industry would see unit prices increase by 0.30%, computer & electrical equipment industry costs would increase by 0.28%. When compared against the backdrop of fluctuating commodity prices and rapidly expanding money supply, price increases of such small magnitude will likely be unnoticeable.

However, energy-intensive industries, such as iron and steel making and petroleum refining would face a greater difficulties under a carbon constrained economy. The primary metal manufacturing industry’s unit costs would increase by 1.7% under a $10/ton co2 scenario, the petroleum refining industry would face a 2.5% cost increase. This level of increase is likely to hurt industry competitiveness, especially when there is significant exposure to international competition (27% of primary metal consumption in the US is from imports).

Furthermore, higher prices for domestically produced products could lead consumers to increase their demand for imported products, produced without emissions constraints. This would have the effect of shifting emissions from the US to other countries, like China, and negating some of the environmental benefits of a cap and trade policy.

There are ways of addressing the anti-competitive effects of a carbon price on certain industries, as discussed in another RFF brief and at AmericanProgress.org, such as giving free allowances to highly energy-intensive industries. However, the data suggest the majority of U.S. manufacturing industries do not have high CO2 emissions per unit of output, and would not face a material competitive disadvantage in the face of a price on carbon.

Before the competitiveness issue becomes too much of a scare tactic, policymakers and constituents should spend more time with the numbers and develop a more nuanced understanding of how U.S. industry will be affected by a price on carbon.

Image Credit: Flickr – A guy with A camera

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