How a Carbon Price Could Reduce Emissions

Australia has just enacted a carbon tax law that it will implement mid-2012. Is a carbon tax a better policy than a cap and trade policy? Better minds than mine disagree over the answer to that question and the primary reason for disagreement is that they are both susceptible to misuse when in place even though both have the ability to effect the right kind of change – which is to say, to reduce carbon emissions while mitigating the cost of doing so.

I’m going to sidestep that argument and I’m going to concentrate on the Power Sector to the exclusion of all others for this article. And now I will suggest that a “Carbon Price” has three goals to achieve in order to use to realize the ultimate objective of reducing the carbon emissions of the power sector of any given jurisdiction without jacking the price of energy and killing the economy:

1. Reduce Demand for Electricity

2. Re-dispatch (using different generators as first call)

3. Lowering the emission profile of new generation to be brought on-stream

And now I’m going to further suggest that the way to do any of this is to RECYCLE the revenue of a carbon price, not to remit them to a government treasury but to the goal of reducing emissions and mitigating the cost of doing so. How do you ensure that the revenue stream doesn’t end up in the government coffers? Put the revenue stream in the hands of a Trustee charged with the goal of reducing emissions and the cost of electricity where possible.

Will a Carbon Price achieve these three goals? What are the Problems?

Reducing Electricity Demand: The problem here is that the elasticity of price for electricity is actually even smaller than that of gasoline. And as everyone knows, as the price of gasoline goes up so does the grumbling; but not the reduction in use.

Re-dispatch: There is a base demand for electricity that is fulfilled by hydroelectric, nuclear and wind facilities because they have the lowest marginal cost to produce that electricity. They are also low carbon emitting sources. As demand runs above base, other generators are called on-stream such as Coal, Fuel Oil and/or Natural Gas, probably in that order. So how high does a carbon price need to be to turn off coal and run renewable energy generation? To make a broad statement, you could double the price of electricity to consumers and reduce emissions by about 5%.

From a consumers point of view, it is the clearing price of power that matters in a wholesale power market. Without a really high carbon price you can’t displace coal and a really high carbon price ain’t going to fly, politically. So, with, say, a $25 carbon price, if demand runs to a level that requires fossil fueled generators to run then that higher price of electricity is paid for every single MWhr of electricity produced at that time. The result is a windfall in gains for generators with a lower marginal cost of production and that windfall is paid for by consumers. (residential, commercial and industrial). Basically, the carbon price is passed on to consumers in a magnified form because even non-emitting generators get the higher clearing price.

New Generating Capacity: There is a better argument here. A Renewable Portfolio Standard, or a Feed-in Tariff or other proactive government policy allows a market operator to insert renewable generation at the bottom of the bid stack so that the (at this time) higher price of renewables is paid for renewable generation without influencing the clearing price of all other generators.

Now for the Good News

McKinsey & Company have a rather famous carbon abatement curve, as shown below. What it shows is that Energy Efficiency programs can reduce emissions at an incredibly inexpensive rate. Follow the curve, as the cost of abatement climbs steeply (from deeply negative cost) and then less so from left to right. You can find this curve here.

So what is the message here? If you take the carbon revenue stream and apply it to energy efficiency programs to ‘buy’ energy efficiencies the cost has been worked out by Robert Cowart of the Regulatory Assistance Program (RAP) to be about $0.03 per kWhr. Not bad, eh? Take revenue, buy efficiency and reduce demand. Reduce demand and reduce the amount of time that fossil fuel is used to generate electricity and thereby reduce carbon emissions. Better still, there are economies of scale in the purchase of energy efficiency programs.


Putting a price on carbon is a great idea, but it is incomplete. The bottom line is that utilizing energy efficiency programs, renewable portfolio standards, Feed-in-Tariffs and other policies greatly accelerate the reduction in GHG emissions. Putting the carbon revenue stream in the hands of a Trustee with a mandate to reduce GHG emissions ensures that the overarching ambition is achieved.

Need an example? The Regional Greenhouse Gas Initiative of the Northeast and Mid-Atlantic states of the U.S.A. Read’em and weep.

Article by Miles McDonald.


Richard Cowart, Regulatory Assistance Project

Per-Anders Enkvist et al, McKinsey & Company

Regional Greenhouse Gas Initiative,


Christian Hewicker et al, Power Perspectives 2030, European Climate Foundation

Putting a Price on Carbon, Yale university

Carbon Tax Passes Senate, Jeremy Thompson, ABC News

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