Thanks all for your thoughts on this. Going to try to take one a week. Today's nerd-rant: Carbon pricing. Why we've lost our way, and how to get it back. And because someone told me to say this, #energytwitter. Thread: https://twitter.com/SeanCasten/status/1293905402686574592

1/ Start with basics that we too often lose sight of. Why do we think it's a good policy idea to price carbon emissions?

2/ (Semantic point: I'm going to use carbon, CO2 and GHG interchangeably here. I get that they're not exactly the same. Hopefully you get why for these purposes, the difference doesn't matter.)

3/ There are only two reasons: One, to lower GHG emissions. Two, because we know from experience (see sulfur trading program, Montreal protocol) that markets are powerful tools to monetize externalities and optimize private sector capital allocation.

4/ If you disagree with either of those points, don't read on. [Eddie Vedder voice: "This is not for you."]

5/ Taking the first point: the goal of C-pricing is to reduce GHG emissions. Not to get bipartisan consensus. Not to reduce deficits. Not to help disadvantaged communities. Those are all good things! But if we do those and don't reduce GHG emissions, the policy is bad.

6/ On the second point: we want to use market forces. This is SO important, and so many C-pricing models have completely forgotten that purpose. Command-and-control regulation is easy. Markets are more complicated.

7/ But we can say one thing generally: For markets to work, the price a buyer pays should be ~ the revenue a seller gets.

8/ (Maybe there's a little stickiness for sales taxes or other costs to maintain functioning markets, but you get my point.)

9/ So the way we efficiently allocate private assets for shoe manufacturing is by ensuring that the $120 I paid for my last pair of running shoes = $120 in revenue to the shoe store.

10/ No one this side of Karl Marx argues that we should instead pay the government $120 and then leave them to allocate that revenue among putative shoe manufacturers and distributors. And yet that is EXACTLY what a carbon tax does.

11/ So a carbon tax ain't a market tool. Stop calling it that. The only thing you know for certain about any economist who claims that a carbon tax will lead to efficient capital allocation is that they don't have any real world experience in a market economy.

12/ But there's a second point about markets that is equally or more important: almost any asset we build to lower GHG emissions has a lower marginal operating cost BEFORE factoring in C-pricing than the dirtier asset it replaces.

13/ It's cheaper to drive an EV than it is to drive a gasoline ICE. It's cheaper to operate a solar panel than a coal plant. Making your house more energy efficient saves you money every hour. The existence of a C-price doesn't change that calculus.

14/ As a result, for C-pricing to change markets, they must drive new capital investment. Once that capital is built, it will operate. But you have to meaningfully change the long-term economics for the investor.

15/ That matters because even setting aside the anti-capitalist flaws in a carbon tax, a tax on your competitor doesn't impact your investment decision. The fines Wells Fargo paid last year did not affect the interest rates you earn at Citibank.

16/ In the same way, putting a tax on CO2 emissions at a coal plant doesn't have any impact on the investment thesis faced by a putative wind farm investor. They don't know whether the coal owners will absorb the cost or pass it on, or how their long-term revenue will change.

17/ (As an aside, ask C-tax advocates whether a coal plant that gets hit with a C tax will pass the costs along to customers - in which case their investors have no economic disincentive - or their shareholders will absorb the cost - in which case energy prices don't change.)

18/ So let's make it three things that proper carbon pricing must do: (a) lower GHG emissions; (b) use market forces to do so, and (c) drive new capital investment in clean energy assets.

19/ A carbon tax is the second worst way to do that, because it only penalizes emission and then depends on the wisdom of the government to redistribute that money back to those who would invest in GHG reduction.

20/ The worst way though is tax & dividend, which by design distributes the proceeds to people OTHER than those who would invest in GHG reduction. It is designed to guarantee that money isn't used to reduce GHG emissions.

21/ (And before anyone starts hating on me for that prior point, go back and read points 3 and 4 above. If you want to use command and control or serve some other purpose than GHG reduction, you weren't supposed to be reading this far. :) )

22/ So why have those ideas gotten so much traction? Partly because the fossil fuel industry likes them. A tax on GHG emissions that doesn't incentivize the construction of lower cost competitive assets is pretty terrific if you want to keep making money selling fossil fuel.

23/ But they're also popular because politicians love to play Santa. Creating revenues that flow into the government for government to reallocate creates massive political pork. Doesn't use markets, but it's politically tempting.

24/ So what should C-pricing do? Simply ensure that carrots = negative sticks. If a solar investor lowers GHGs by 1 ton a year, they should get a revenue stream exactly equal the payment stream that a coal plant gets from emitting that same ton.

25/ That will change the investment thesis of the clean asset, create a penalty for the dirty asset, and bring clean assets into the market that will out-compete their dirty predecessors. And use markets!

26/ Roughly speaking, that is the theory behind cap & trade, although virtually every C&T law in practice has distorted that logic by massively over-allocating free allowances to pollute, creating too many sellers and distorting market signals.

27/ But that's a fixable design flaw. (Give me a month or so and I'll be dropping a bill to fix that. Watch this space.)

28/ A few final thoughts. One, C-pricing is never going to work for every sector. It's hard / impossible to meter carbon absorbtion by plants in the ag sector.

29/ Also, the cost of asset ownership in the transportation space is overwhelmingly dominated by the cost of the vehicle (while heat & power spaces are dominated by the cost of fuel.) So the better place to affect investment decisions is on the capex.

30/ That doesn't mean carbon-pricing doesn't work - just that it has to be seen as complementary to other tax and practice-based policies.

31/ But it is an amazingly powerful tool, so long as we make sure to use it as a way to lever private markets to lower GHG emissions... and leave it at that. /fin