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Decarbonizing homes and the price of gas

Our climate justice framework for BC is to eliminate fossil fuels by 2040. In the household sector, this poses a significant challenge, not so much in terms of technology and knowledge, but because natural gas is much cheaper than electricity per unit of energy. Even though BC has among the lowest prices in North America, and for relatively clean electricity at that, pricing undermines incentives to shift away from fossil fuels.

In the Lower Mainland, the delivered cost of natural gas is approximately 3.28 cents per kWh, plus 0.45 cents per kWh in carbon tax.  This compares to BC Hydro residential rates of 6.67 cents (tier one) and 9.62 (tier two) per kWh for electricity.  Thus, gas prices are 56% the cost of the tier one electricity rate and 39% of the tier two rate, creating a perverse incentive to use gas as a fuel source instead of electricity.

Unfortunately, prices do not tell the truth. In terms of climate action and economics, there is an externality, or a cost borne by third parties to the market transaction, associated with burning fossil fuels. A recent study put the value of these external costs at nearly up to $900 per tonne of CO2.  While this is the top of the range, it would translate into about 16 cents per kWh, and implies that the price of natural gas is as much as five times lower than it would be if all costs were included in the market price. [update: see comments for some debate on this point; also this post.]

Decarbonizing homes requires, minimally, that the gap between current natural gas and electricity prices be eliminated over time through effective carbon pricing. And this must also take into consideration looming increases in electricity prices. The cost of natural gas may rise on its own account, but additional carbon pricing measures may be required to avert a widening gap. Longer-term, making prices tell the truth is needed if BC is to reduce and eventually eliminate fossil fuels like natural gas over the course of the next few decades.

A deeper problem is that the BC government puzzlingly considers natural gas to be a source of clean energy, and often talks about GHG reductions and increased gas production in the same breath. At best, it is merely the cleanest of fossil fuels. In regions where electricity is produced by coal, a switch to natural gas can lower GHG emissions per unit of energy, although in the case of shale gas fracking, natural gas emissions may actually be on par with coal.

From a consumption perspective, space and water heating are the two sources of GHG emissions in homes: space and water heating together comprise 99% of residential emissions (the remaining 1% is from appliances).  Electricity and natural gas are  competing energy technologies for providing these services. Existing homes using natural gas heating/cooling and hot water systems (typically hydronic systems) could be converted to renewable fuel sources such as waste heat, biomass, geo-exchange, and solar thermal. Heap pumps of various types (including ductless models that can replace electric baseboard heaters) are also a very efficient way of providing space heating. Neighbourhood-level or district energy systems (including waste heat recapture) could also play a major role in the transition away from fossil fuels.

BC’s population is expected to increase from about 4.6 million residents to over 6 million by 2036.  New housing and redevelopments should not be adding to BC’s appetite for natural gas, nor should energy efficiency programs subsidize conversion to natural gas. Instead, a slow-and-steady transition off of natural gas toward clean electricity from the grid and other on-site and neighbourhood-scale alternatives is needed, synchronized with energy efficiency gains to avert a major increase in electricity demand that could drive up prices.

The biggest overarching concern is that any such moves would massively increase poverty, or specifically energy poverty, where households spend a disproportionate share of their income on energy. A major plan for retrofit programs aimed at low-income households, and the older housing stock, multi-unit buildings and rental stock where low-income households are more likely to live is needed. Current energy efficiency grant programs are aimed at owners of typical single-family homes, which pretty much makes the irrelevant for low-income households. In addition to this, some form of income transfer (ideally, funded out of growing carbon tax revenues) would likely be needed.

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Comment from Donald Hughes
Time: July 28, 2011, 1:18 pm

“A recent study put the value of these external costs at nearly $900 per tonne of CO2.”

Not really. That was an extreme bound (95th%) of the most catastrophic estimates at a low discount rate. You could have easily picked the average estimate of the data used by the US working group at a 3% discount rate then their projection is $28 today. But that’s about where the carbon tax is at, meaning it is plausible within the framework of the report you cited that there is no real need for movement against natural gas. So an accurate carbon price seems essential.

Comment from Marc Lee
Time: July 28, 2011, 2:27 pm

Bizarre that you would prefer the status quo estimate. More pessimistic scenarios based on the latest science would seem to be prudent. And the bulk of modeling results run to several hundred dollars per tonne.

In fact, the paper takes the US gov’t working group modeling as its starting point then probes some key assumptions in re-assessing modeling results to get a range of results, of which $893 is at the top end. To quote the authors:

“Our report finds deep flaws in the U.S. government’s $21 per ton estimate. That inaccurate estimate promotes inaction, with enormously harmful consequences.

“Our research incorporates an up-to-date understanding of climate risk and uncertainty, and finds that the true cost of carbon emissions could be almost $900 per ton today, and more than $1,500 by 2050. Granted, these are the high end of the range of 16 scenarios that we studied. We aren’t sure that the costs will be that high – but we also can’t be sure that climate change won’t be that expensive. It’s the fire insurance problem: you buy insurance because you can’t be sufficiently sure that your house won’t burn down.”

Comment from Donald Hughes
Time: July 28, 2011, 5:38 pm

Well, you simply stated: “A recent study put the value of these external costs at nearly $900 per tonne of CO2.”

The study did not do this. The most extreme estimate for average social cost was $481. This is almost entirely because it chooses a discount rate of 1.5% over 3%. Using 3% gets you $118. If you use the very low discount rate then your kWh of natural gas is closer to 11 cents. Imagine that electricity rates rise 30% soon, that’s roughly 8.5 cents tier 1 and 12.5 cents tier 2. Obviously these numbers suggest less dependence on natural gas but it doesn’t suggest excluding it from the mix.

Importantly, if you use the more conventional discount rate, your point mostly evaporates. This would cost natural gas at 5 cents per kWh. At that rate it seems less important that we pull out all the stops to transition off natural gas. So your point only obtains under very specific assumptions that weren’t outlined in your post.

Comment from Marc Lee
Time: July 28, 2011, 6:45 pm

DH, thanks for clarifying the detail. But I think you’re missing the big picture, which is how we get from 390 ppm to 350 ppm. It seems clear that this means something like zero fossil fuel emissions plus lots of tree planting and any other techniques we can come up with to sequester carbon.

The study puts out a range of estimates that show, using more realistic assumptions in a standard model that the externality associated with burning fossil fuels is way high. Exactly how much we we cannot really know, but enough to say that major action is required.

There is a lot of good detail in the paper about limitations of modeling as they play into standard results. The DICE model used is a problematic in that a temperature increase of 18 deg C (!) amounts only to a loss of 50% of GDP. Seems to me there is very good reason to think the costs are closer to the high end of the estimates made.

Comment from Donald Hughes
Time: July 28, 2011, 7:57 pm

Your original post pivoted around the quickly stated idea that an optimal carbon tax is $900 tCO2e. I just showed that this was a controversial and not the obvious take-away from the study. The average estimate in the most catastrophic case at the lowest discount rate already builds in probabilities so your insistence that it is at the upper bound amounts to a hunch. If you already believe we need to end fossil fuel use then all this talk about optimal natural gas prices seems beside the point, especially because there are a lot of reasonable scenarios where the numbers you provided don’t prove your point. Zero fossil fuels requires less that old apartment buildings get new boilers and more that all of B.C.’s roads be left to let grass overgrow them. I wish you luck selling a $900 carbon tax to a population that flips out over modest and beneficial sales tax reforms.

Comment from Purple Library Guy
Time: July 28, 2011, 8:39 pm

Hughes has a point.
What I take from that point is that this sort of price modelling is not as useful as all that. It’s an artificial and indirect way of reaching a conclusion, that wouldn’t seem attractive if we didn’t overvalue markets.
That is, normal reasoning would work along the lines of “The costs of global warming are very high, indeed catastrophic–clearly worth increasing natural gas heating costs to match or exceed the cost of electrical heating (or alternatively, subsidizing carbon-free forms of heating to match the price of natural gas heating). Therefore, we should probably do that sort of thing.”

This kind of reasoning goes, “What’s important in decision making is markets, so I’ll go through a cumbersome process of quantifying a raft of highly uncertain costs and coming up with more or less arbitrary future-discounting rates so as to derive figures that vary by orders of magnitude saying what carbon ‘should’ cost in a hypothetical market that accounted for the bads it will generate. Then if this cost matches the value judgments I already made I will pretend that it is the cost, describing how markets should have been behaving, that guides my actions.”

The real point here is that natural gas prices are too low, or electricity prices too high, to let us achieve our carbon reduction goals without some kind of interference in markets. If we consider those goals very important (which I do) then we should interfere in the markets enough to change the situation. If not, we shouldn’t. But nobody’s going to change their minds about whether it’s worth doing or not based on a hypothetical cost-accounting exercise, and trying to use a kind of idealized counterfactual market to wean people off their idealization of the actual market is rhetorically self-defeating. It sticks stubbornly to the frame preferred by the free-markets-are-perfect brigade.

Comment from Marc Lee
Time: July 29, 2011, 7:40 am

DH, I will amend the paragraph you take issue with. But basically I think we disagree about the scale of the problem and discounting future generations. The SCC estimate was more of an aside than the main point of the post, but I think I’ll come back to the issues you raise in a seperate post.

Ultimately, I was trying to point out that current price incentives in BC favour natural gas are a problem. By 2040 I would not want to see any natural gas in the mix, though it will likely take all three decades to get there. In the near term it makes sense to remove that cost advantage, though PLG makes a good point that effective the price mechanism really is anyway. A mix of carbon pricing, regulation, standards and subsidies is the more likely policy mix.

Comment from Donald Hughes
Time: July 29, 2011, 12:08 pm

I don’t think it is a question of who thinks climate change is more of an issue. I just said that your point only makes sense in a particular model that you didn’t yet explain, and that it seems useful to make clear to readers that your picking of the $900 number was based on a hunch.

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