A Small Test of Price Theory

Posted on January 13, 2013 by Adam Bailey

I like a decent cup of coffee with my breakfast.  Usually the water is boiled in our electric kettle.  But today we put the water in a saucepan and boiled it on our gas hob.  Why?  A fault with the kettle?  A power cut?  No, just rational economic behaviour in response to price.

For almost a year we have been taking part in the Low Carbon London Smart Meter trial, a voluntary trial of smart meters by our electricity supplier, EDF Energy, and partners.  In the cupboard under the stairs where our old meter used to be, we now have a modern meter that sends out half-hourly readings by wireless.  Periodic visits by meter-readers are a thing of the past.  In our kitchen we have a monitor giving information about our electricity usage and its cost at various scales (current, last hour, daily, monthly).  This has helped in managing our usage.  For example, I had vaguely assumed that having a shower took about 5 minutes, but it is clear from the monitor that the shower is often on, using electricity, for considerably longer.

EDF Energy have now taken the further step of offering, for homes with smart meters, a special tariff known as Economy Alert.  This enables the company to make short-term changes in price in response to circumstances, and so use price to manage day-to-day demand for electricity.  There are three rates: normal, low and high.  The normal rate of £0.11 per kWh, which applies most of the time, is slightly below the rate paid by those on a standard fixed tariff.  Whenever the low or high rate will apply, we are given 24 hours notice via the monitor and by text, allowing time to plan.  The low rate of £0.04 per kWh makes it worthwhile, for example, to shift use of the washing machine into low rate periods, but my advice to family members was not to try too hard to take advantage of the low rate.  The high rate, however, is £0.67 per kWh, six times as much as the normal rate, so it is worth trying hard to minimise electricity use during high periods.

Today (from 5 am to 11 am) was our first daytime high period, and it was interesting to see how we responded.  Based on this small, non-random and unrepresentative sample, I would say that a significant price difference, clearly communicated, can have a significant effect on the behaviour of energy consumers.

Are smart meters, and variable tariffs such as this, a good idea?  Yes.  Could they help manage electricity demand in a way that most consumers would find acceptable?  Yes.  Could this help reduce carbon emissions and mitigate climate change?  Yes to that too, but only to a small extent, even if widely adopted across the world.  The problem of climate change is much bigger than that and needs big solutions as well as small contributions.

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How to Choose a Christmas Tree

Posted on December 10, 2012 by Adam Bailey

Is a natural or an artificial Christmas tree the more environmentally-friendly option?  The answer may depend on the consumer’s circumstances.

As environmental issues go, this is admittedly a small one.  But if we can’t get right small issues like this, what hope is there for making the right choices on bigger and more complex issues?

Our tree, Christmas 2010 (and 2011 and 2012, and probably many years to come)

Our tree, Christmas 2010 (and 2011 and 2012, and probably many years to come)

A widely-quoted and very detailed study by Ellipsos (1), a Canadian consulting firm, compared locally-grown natural trees and artificial trees imported from China, applying the methodology of Life Cycle Assessment in accordance with the relevant international standards (ISO’s 14040 & 14044).  Environmental impacts were assessed in detail for production, transport, use and disposal, with the results grouped under four damage categories: human health, ecosystem quality, climate change and resources.  The central results suggested that natural trees had lower climate change and resource depletion impacts, while artificial trees had lower ecosystem impacts.  Human health impacts were very similar (2).

However, these results were shown, in the study’s sensitivity analysis, to depend heavily on assumptions made.  Two of the most important relate to the life of the artificial tree, taken to be 6 years, and the journey made by the consumer to buy the tree (5 kilometres each way by car).  A general limitation, in accordance with advice in ISO 14044 (3), is that no weightings or valuations were applied to the damage categories to obtain a single overall measure of impact for each type of tree (4).  Therefore, although the study states that the natural tree is a better option, this conclusion is not clearly supported by its results.

Here are my conclusions, based on the Ellipsos study and other sources:

Guideline 1
If you have kept an artificial tree from last year, then it would be advisable to assess the degree of risk it represents in respect of lead toxicity, having regard to age, physical condition and any information provided.  Depending on your assessment, you might decide it can be used as before, or can be used with precautions, or is best disposed of.  Precautions might include keeping young children away, washing hands after contact, and not placing gifts beneath the tree.
Explanation:  A study by Levin et al of lead exposure in US children (5) identified artificial trees as a possible source of harmful exposure to lead, used as a stabilizer in PVC, referring to research by Maas et al (6).  This research concluded that, although there was no significant exposure risk from the average artificial tree, a substantial risk to young children was possible in a worst-case scenario.  The relevance of a tree’s age is twofold: older trees are more likely to begin to disintegrate and release lead dust, and newer trees are more likely to be lead-free (with tin as a stabilizer instead) (7).

Guideline 2
If you have an artificial Christmas tree which you assess as reusable without unacceptable lead risk, then re-using it is the environmentally-friendly choice.  
Explanation: There are no significant environmental costs of using the tree again.  The environmental costs at the production and transport stages have already been incurred and are therefore irrelevant to your current decision.

Guideline 3
If you need to buy a tree, but expect that your circumstances will change within 2 or 3 years so that you would not keep an artificial tree longer than that, then a natural tree is probably the environmentally-friendly choice.
Explanation: The environmental impacts of an artificial tree in production, including consumption of resources such as iron and carbon emissions from the energy used, are much higher than those of a natural tree (8).  Because of this, the overall environmental impacts of an artificial tree per year of use will be higher than those of a natural tree unless the artificial tree is used for many years.

Guideline 4
If you need to buy a tree, and expect that you would keep using an artificial tree for many years, and if you would have to make a long car journey for the sole purpose of buying a tree of either kind, then an artificial tree is probably the environmentally-friendly choice.
Explanation:  A 16 kilometre car journey to buy a natural tree that will be used once and then disposed of makes a large contribution to the life-cycle environmental impact of that tree in respect of both climate change (carbon emissions) and resource consumption (petrol).  According to the Ellipsos study, the impacts of a natural tree are then worse than those of an artificial tree with a 6 year life in respect of human health and ecosystem quality, and about the same for climate change and resources (9).

Guideline 5
If you expect that you would keep using an artificial tree for many years, and could buy either a natural or an artificial tree without making a long car journey, then choose the kind of tree you prefer or find more convenient or is cheaper!
Explanation:  I can find no convincing environmental reason to prefer either kind of tree in these circumstances.  There does not seem, for example, to be sufficiently reliable information on rates of carbon sequestration by young trees.  Christmas trees are typically harvested at 12 years or less, so inferences cannot reliably be drawn from studies of mature forests.  For its sensitivity analysis in this respect, the Ellipsos study considers a range of sequestration rates of CO2 per hectare per year from 3 tons to minus 0.5 tons (10).

And finally … bear in mind that this is a very small issue.  As Ellipsos point out, regardless of the type of tree chosen, its environmental impacts are negligible compared to, say, regular car use (11).

Addendum (12 Dec 2012):  Since posting the above I realise that it is also possible to rent a natural tree, which after Christmas the supplier would take away, replant, grow for another year, and rent out again.  Where this can be done without the supplier having to make long journeys for individual trees, it would probably also be an environmentally-friendly option.

Notes & References

1.  The Ellipsos Study:  Couillard S, Bage G & Trudel J-S (2009) Comparative Life Cycle Assessment ofArtificial v Natural Christmas Tree                                                                    http://www.ellipsos.ca/site_files/File/Christmas%20Tree%20LCA%20-%20ellipsos.pdf

2.  Ellipsos as above, p 36

3. Wikipedia  Life Cycle Assessment      http://en.wikipedia.org/wiki/Life_cycle_assessment#Life_cycle_impact_assessment

4. Ellipsos as above, 2nd review letter 15/12/2008 pt 2 (appended to main report)

5.  Levin R et al (2008) Lead Exposures in US Children, 2008: Implications for Prevention Environmental Health Perspectives Oct 2008  pp 1285-1293 (see section on PVC) http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2569084/

6.  Maas R P, Patch S C & Pandolfo TJ (2004) Artificial Christmas Trees: How Real are the Lead Exposure Risks? Journal of Environmental Health Dec 2004 (Abstract) http://www.ncbi.nlm.nih.gov/pubmed/15628192

7.  Ellipsos as above, p 17

8.  This can be inferred from Ellipsos, pp 27 & 36

9.  Ellipsos as above, p 41

10.  Ellipsos as above, p 43

11. Ellipsos as above, p 8

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Mandatory Emissions Reporting – An Evaluation

Posted on November 22, 2012 by Adam Bailey

The UK is to require quoted companies to report on their greenhouse gas emissions (1).  This modest measure raises a number of economic issues.

Why is the government introducing this requirement?                                                              It believes that mandatory reporting will complement pricing instruments in inducing businesses to reduce GHG emissions.  Other stated aims are to help businesses reduce fuel costs and manage climate change risk, and to help investors take account of climate change risk (2).

Don’t many companies already report on their emissions?
Yes.  Many companies report on-site emissions under the EU Emissions Trading System or the Carbon Reduction Commitment Energy Efficiency Scheme.  There is also much reporting under voluntary schemes such as the Carbon Disclosure Project (3).

So what exactly will change?
Quoted companies will have to report emissions in a specified place (their annual directors’ reports), stating their methodology.  As well as on-site emissions, they will have to report emissions from freight transport (4), and indirect emissions associated with their purchased electricity, heat, steam and cooling (5).  Emissions reports should become more consistent and comprehensive, and easier to access and interpret.

What about indirect emissions from companies’ supply chains, including overseas suppliers?
In general these are excluded, a significant limitation, although their inclusion would greatly increase compliance costs and perhaps be hard to enforce.  The treatment of emissions from joint ventures and leased assets is currently uncertain (6).

How can information on emissions help in managing climate change risk?
The physical risks to a company from climate change are related to the effect on climate of cumulative global emissions, but not to its own emissions, so reporting emissions will not help in managing physical risk.  Reporting emissions can however be helpful in managing the risks from government policies on emissions.  Information on a company’s emissions provides a baseline for assessing the risk associated with possible future events such as a price rise within an emissions trading scheme or the introduction of a carbon tax.

Will mandatory reporting help address the fundamental market failure that companies emitting GHG’s do not bear the full cost of the damaging climate change to which they contribute?
No.  It will not significantly change the costs borne by companies.   The compliance cost is a tiny fraction of the external cost due to company emissions, valued at any reasonable carbon price.

Is there a more specific market failure in respect of information on emissions that mandatory reporting will address?
Given two otherwise equivalent investments, one associated with higher emissions and therefore greater policy risk, an investor might make the wrong choice because of lack of information.  This could be financially detrimental to the investor, but also harmful  to society if many investors make such wrong choices so that projects with higher emissions go ahead in preference to equivalent projects with lower emissions.  Mandatory reporting can mitigate this source of market failure in respect of capital allocation.

What about the argument that mandatory reporting will help ensure that managers give due attention to their companies’ emissions?
The idea here could be that managers are focused on their companies’ interests and need to be induced to have regard to society’s interest in reducing emissions.  It is credible that mandatory reporting, and the reputational pressures to which it might lead, could have a small effect in this direction.  Alternatively, the idea might be that, because of the agency problem in large companies arising from the separation of ownership and management, managers are not always focused on their companies’ interests, and need to be induced to have regard to their companies’ climate change risk.   While the agency problem is real, this is a poor reason for intervention since governments cannot have sufficient knowledge of companies to correct their varied internal failings.

Given the importance of climate change, shouldn’t the public have a right to information on company emissions, irrespective of any effects of reporting on company behaviour?
This is an interesting argument, albeit not one used by the government.  The underlying principle might be that where a) a company’s activities give rise to significant external costs, b) the nature of the externality is such that its source and scale are not obvious to those affected (unlike, say, noise from a building site), and c) information can be provided at reasonable cost, then those affected should have a right to information.  In the case of emissions and climate change, of course, ‘those affected’ includes everyone.

An overall assessment?
This is a sensible measure.  The capital allocation argument is sufficient justification, and this argument is strongest for precisely those companies the government is targetting, that is, quoted companies owned by or seeking funding from a large body of investors who may lack close familiarity with their activities or the bargaining power to demand information.

Notes & References

1.  DEFRA (2012) The Greenhouse Gas Emissions (Directors’ Reports) Regulations 2013 (Draft)    http://www.defra.gov.uk/consult/files/consult-ghg-regulations-20131.pdf

2.  DEFRA (2011)  Impact Assessment of Options for Company GHG Reporting   p 1        http://www.defra.gov.uk/consult/files/20120620-ghg-consult-final-ia.pdf

3. Kauffmann C & Less C T  Transition to a Low-Carbon Economy: Public Goals and Corporate Practices     OECD (2010)  pp 15-17                                                    http://www.oecd.org/investment/guidelinesformultinationalenterprises/45513642.pdf

4.  See the Impact Assessment (above) Table 13 p 44, which shows most of the estimated benefit coming from freight transport.

5.  Draft Regulations (above) para. 3(3).

6.  Deloitte LLP  Consultation Response to DEFRA  18/10/2012  pp 1-2                              http://www.iasplus.com/en/publications/united-kingdom/comment-letters/uk-ghg-comment-letter

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Perspectives on Coal

Posted on October 12, 2012 by Adam Bailey

Is coal the fuel of the past, the present or the future?  The answer may depend on where you are.

You rarely hear about coal now in the UK.  Before World War 1 the UK produced almost 300 million tonnes annually (1).  Following many decades of decline, production in 2011 was just 20 million tonnes.  Cleaner, more convenient energy sources have almost entirely replaced coal for domestic and industrial use.   But 30% of the UK’s electricity is still generated from coal (2), over half of which is imported.

Although the US has a large coal industry producing about 1,000 million tonnes, coal’s share in electricity generation is now falling quite fast. New environmental rules are expected to force closures of some older coal-fired power stations, while the ‘shale gas revolution’ offers a cheap and clean alternative to coal (3). The case for switching to other energy sources is underlined in a paper by Paul Epstein of the Harvard Medical School and others (4).  Focussing on the Appalachian region, they estimate the full costs of the environmental and health impacts associated with the extraction, transport and use of coal.  They conclude that accounting for these costs would at least double the price of coal.  The largest element of these costs relates to regional air pollution, but the costs of the global climate change impacts are also very large.

With US mining communities facing job losses, an obvious response is to increase coal exports.  The Washington-based Energy Policy Research Foundation (5) argues that, because US coal is cheap, increased exports simply replace exports from other countries, and do not add to the worldwide environmental costs associated with coal.  Basic price theory predicts however that if supply increases and demand is not inelastic, then quantity supplied and consumed will increase.  A better argument is that the benefits of increased energy supply from coal in reducing poverty must be weighed against its environmental costs.

Consider China, where the number of people in extreme poverty has fallen by an estimated 500 million since 1990 (6).  While many factors have contributed to this achievement, there is surely a connection with the fact that coal production and consumption have tripled over the same period?  This has permitted a huge expansion in electricity generation, 80% of which is from coal (7).  China’s coal consumption in 2011 was 3,300 million tonnes, almost 50% of the world total (though in per capita terms below the US level).

China’s proven coal reserves are estimated to represent only 33 years’ production at the current rate.  A high proportion of its reserves are in water-scarce regions of North China, and  the environmental costs associated with coal in China include the impact of mining on water resources (8).  The National Energy Administration’s current 5-year plan seeks to cap production and consumption at 3,900 million tonnes, implying that an increased proportion of China’s growing energy demand is to be met from other sources (9).  China has also recently begun importing coal, the amounts being small in relation to its total consumption but large enough to have a major impact on world markets (10).

Since 1995, worldwide international trade in coal has doubled to 1,000 million tonnes, with four Asian countries – China, India, Japan and South Korea – accounting for almost 60% of total imports in 2011.  Because coal has a low value-to-weight ratio, transport costs are a significant element in prices charged to importers, and transport by sea is much cheaper than by land.

Indonesia is well-placed to meet Asian coal demand, and has increased its production from virtually nil in 1981 to over 300 million tonnes in 2011, most of which was exported.  Australia, with a longer history of coal mining, has steadily increased its production over the same period to over 400 million tonnes in 2011, of which again most was exported.  Coal production has also grown steadily in South Africa which, because of its location, can export either to Asia or to the smaller European market, taking advantage of changing market conditions.  Neighbouring Mozambique, a very poor country with previously unexploited coal reserves, is now rapidly developing a coal industry with substantial inward investment, and began exporting in 2011 (11).

Notes and references

1.  UK Department of Energy & Climate Change Coal Production 1853 to 2010  http://www.decc.gov.uk/assets/decc/11/stats/energy/energy-source/2331-coal-production-1853-to-2010.xls

2.  UK Department of Energy & Climate Change Digest of UK Energy Statistics Chapter 5 p 7   http://www.decc.gov.uk/assets/decc/11/stats/publications/dukes/5955-dukes-2012-chapter-5-electricity.pdf

3.  NBC News 12/6/2012  Coal Producers Find Themselves in a Hard Place  http://www.msnbc.msn.com/id/47787665/ns/business-oil_and_energy/t/coal-producers-find-themselves-hard-place/

  1. Epstein P R et al (2011)  Full Cost Accounting for the Life Cycle of Coal  Annals of the
    New York Academy of Sciences  1219 pp 73 & 91   http://solar.gwu.edu/index_files/Resources_files/epstein_full%20cost%20of%20coal.pdf

5.   Energy Policy Research Foundation (2012) The Economic Value of American Coal
Exports  http://eprinc.org/?p=929

  1. World Bank 6/2/2010  Extreme Poverty rates Continue to Fall   http://data.worldbank.org/news/extreme-poverty-rates-continue-to-fall

7.   US Energy Information Administration  International Energy Outlook 2011 p 97  http://www.eia.gov/forecasts/ieo/pdf/0484(2011).pdf

  1. Greenpeace (2012)  Thirsty Coal: A Water Crisis Exacerbated  http://www.greenpeace.org/eastasia/Global/eastasia/publications/reports/climate-energy/2012/Greenpeace%20Thirsty%20Coal%20Report.pdf

9.  Bloomberg News 22/3/2012  China to Restrict Coal Demand to 3.9 Billion Tons  http://www.bloomberg.com/news/2012-03-22/china-to-restrict-coal-demand-output-to-3-9-billion-tons.html

10.  Tu K J & Johnson-Reiser S (2012)  Understanding China’s Rising Coal Imports  Carnegie Endowment for International Peace   http://www.carnegieendowment.org/files/china_coal.pdf

11.  African Economic Outlook: Mozambique 2012  http://www.africaneconomicoutlook.org/fileadmin/uploads/aeo/PDF/Mozambique%20Full%20PDF%20Country%20Note.pdf

Other sources used in preparing this post were:

BP: Statistical Review of World Energy June 2012  (for coal production, consumption and reserves, and electricity generation).  http://www.bp.com/statisticalreview

International Energy Agency: Key World Energy Statistics 2012 (for coal imports and exports, p 15)   http://www.iea.org/publications/freepublications/publication/kwes-1.pdf

World Coal Institute: Coal Facts 2005 (for older coal trade statistics)  http://www.google.co.uk/search?sourceid=navclient&ie=UTF-8&rlz=1T4ADFA_enGB458GB458&q=coal+facts+2005

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