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Cost of Change

To environmentalists, the economic obstacles faced by new energy technologies are maddeningly unfair. The reason is that the costs of global warming-unlike costs such as labor, insurance and raw materials-are not included in the price of energy. In other words, the price of the kilowatt-hours that heat U.S. homes includes the power company’s cost of fighting lawsuits brought by environmental groups, but not the potentially enormous costs to society from climatic change. Economists, for their part, readily agree that this is a problem. Unfortunately, it is not clear what to do about it.

In economic terms, these unaccounted-for items are known as externalities-costs or benefits that are not adequately reflected in market prices. The problem of incorporating externalities into prices has long bedeviled economics. (Textbooks on externalities were published as long ago as 1917.) A classic example of the awkwardness of handling externalities is the case of the small business that releases a blast of noxious gas and damages its neighbors’ property-wrecking the paint on cars and houses, say. All 50 states have enacted private- and public-nuisance laws that permit individuals and the government to take the offenders to court and force them to pay for the cleanup. If that doesn’t stop further emissions, injunctions can follow. Eventually, in theory, miscreants realize that they can’t avoid legal action and choose to stop polluting, presumably passing the costs of using cleaner technology on to consumers. In this fashion, pollution abatement becomes incorporated into the market price. But as almost everyone agrees, the methods for doing it-lawyers, litigation and legislation-are halting and slow.

Global warming, alas, fits poorly even within this awkward framework. To begin with, much of the problem is due to entire societies, not specific corporations. And because nobody knows the rate at which global warming will occur, or precisely what the effects will be when it takes place, there’s no simple target to shoot for. Global-warming activists often suggest a “carbon tax” on fossil fuels to account for the future costs of climate change. Fair enough, but how high will those costs be? If U.S. consumers pay $1 billion a year, would that be enough to cover the problem? How about $10 billion? $100 billion? The level of economic damage that might be inflicted by greenhouse gas abatement is so uncertain that even the Kyoto treaty on global warming, to date the most ambitious attempt to address climate change, says not a word about what the “right” level of emissions should be.

Compounding matters, the political system has shown little inclination to wrestle with the problem of greenhouse gases. Bill Clinton, arguably the most green-friendly president in decades, refused even to submit the Kyoto treaty to the U.S. Senate. Notoriously, one of President George W. Bush’s first acts of office was to abandon the Kyoto treaty-without feeling it necessary to present any alternative proposal.

Even energy research has hit hard times. According to James J. Dooley, an energy researcher at the Pacific Northwest National Laboratory, U.S. public and private investment in energy R&D have been declining steadily for 20 years. Between 1979 and 1999 public energy-research spending fell by more than two-thirds in real terms. And every other developed nation except Japan has also cut research funding. “With few exceptions, energy R&D simply isn’t on the radar,” he says.

“Look at the projections,” says Dermot Gately, an economics professor at New York University. “Cheap petroleum forever. Cheap natural gas. Cheap coal forever-the United States is the Saudi Arabia of coal. It’s energy Nirvana. Almost every solution to climate change involves driving up those wonderfully low prices. Where’s the mandate for change in that?”

Without clear economic benefits, technological change is most likely in niche markets. An example is the current tests of natural-gas engines in taxi fleets in Long Beach, CA, Atlanta, New York City and other cities. New Zealand, too, has switched most of its taxi fleet to natural gas. (Natural gas burns more cleanly because it is chiefly composed of methane, a simple molecule whose combustion produces carbon dioxide and water vapor but almost no soot or sulfur dioxide [see “Hitting the Natural-Gas Jackpot”].) Why taxis? Urban air pollution is disproportionately due to taxis, which run constantly, under the most taxing traffic conditions. In addition, taxis, which are confined to particular cities, don’t need a nationwide network of alternative-fuel stations.

“The idea in all of these things is to come in from the margins to the center,” says Stanford’s Victor. “But it’s never easy.” Once the technology has penetrated the niche, engineers can work on bringing the costs down. For those who want clean energy fast, though, the best hope in Victor’s view “is for what people now like to call a disruptive’ technology-something that forces huge change. But those don’t happen often.”

Curiously, Gately suggests, innovators may take some heart from the historical record. “We’ve never been good at predicting energy supplies,” he points out. “Something always happens.” Although he, like most energy economists, thinks it unlikely that an event like a terrorist attack could have a long-term, significant impact on energy supplies, he says it’s “prima facie foolish” to discount the possibility of catastrophes in the Middle East or the Caspian Sea. The energy industry can be incredibly volatile-recall that in the five years between 1926 and 1931, the price of Texas crude fell more than 98 percent. In our own day, utilities that spent the summer of 2001 wrestling with electricity price spikes in California spent last fall trying to gauge the impact of war in Afghanistan on the nearby, oil-rich nations around the Caspian Sea. If the U.S. campaign against terrorism creates an explosive reaction, the regime of low oil prices may collapse. Imagine, for example, the effects of terrorist attacks against key pipelines or oilfields. “In one way or another,” Gately says, “we’ve been fighting [in oil country] since Desert Storm. You have to ask, would Americans be more willing to think seriously about energy if, God forbid, something unexpected happened over there? Would they maybe start thinking about fuel cells and carbon taxes? It’s always possible.”

So the silver lining of tumult in the Arab world might be a greater willingness to address global warming? “I wouldn’t put it that way,” Gately says. “I’d say that the crystal ball is as murky as ever. And since we don’t know the future, you can’t rule out the possibility of a happy outcome.”

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