With a strong focus on decarbonization, many proposals for putting a price on carbon emissions have been discussed recently. In this episode, we talk about carbon tax, cap and trade (aka emissions trading schemes), and CCS tax credits and what they mean for mineral rights and royalty owners. What you find out may surprise you.
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What is a Carbon Tax?
A carbon tax is a fee that is imposed on businesses that emit carbon dioxide as part of their normal operations. The theory behind this type of tax is that by charging based on the output of greenhouse gases like CO2, businesses will be incentivized to reduce emissions into the atmosphere. The goal is to protect the environment by reducing the amount of CO2 that is released which proponents of the tax theorize will reduce the amount of global warming.
Industries that burn carbon based fuels (e.g. fossil fuels) including coal, oil and natural gas and refined products would feel the effects of a carbon tax but did you know that most of the burden of this approach would be borne by taxpayers?
This is one form of placing a price on carbon emissions.
What are the Pros and Cons of a Carbon Tax?
One of the possible benefits of a carbon tax is that it may have some effect on helping to reduce carbon emissions. It might be because it is more expensive to drive your car because it costs more to fill it up so you drive less. A change in behavior like this might reduce the demand for carbon intensive fuels because they cost more. Other benefits could include:
- It is not a direct control over carbon emissions or the activities that generate greenhouse gases. In other words, the government doesn’t dictate how much oil or natural gas or coal that is allowed to be burned, instead it is indirect by placing a price on these emissions, allowing the companies to decide what to do.
- It may help spur innovation in energy efficiencies and provide financial incentives for companies and consumers to transition to more sustainable forms of transportation without having to use tax credits.
- It might bring nuclear energy back into favor since it is one of the safest sources of energy and the only reliable way to generate carbon neutral electricity.
That said, there are definitely a few drawbacks to a carbon tax:
- Taxes like a carbon tax usually have the effect of increasing prices for consumers. For example, take a gallon of gasoline. Various federal, state, and local governments levy taxes and fees on transportation fuels like gasoline and diesel. State taxes and fees average 30 cents per gallon and federal tax is 18.4 cents per gallon. So the average cost of these taxes and fees is around 50 cents. If the government were to implement a carbon tax an unfortunate consequence would likely be an extra 89 cents per gallon. This would disproportionately affect lower income households and could hurt American businesses.
- It would also likely increase electricity costs for American households and businesses. For example, Australia implemented a carbon tax in 2012 and they initially charged 23 Australian dollars per ton (which was later increased). Facilities that emitted more than 25,000 metric tons of CO2 equivalent per year were liable under this tax as were natural gas suppliers. According to a study, in the first year under this carbon tax household electricity prices rose by 15% and by 2014, 19% of Australian household electricity costs were a product of the tax. One of the unintended consequences of this tax was the closing of several businesses that were directly linked to this tax which caused unemployment to increase. In July 2014, the Australian parliament repealed the tax, and when they did this the Treasury estimated it would save Australian households an average of 550 Australian dollars per year.
- Another disadvantage to a US carbon tax is that it would disadvantage US businesses and likely cause even more jobs and the emissions associated with these jobs to leave the US and go to other countries without these restrictions. It would be hard to tax imports to try to level the playing field.
What are Alternatives to a Carbon Tax?
- A cap and trade structure is one alternative to a carbon tax and would likely be a cleaner way of incentivizing companies to reduce emissions. This is also sometimes referred to as an Emissions Trading Scheme or ETS which producers that emit more CO2 could potentially buy emissions credits from producers that emit less CO2. This is one of the more palatable ways of reducing CO2 emissions. In fact, the American Petroleum Institute recently endorsed carbon pricing as a way to help curb greenhouse gas emissions. One of the reasons for this is it would provide a quantifiable cost associated with CO2 emissions vs. having to navigate ever changing government regulations.
- Another alternative to a straight up carbon tax is a carbon capture tax credit which is referred to as a Section 45Q Tax Credit enacted by the US government in 2008. Under section 45Q, companies can generate a tax credit (or “tax liability offset” for the CPA’s out there) per captured ton of carbon dioxide. The amount of the credit depends on how the CO2 is captured, whether for geologic sequestration or for enhanced oil recovery or other uses. We will link to more information in the show notes on this tax but what I want to focus on are the pros and cons of this carbon capture tax credit scheme.
Why Would an Emissions Trading Scheme or Carbon Capture Tax Credits be better than a Tax?
Some of the benefits may include:
- It would help the economics of coal and natural gas power plants that also utilize Carbon Capture. This would help meet the demand for affordable and reliable energy while minimizing carbon emissions.
- One of the ways that the US power sector could pay for these CCS projects is by selling the tax equity generated by the project. In other words, companies that emit CO2 might be incentivized to purchase these tax credits from the companies that have implemented CCS and receive these credits. So it would be another source of revenue to help offset the project costs.
- It provides a quantifiable cost on CO2 emissions and allows companies to factor these costs into the economics of new projects, whether it is drilling a new oil & gas well, building a new power plant, or new factory. If the regulations don’t fluctuate based on the whim of the administration in power at the time, it helps companies plan. This is especially important for large investments like building an offshore production platform to produce oil & gas as these projects can take a decade to go from concept to where they start producing.
- It is more of a free-market driven solution to reducing carbon emissions. Companies that innovate to reduce the cost of capturing carbon dioxide can leverage this competitive advantage and generate additional revenue through the sale of these carbon credits.
- An emissions trading scheme might also help nuclear power come back into favor as it produces zero emissions and I could imagine would benefit tremendously from the sale of carbon credits to other industries.
How Will Companies be Incentivized to Build CCS Projects?
The way that I think you incentivize companies to pursue more CCS projects is to make it economic to do so. Again, whether it is through the existing 45Q tax credit, or through some sort of an emissions trading scheme where they could monetize the reduction in CO2 emissions to help offset the cost of construction.
The current 45Q tax credit requires that eligible facilities begin construction by 2024. While there are several projects in the pipeline, I hope the government extends this deadline to allow companies to finalize investment decisions given the delays caused by the pandemic.
Also, another factor that will help incentivize companies to spend money on CCS projects is if the price of crude oil remains at current levels. One of the ways that CCS developers make money is by selling CO2 for use in Enhanced Oil Recovery (EOR) or by using it directly as in the case of companies like Oxy which has their Low Carbon Ventures division which is focused on CCS. You can find out more about CCS and EOR in MRP 99: Carbon Capture and Enhanced Oil Recovery.
How Would a Carbon Tax in the US affect Oil & Gas Drilling?
- It could increase the cost of new projects and could reduce the amount of new production in the United States.
- It would likely just offshore jobs and production to countries with less restrictive environmental policies in place. So it would likely not reduce global emissions since another country would pick up the slack caused by the drop in US production and it would hurt the US economy and jobs in the energy industry.
- And while countries like Saudi Arabia or Russia would fill the void created by a drop in US oil and gas production, it could cause a short-term increase in the price of crude oil if supply falls enough.
How Would a Carbon Tax Affect Mineral Rights and Royalty Owners?
Likely carbon tax would be bad if it caused a drop in new drilling. Fewer wells means less royalties for mineral and royalty owners.
I think other low-carbon incentives like the 45Q tax credits or a carbon trading system could be good because it may inspire more Carbon Capture and Sequestration projects and more Enhanced Oil recovery projects as a result. This would result in increased crude oil projects and the extension of the life of these oil wells which would mean more royalties paid to mineral and royalty owners.
What is the Outlook for Carbon Taxation or Carbon Sequestration Incentives
It seems just a matter of time before some sort of price is placed on carbon emissions given the US Government’s target to a zero emissions future.
The way to practically spur development may be through the initial use of things like the 45Q tax credit or emissions trading schemes. In the future, I hope that innovation occurs in this space to make low-carbon energy affordable and reliable for everyone. I think this is a much better solution than draconian measures like banning fossil fuel use proposed by things like the Green New Deal or legislation implemented in California and other states. A good example of innovation is the electric vehicle company, Tesla. They are a major innovator in electric vehicle technologies and frankly their cars are cool. While there is nothing like the sound of an American muscle car, the performance of some of the higher end Tesla cars is nothing short of amazing. They are bringing the cost down and honestly we have thought about buying a Model 3 the next time my wife’s lease comes up since most of her driving is in the city and you can get it with all-wheel drive for the snow here in Colorado.
We need more Tesla-like companies innovating in energy and CCS and in all areas of improving CO2 emissions. I think we’ll see a lot of innovation and an increase in Carbon Capture and Storage or Utilization projects, especially for Enhanced Oil Recovery. I think we’ll also see innovation in reducing emissions and in energy efficiency as long as there are economic incentives in place.
It will be interesting to see how things develop.
Resources Mentioned in This Episode
- What Will An American Carbon Tax Cost You? This excellent article on Forbes talks about the real cost of a carbon tax.
- The Case Against a Carbon Tax. This paper by the Institute for Energy Research outlines what happened when Australia implemented a carbon tax and why they repealed it just two years after adoption.
- American Petroleum Institute endorses carbon pricing as oil and gas industry faces pressure on emissions
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