Implications of the MN Social Cost of Carbon Ruling

On April 18, Minnesota Administrative Law Judge LauraSue Schlatter ruled that utilities must use (higher) federal estimates when complying with state regulations to take into account the “social cost” of carbon dioxide emissions in their long-term planning. Despite the host of problems with the federal estimates of the social cost of carbon that came up in testimony, Judge Schlatter nonetheless ruled they should be used instead of the older estimates that had been the practice in Minnesota since the 1990s.

There was little new conceptually in the trial—all of the problems with the federal SCC have been documented by IER and others for years. Even so, the recent ruling, if it is endorsed by the Minnesota Public Utilities Commission later this year, means that Minnesota utilities will face an implicit penalty on carbon dioxide emissions that is ten times higher than before. Even on its own terms, this is a symbolic gesture that will do infinitesimally little to reduce global emissions but will make energy more expensive in Minnesota.

The Background

To understand the regulatory and legal background to the recent decision, we quote from a September 8, 2014 E&E article by Jeffrey Tomich:

The federal government’s social cost of carbon values is going on trial in Minnesota.

Required by state law to establish a dollar value for the environmental damages caused by power plants carbon dioxide emissions, state utility regulators sent the contentious issue to an administrative law judge.

…[T]he case will pit advocacy groups that successfully petitioned the Minnesota Public Utilities Commission [PUC] to refresh outdated values for damages caused by CO2 emissions against utilities and big power users, which will try to poke holes in the methodology used by the federal interagency work group and experts.

The PUC presided over four hours of discussion yesterday before voting unanimously to refer the matter to the state Office of Administrative Hearings, where an administrative judge will determine whether the federal social cost of carbon values is the best available measure of CO2 externality costs.

The trial featured testimony from some of the leading figures who question the federal estimates of the SCC. For example, here is climate scientist Roy Spencer’s firsthand report on his September 2015 participation. The trial also featured testimony from noted climate scientist Richard Lindzen, and economists Richard Tol and Anne Smith. (Climate scientist Judith Curry—who was not involved directly in the trial—provides links and analysis of their testimonies in this post.)

The specific controversy concerned the estimates of the SCC that Minnesota regulators should use for the state law mandating that utilities take environmental damages into account when choosing energy sources. Thus far, the MN Public Utilities Commission uses a range of 42 cents to $4.37 per ton of carbon dioxide, deriving from estimates originally established in 1997. In her recent decision, Judge Schlatter ruled that this range should be supplanted with estimates based on federal calculations, implying a range of $11 to $57 per ton.

The Impact of the Ruling

Despite the judge’s ruling, various accounts argue that the MN Public Utilities Commission can reject her opinion and use whatever estimate of the SCC it desires. As Roy Spencer cynically observed after his testimony:

No matter which way the judge rules, I hear the ruling will likely be appealed. Then, no matter what the final ruling is, the Minnesota Public Utilities Commission can probably just do what they want to do, anyway. I believe that the Commission simply asked the judge to help them with the process.

However, assuming the PUC follows the advice of the judge and (later this year) matches the regulatory value to the federal estimate, there will be winners and losers. The groups that urged the switch, such as the Minnesota Pollution Control Agency and the Minnesota Department of Commerce, will obviously be pleased.

However, business groups have pushed back, arguing that the tenfold increase in the penalty on carbon dioxide will entail a loss of competitiveness and higher energy prices for consumers. Minnesota Chamber of Commerce’s Bill Blazar told MPR (Minnesota Public Radio) News that everyone desired environmental sustainability, but that the “challenge…is to figure out a way to implement the policy in a way that keeps Minnesota companies competitive and employing Minnesotans.”

Federal Estimates Inapplicable at Statewide Level

Besides the many problems with the federal estimate of the SCC—again, which the IER team has summarized in this comprehensive comment submitted to the government in 2014—there is an even more fundamental problem with applying such concepts at the state level. Specifically, the problem of leakage rears its head with greater vigor, the smaller the jurisdiction on which a carbon dioxide penalty is applied.

On its own terms, the alleged problem of manmade climate change is a global phenomenon. If only a small portion of households and businesses are subject to a carbon penalty, then part of their reaction will be to move to less regulated jurisdictions. This “leakage” out of the regulated area means that the reduction in emissions is not as powerful as would have occurred with a more uniformly enforced policy.

To see the principle clearly, imagine an exaggerated scenario where regulators in Minnesota approached one small business and enacted a $1,000 per ton carbon tax. However, that draconian penalty would only apply at that precise address; all other Minnesota businesses were subject to the old rules. What would happen?

Well, clearly, the existing business would move. That would be a much cheaper solution than staying at the current location and paying $1,000 per ton of emissions, even if steps were taken to reduce them.

When the existing business owner had moved his operations—perhaps just down the street—the heavily taxed property would be taken over by someone with zero emissions. Or, the property might just lie vacant.

Naïve observers might look at the emissions from this particular property before the new policy, and then look at emissions after the $1,000 carbon tax had been in place for a year, and then conclude that it was a smashing success, driving emissions down virtually 100 percent.

But of course, globally emissions wouldn’t have budged an iota. As we’ve explained, the original business owner would simply shift his operations elsewhere. So in this contrived scenario, there would have been absolutely no environmental gain, but conventional output would be lower because the business had to waste valuable resources moving to another location.

Now in our world, with smaller carbon tax penalties and jurisdictions that are larger than a single property, the problem of leakage is not so severe. Policymakers can reduce global emissions by enacting carbon taxes (or other restrictions) in their jurisdictions. However, it is still true that the impact of these policies is weakened to the extent that businesses react by shifting operations. To reiterate, the smaller the jurisdiction, the more significant the problem.

Therefore, even if one stipulated—for the sake of argument—all of the assumptions that the Obama Administration Working Group employed to generate its estimates of the social cost of carbon, it would still be wildly inappropriate for jurisdictions such as a U.S. state to employ them directly. These estimates, even on their own terms, only make sense if they correspond to policies implemented on large fractions of humanity.

Conclusion

A Minnesota Administrative Law Judge decided to set aside the numerous problems that expert witnesses—both climate scientists and economists—had raised regarding the federal estimates of the social cost of carbon. However, by itself the judge’s ruling may have no actual impact, because the MN Public Utilities Commission is free to disregard her recommendation. If they so choose, they can refrain from raising the implicit penalty on carbon dioxide emissions for utilities in their state by a factor of ten.

If, instead, the PUC decides to go down this route, it will impose economic hardship on Minnesota businesses and consumers for relatively little gain—even if the federal procedures were correct. The fundamental problem is that global estimates of the social cost of carbon are inapplicable for small jurisdictions. Lacking coordinated action from not only other states but also governments around the world, unilateral statewide penalties on carbon dioxide emissions are largely a symbolic gesture that nonetheless has quite tangible harms. Judge Schlatter’s recent ruling would harm Minnesotan consumers and businesses while providing virtually no change in the global climate.

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