Dan Steinmeyer
April, 1998
Summary
Capital is traded against energy in all aspects of life. In other words, we pay more initially to achieve lower operating costs. An example is when we buy appliances with increased efficiency, paying a little more for them initially in order to reduce their operating cost. This trade is even more important whenever engineers design equipment. Engineering practice follows well-defined rules and when these rules are converted to economic terms, three remarkably powerful lessons emerge. First, the economic impact of energy efficiency decisions for new facilities is low . "The world is flat" summarizes the fact that deviations as great as 50 percent from optimum energy efficiency can have small economic impact.
Second, doubling the price of energy by introducing an energy tax can lead to a 34 percent drop in process energy use. And third, major long-term reductions can be achieved without destroying industry's competitive position. The key is that the money raised by the tax needs to be returned to provide an incentive for a capital replacement program. This return of the money is the "revenue-neutral policy."
The size of a tax increase and the balancing investment rebate has to be large enough to have an impact on the investment decision process. Yet the net economic impact has to be small enough to stay inside the "noise/risk level" of the investment process, in order to not drive the process industries overseas. This appears to be feasible.
The capital-energy trade is augmented by the benefits of new technology (i.e., learning), even though learning appears to be a distinct and separate topic.
Context
The debate about global warming has led to much discussion about how to reduce energy use. Industrial energy use represents about one-third of the total. Since industrial use is sensitive to price, initial proposals suggested an energy tax as a simple mechanism to drive a reduction in energy use. A relatively large tax, in the range of the current base energy price, would be necessary to achieve the targeted 35 percent reduction in energy use. As initially proposed, the energy tax would only be imposed on the developed world. The major argument for focusing on the developed world is that the developed world dominates energy use and should demonstrate leadership in the drive toward reduced energy usage and greenhouse gas emissions.
An energy of tax of this magnitude has some obvious problems. First, a tax of this size would probably cause relocation of the process industries to regions in the developing world that didn't adopt this tax. Second, new facilities built in the developing world would not be affected by the high energy price and would not be pushed to trade capital for energy. One of the results of discussing how to avoid these problems is a proposal of a "revenue-neutral energy tax." This report is a result of the merger of the revenue-neutral discussion with long-term analysis by the author regarding the question: "What happens when capital is traded against energy—quantitatively?" The answer that came from the merger of these topics was: "If handled properly, a revenue-neutral tax policy could be a very good idea." More specifically, a revenue-neutral tax policy with a large energy tax could achieve something in the range of a 35 percent reduction in energy use without destroying the process industries in the developed world. Included in this report is a first pass at how to implement a revenue-neutral policy.
A separate discussion exists in government and industry on the questions of "how to encourage technological change (learning)—and—how to predict its impact." Trading capital for energy is fundamentally different from learning. However, the topics of the capital-energy trade and learning overlap because any new facilities that are built as a result of a policy that encourages replacement will inherently be more efficient because they are newer. These benefits can be added to the benefits of the trade of capital for energy. The learning benefits extend well beyond energy efficiency and perhaps only approximately 1/10 of the total learning benefit lies in the energy area.
In the long run, technological change is a more important topic than the trade of capital for energy but it is an enormous topic in its own right and it is only lightly treated here.
35 pp., 1998, $14.00, IE984
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