Goldman on global warming
[this is a rather unusual topic for a Goldman Sachs daily economic
commentary]
Goldman Sachs US Economic Research
US Daily Financial Market Comment (Phillips): A Glacial Response to Global Warming
November 30, 2006
Climate change has become an increasing focus in the states, the
courts, and other countries, but has not gained as much momentum at
the national level in the US. Public opinion is mixed and has not
changed noticeably since the 1990’s. Economic concerns also come into
play, and often trump environmental issues. In addition, there is not
yet enough support among politicians for any given solution, and
there is little pressure to compromise.That said, the midterm elections will push global warming higher on
the national agenda next year. Congress is likely to hold numerous
hearings and may pass legislation out of committee. However, despite
an increased focus, it is unlikely that any proposal will become law
in the next two years due to White House opposition and insufficient
support in the Senate.Longer term, support for new policies looks likely to gradually
increase. Action at the state level and internationally may increase
the pressure on the federal government to eventually act. The 2008
election is also likely to increase support for emissions
restrictions in the White House and Congress. If this coincides with
a strong economy and international movement on the issue, enactment
of a nationwide policy is within reach.
In the US, there is little political pressure to address climate
change. Environmental issues in general are not front and center for
most voters and are unlikely on their own to sway political
preferences. Only 1-2% of Americans spontaneously mention
environmental issues among those they want the government to address,
and not all are concerned about climate change. Even among
environmental issues, global warming does not rank highest among
voter concerns. 62% of Americans indicated earlier this year that
they were worried “a great deal” or “a fair amount” about global
warming. This is a solid majority, but is virtually unchanged from
public opinion in the early 1990’s and is lower than the percentage
concerned about water pollution and the ozone layer.
Public opinion hasn’t shifted very much in response to energy prices.
Surprisingly, public opinion is essentially unchanged over the last
few years regarding auto fuel efficiency standards, solar subsidies,
and alternative auto fuels. Roughly 75% of the public supports such
policies, roughly the same percentage as in 2000. Not as
surprisingly, proposals to raise the taxes on gasoline or electricity
get only 20-30% support. While this doesn’t rule out a small increase
it implies that a hike of the magnitude necessary to noticeably
reduce demand is unlikely, even under different political leadership.
(The gasoline tax was raised from 14 to 18 cents in the 1993. The
tax, which is not indexed, finances a federal highway fund that will
be in deficit after 2008 under current projections, so a nominal
increase is possible.) Interestingly, support for nuclear power in
the US has grown more than any other source, and a majority now
supports expansion at least in concept.
But, it may not take much to get the public motivated, and there are
early signs of change. Environmental issues rank low in voters’
minds, but so does social security, the wealth gap, and foreign
trade, three issues that politicians have been able to tap into
recently. If Congress raises the issue’s profile and forces the White
House into a debate on the topic, it could gain political importance.
A majority (58%) of Americans now believe global warming is already
taking place, up from a minority (48%) in the late 1990s. A growing
minority (38%) believe global warming will affect their own lives.
Economic tradeoffs are at the center of the issue. Public concern
over the environment tends to rise and fall with economic growth. For
instance, a series ofGallup surveys assessing public environmental
concern correlate solidly (0.80) with 5-year cumulative returns in
the S&P 500. Public concern over global warming peaked in 2000 along
with US equities, and has only recently started to rebound from the
subsequent decline. However, polls also reflect more tension now
between economic and environmental issues than they did at any point
in the 1990s. Partisan politics also come into play: 70% of Democrats
state they are willing to put the environment before the economy, but
less than half of Republicans share this view.
This raises one of the most important questions facing policymakers
at the moment: should legislation focus on the emissions “intensity”
of economic activity, or on absolute levels? A focus on the emissions
intensity of economic activity would in most cases make the economic
cost negligible, but would allow emissions to rise from current
levels. A focus on absolute emissions targets would ultimately reduce
greenhouse gases, but makes no economic promises. In addition, some
sort of economic “safety valve” may become necessary, similar to one
approach offered in the Senate. This would allow emissions caps to be
broken if the market is willing to pay above a certain price for the
right to emit.
Underlying much of the debate over policy responses is concern over
domestic industry’s ability to compete with lesser-regulated trading
partners. The US Senate unanimously rejected the Kyoto protocol at
least in part on grounds that it would not restrict emissions from
China and India, among others. Domestic legislation avoids this
explicit debate, but is likely to raise concerns particularly given
that China will be the world’s single largest emitter by 2015,
overtaking the US. Even in Europe, where concern over climate change
is much greater, one third is unwilling to pay anything to address
climate change, and only one quarter of Europeans are willing to make
the economic sacrifice the recent Stern report estimates is necessary.
The short term outlook (2007-2008): Congressional Democrats are
likely to increase the focus on global warming, but policy change
looks unlikely in the near-term. Congressional committees are likely
to hold numerous hearings to raise the profile of the issue,
particularly in the Senate. It is fairly likely that the Senate will
take another vote on some kind of climate change legislation in the
next session of Congress.
However, despite Democratic control of Congress, enactment of climate
change legislation over the next two years appears unlikely. As
outlined above, public support is lacking. In the Senate, supporters
of carbon restrictions are still far from the number of votes they
need to pass legislation. (The McCain-Lieberman bill would likely
receive no more than 47 or so votes next year. A scaled-down approach
might receive a majority, but not the 60 votes usually needed to pass
the Senate). Presidential aspirations of several senators may make an
agreement even more difficult. In the House, a few influential
Democrats have close ties to the auto industry that may slow
legislation. Finally, regulated industries, led by coal-dependent
utilities, are likely to fight hard against such a proposal, and
together carry significant clout.
For now, action is likely to take place at the state level.
California has enacted legislation, and a group of northeastern
states have formed the Regional Greenhouse Gas Initiative (RGGI,
summarized below). A handful of other states, mostly in the west and
southwest, are moving in this direction as well. However, we estimate
that taken together, these aggressive policies would reduce national
emissions by less than 3% versus a “business as usual” case by 2020,
or 16% above today’s levels.
The medium term outlook (2009-2012): It isn’t yet clear who will run
for the White House in 2008, but there is a good chance the next
president will be more receptive to mandatory carbon restrictions
than the current one. First, historical trends favor a Democratic
victory in 2008, which at least indicates a small advantage.
Historically, when the President’s party suffers heavy losses in
Congress in a midterm election, it is more likely to lose the
following presidential election, and the same party has won the White
House three times consecutively only once since World War II.
Virtually all potential Democratic nominees support mandatory carbon
caps.
In addition, the most likely Republican contender, Arizona Senator
John McCain is strongly in favor of mandatory carbon caps and is the
lead sponsor of the more aggressive Senate legislation. Arkansas
Governor, Mike Huckabee, hasn’t taken a formal position but has
suggested he would take a “better safe than sorry” approach, implying
he might support regulation. Former New York Mayor Giuliani’s
position is unclear. Former Massachusetts Governor Mitt Romney is
more aligned with mainstream Republicans, and pulled his state out of
the Regional Greenhouse Gas Initiative, after initially supporting
it. Candidates can always change their position, of course, as
President Bush did on mandatory carbon reductions following the 2000
election.
Assuming that the Democratic candidate has a slight advantage in
2008, and that among Republicans John McCain is the favorite, the
next President seems fairly likely to be supportive of legislation to
cap carbon emissions. Congress is more difficult to assess, but
Democrats look relatively likely to hold or gain seats in the Senate,
and lose seats but maintain their majority in the House.
If a new policy is agreed upon in the next Administration, it is
likely to use a cap and trade system with offsets. Whether the system
is tied to economic growth or absolute levels depends on the next
President, though based on their records McCain and Clinton appear
more interested in absolute levels while Congress is more likely to
support economic growth-based targets.Given international
competitiveness concerns, it seems unlikely that the US would ratify
the Kyoto agreement even under a Democratic president and a Congress
similar to this one. However, the next Administration could pursue a
new international approach that places more of a burden on the BRIC
countries, for instance.
The long term: Under any scenario, some things are fairly clear.
First, at a minimum, power from renewable sources and natural gas is
likely to increase, as the federal government adds subsidies and
state actions require emissions reductions and renewable portfolio
standards (RPS). Some states are already in the process of gradual
implementation, others have yet to act.
The federal government is likely to act eventually, given a gradual
increase in public concern. In addition, scientific evidence is
building that global warming is occurring and that the main source is
human activity, so public concern may begin to mount more quickly
than it has in the past. The federal government is also likely to
come under additional pressure, from business, which will
increasingly demand regulatory certainty before committing capital to
projects that may eventually come under regulation yet to be determined.
Finally, at least for the next decade (the timeframe addressed in
most proposals) there is little prospect significant relief in global
energy demand. Higher prices are likely to increase support for
conservation, make less-carbon intensive technologies economically
viable, and maybe even increase general awareness of environmental
issues. On the flipside, higher energy prices are also likely to
increase concern over the cost of regulation. That said, as a
percentage of total energy costs, carbon regulation could become
relatively less expensive as the overall cost of energy increases, as
at least some of these are likely to be fixed costs. New restrictions
(tax-tax based or otherwise) could also induce lower demand,
offsetting at least a small part of the additional cost.
Alec Phillips