Oil Companies + Carbon Pricing = True Love?

An unexpected pairing, for better or worse

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• Utilities: between a rock and a hard place

• China: the 5 climate numbers you need to know

• Nuclear power: the hero we need, but don’t (yet) deserve

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Everyone loves a great romance, right?

Romeo and Juliet, Beauty and The Beast, Lady and The Tramp… the list goes on!

Well get ready for the next epic romance that is sure to rock the world…

Oil companies & Carbon Pricing… K.I.S.S.I.N… wait, what?

Yep… you heard right. Over the past years, and as recently as last week during the US Climate Summit, a long list of international oil companies and lobbyists have been advocating for carbon pricing (also referred to as carbon taxes).

When I first learned about this match made in heaven, I was entirely perplexed. Oil has lots of carbon in it. If we priced or taxed that carbon, it would make oil products more expensive, and thus less attractive to buyers.

So how can climate advocates and a carbon-reliant industry both want the same thing?

Let’s dig in and see if we can figure it out.

• What is carbon pricing? How does it work?

• Why would oil companies support a carbon price or tax?

• Why might that not necessarily be a bad thing?

Carbon pricing, explained 📚

Carbon pricing, as opposed to voluntary carbon offsetting, is a government mandated mechanism to levy a fee on goods, services, or activities that generate CO2 — ultimately aimed at accelerating the transition toward a low carbon economy.

Said simply: carbon intensive goods become more expensive or less lucrative

Globally, carbon pricing mechanisms generate nearly $50Bn in revenue across more than 50 jurisdictions. These carbon pricing mechanisms average ~$20/t-CO2, but range from ~$1/t-CO2 to >$100/t-CO2, and they are applied to varying portions of economic activity — for example, some cover transportation (EU) and some do not (S. Africa).

As with any tax, there’s two things to understand: revenue collection and distribution

Revenue collection

There’s generally two approaches to revenue collection:

• Tax or price: Under this approach, the government levies a set rate on any emissions generated. At the end of a year, the entity generating emissions pays for its footprint in its taxes. Here it is important to set an appropriate price given that the price is pre-determined, and not dictated by the market.

• Cap & Trade: Here, the government sets a “cap” on the total amount of carbon emissions allotted to a sector. They give out emissions allowances, and then companies must manage their own footprint. If a company exceeds their allowance, they must buy more credits. If they go below their allowance or generate credits (like biofuels do in California), they can sell them to the market. The EU Emissions Trading Scheme (ETS) is the largest global example of this approach (~$25Bn annually, or roughly 1/2 of global carbon pricing revenue)

With both approaches, the legislator has to decide (1) the price or price floor, (2) the sectors of the economy covered, (3) how the mechanism will evolve in the future.

Revenue distribution

Once any pricing scheme is implemented, the government must also determine what to do with the revenue they generate. For example, a large share of gasoline taxes are put toward road and infrastructure repair. (this is why EV taxation is tricky, no gas!)

When it comes to carbon pricing, there is no set formula for revenue distribution. Should it go to consumers? Should it be sent toward clean technology innovation? How about helping the sectors that are the hardest to abate? Or communities that are hardest hit by climate change?

While we don’t have the answers, it is important to be aware of these considerations.

So… why do oil companies like carbon pricing? 🎁

First, let me be clear — I believe the best version of a transition to a low carbon economy is one that works together with oil companies, not one that excludes them.

Oil and natural gas together account for over half of global primary energy demand, and almost $1Trn in annual investment. Moreover, the bulk of the global chemical, geological, and process engineering knowledge sits within these major institutions. Even in a net zero world, we are going to badly need this expertise.

Now — let me put my skeptic hat on and offer a few reasons why oil and gas institutions may be advocating for a carbon price. Some more genuine than others.

It’s flexible: Maintain control and pricing power 👊🏻💰

As opposed to other regulatory approaches that accelerate a low carbon economy — for example, mandated vehicle emissions standards — a carbon price leaves change up to market forces. This means that oil companies can keep their license to operate and have the opportunity to evolve, rather than reacting to forced change (e.g., diesel bans).

Perhaps more importantly — any carbon price levied could be passed on to consumers.

For some quick math…

• A gallon of gasoline has about 20lbs, or about 0.01 tonnes of CO2

• This means a carbon price of $50/t-CO2 equates to ~$0.50/gallon

• State and federal gas taxes already amount to ~$0.50/gallon

On a base price of $3-4/gal, another $0.50 is likely not enough to push an already cash-strapped consumer to an EV that today, has a higher upfront cost. If I’m an oil company, I’ll take that trade-off rather than forced EV adoption or sales any day…

It’s hard to pass: Government paralysis & global footprints 🗳️⚖️

Let’s not forget our friend Uncle Sam. Not always the most efficient of actors.

Taxes of any shape or size are notoriously controversial and difficult to pass. Carbon pricing is no different. I’d venture to say that oil companies advocate for this mechanism precisely because it will be hotly debated — likely causing delays or even complete legislative paralysis.

Now remember — oil markets are global markets, and most large oil companies have multi-national footprints. So if you thought passing taxes in the US was hard, try constructing a unified global pricing mechanism that fairly measures and prices carbon across international borders¹. Yikes…

It’s… right: A more efficient and equitable instrument 🕊️

Perhaps the most altruist of the bunch, carbon pricing is regarded as the most efficient and equitable solution. If applied uniformly across the economy, it doesn’t single out one actor more than another. Carbon is carbon. This avoids the ‘boogie-man’ stigma that is often laid at the feet of oil companies.

Additionally, the exploration, refinement, and logistics surrounding oil (Scope 1 & 2 emissions) only account for ~10% of total emissions. The rest are “scope 3”, or those from burning said gasoline. This means that under any carbon pricing scheme, there would have to be clear boundaries of who pays for what — and there’s a non-zero chance that oil companies would only have to pay for Scope 1 & 2, the emissions directly ‘under their roof’.

And… why is this not necessarily a bad thing? 🤷

It is hard to look at the above list of drivers and get a warm and rosy feeling about carbon pricing… how can it be a good thing?

Well… regardless of the above motivations, economists still full-heartedly agree that carbon pricing is the most equitable and efficient mechanism to drive behavioral change. If you increase the cost of carbon-intensive business, the market should start to reward low carbon activities and innovate towards a low carbon future… right?

I can get on board with this thinking, but a few things have to be true…

1. Measuring & reporting: a system is only as good as the data that underpins it. Without clear, consistent, and accurate reporting of GHG emissions (already a struggle today…) any system implemented would be challenged and ineffective. Garbage in, garbage out.

2. Minimum requirements: if I’ve taken anything away from the “stonks” craze, it is that markets are not always as efficient as they are deemed. So… any carbon pricing mechanism implemented should be accompanied with a “floor” or minimum amount of action required. Whether that is a price floor, or an emissions floor… we can’t leave it all up to the market. (this is what the IMF is advocating for)

3. Equitable distribution: I personally think the hardest part of any carbon pricing scheme will be the redistribution of revenue. How do you decide where the money that gets collected goes? I don’t have the answer, but if the funds collected are not used in an efficient and equitable fashion, the carbon price could be no more than another government failure

Oh… and let’s not forget… you actually have to get the above passed as a law!! If you can do all of that — I’m a believer. But let’s not put it all on black… 🎰♠️♣️

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Now… where does this leave us?

Let’s be real — this transition is going to take major (but worthwhile) investment. Estimates range around 2% of annual global GDP to achieve a net zero future.

With this level of capital allocation, regulation and public sector participation is bound to happen. So it’s not an if question, but a when & how.

Move fast and break things

Personally, I’m a fan of the ‘move fast and break things’ approach when it comes to carbon pricing. We’ve never faced a global transformation this large, so we’re bound to get things wrong along the way. I’ll take action sooner rather than later, with a clear and workable plan for policy evolution, rather than paralysis and bickering that prolongs action for years and years. We don’t have time to wait.

Maybe, just maybe… oil company advocacy can play a small part in speeding up that timeline. Pragmatic optimism… engage! Here’s hoping for a cleaner future.

Until next time…

1. One of many examples of a tricky challenge: how would marine travel and shipping be taxed when the ports of entry are not always the end destination for the products.