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