[lbo-talk] Goldman on global warming

[Doug Henwood]

[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