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Joe Nocera’s wrong: A carbon tax wouldn’t help Canada’s tar sands

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In his column on the Keystone XL pipeline today, Joe Nocera argues that a tax on carbon emissions would actually provide a boost to advanced fossil-fuel projects like the tar sands in Canada. That's not quite, but it's worth exploring why in a bit more detail.

First, let's step back and start with basics: When the market price of oil rises for a sustained period of time, two things typically happen. Consumers start using less of the stuff, if they can. And oil producers, for their part, start drilling in harder-to-reach areas that were once unprofitable.

A good place to see this has been in Canada. The tar sands in Alberta do contain oil, but it's heavy, viscous stuff that doesn't flow well. The bitumen either has to be strip-mined or treated with steam or other solvents. That process is more expensive than regular drilling, and it's hard to make money on new tar-sands projects unless the price of crude is above $60 to $80 per barrel. That explains why the boom in Alberta's tar sands is a fairly recent phenomenon. Until prices rose, much of the oil wasn't profitable to harvest.

However, it doesn't follow that a tax on carbon emissions would have a similar impact. Let's take a look at Nocera's argument:

[NASA's James Hansen] told me he would like to see oil companies pay a fee, which would rise annually, based on carbon emissions. He said that such a tax could reduce emissions by 30 percent within 10 years.
Well, maybe. But it would also likely make the expensive tar sands oil more viable. If you really want to eliminate expensive new fossil fuel sources, the best way is to lower the price of oil, which would render them uneconomical.

The bolded part is the problem. Imagine that the market price for oil was $50 per barrel. Many companies wouldn't find it profitable to expand into Alberta's tar sands. Now, say that the Canadian government comes along and suddenly imposes a carbon tax that's worth $30 per barrel of oil. Crude now sells for $80 per barrel, yes, but $30 of that goes to the government. Those companies still wouldn't find tar-sands extraction worthwhile.

And that's a simplistic scenario.* Odds are, a tax on fossil fuels would also cut into consumer demand. That would lower the underlying market price, making projects like the tar sands even less appealing. Consider also that oil from Alberta's tar sands creates 14 percent to 20 percent more greenhouse-gas emissions over its lifespan than other types of crude. So it would be at an even greater disadvantage in a carbon-tax world.

A carbon tax is essentially a way for policymakers to increase the price of fossil fuels and curb consumer demand without giving producers more incentive to exploit harder-to-reach supplies. There are plenty of arguments for and against a carbon tax, but by itself, it wouldn't give an added boost to pricey new fossil-fuel sources.

* (A really, really simplistic scenario. It's also possible that part of the burden of the tax would fall on producers, as Greg Mankiw has argued. Plus we haven't even considered what would happen if OPEC intervened in response, etc.)

Further reading:

--The basic economic concept we're discussing here is the "tax wedge." Here it is in chart form.

--How would a carbon tax work? Let's ask British Columbia.

--Just how dirty are Canada's tar sands, anyway?