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An Economic Argument for a Tax on Methane

methane tax policy choices

President Obama’s plan to reduce methane emissions in the oil and gas sector is a significant step forward in reducing U.S. greenhouse gas emissions.  As stated in the White House’s press release from Wednesday, co-benefits to state tax revenue and improved regional air quality make the forthcoming regulations even more important.  Industry should not be overly opposed to the new regulations as many emissions mitigation technologies have been shown to be cost-effective, with returns estimated to take 1-3 years.   

In conversation at the Center for Strategic and International Studies on January 14, Ryan Lance, CEO of ConocoPhillips, briefly addressed the upcoming methane rules with a luke warm response, saying he wished the voluntary measures had been given greater time to work. 

Mr. Lance’s comment recognizes that the oil and gas industry has made some strides in reducing methane leakage.  For example, green completions, which capture fugitive methane during the drilling phase, are becoming more common.  Plunger lift systems and more efficient compressors are also being utilized with greater frequency.

However, the truth is that the oil and gas industry is still accountable for an unnecessary amount of methane emissions.  The oil industry is also responsible for an egregious amount of flaring. 

Flaring methane, as opposed to allowing the methane to leak into the atmosphere, lowers net greenhouse gas emissions by converting the methane to carbon dioxide.  (Methane is 34x more potent of a greenhouse gas over a 100-year period according the latest IPCC report, not 25x as cited in the White House press release.)  Despite its relative climate benefits, flaring represents blatant economic waste, especially when we are furiously drilling for natural gas elsewhere.

During Mr. Lance’s comments he rightfully stated that the industry did not want to waste methane, as it is a sellable commodity.  However, the facts show that energy producers in recent years were more interested in drilling for oil.  With high oil prices, the industry was faced with a capital deployment problem – to drill more oil wells or investment in methane capture.  The decision in places like the giant Bakken field of North Dakota was the former.  As such, regulations to reduce methane emissions are necessary. 

From an economic perspective, technology rules, like those suggested by the White House, are not the most efficient form of regulation.  This is primarily true because specific technology requirements are inflexible.  A more efficient and effective solution to limiting emissions is to impose a tax on methane emissions industry wide.

The President and his staff are aware of the economic theory.  He has pursued his executive action strategy via the EPA because of Congress’s unwillingness to consider carbon policy.  And, of course, the word tax in Washington is a toxic discussion item.  It should not be in this case. 

Industry should prefer a reasonably priced tax because it allows for flexibility and least cost decision-making unlike specific technology regulations.  A tax would also be better for investment planning when compared to the potential of additional future regulation. 

The shale revolution and rapidly declining breakeven prices illustrate that the oil and gas industry is extremely good at technological innovation and bringing down the cost of production.  An appropriately priced tax would encourage the same drive to reduce mitigation costs below the price of the tax.      

The big political question is whether the GOP would support a new tax?  They should.

Any revenue generated from a tax on methane could be used to reduce existing taxes – like income, payroll or corporate taxes.  Such a plan would make federal tax revenue net neutral.  Capturing leaking methane from oil and gas also increases domestic energy production.  In this scenario, the GOP should support a methane tax based on their commitments to no new net taxation, limited regulation and energy independence.  Even Congressional climate deniers could get behind actions that promote local air quality and public health.

But, why bring this up now?  Oil and gas are being hammered by low prices.  Exactly.

When oil was at $100 new shale oil companies in the Bakken of North Dakota were flaring $100m a month in methane.  Why?  Because it was a better value proposition to produce more oil quickly than to capture comparatively low priced natural gas.  Now that the margin is smaller companies will experience a larger relative gain by capturing and monetizing waste.

Taxing methane leakage across the industry presents a unique policy opportunity due to its multiple economic and political benefits.  The readily available technology also means that a new rule could be enacted immediately.

Photo Credit: Methane Tax and Economic Policy/shutterstock

Nathan Ratledge's picture

Thank Nathan for the Post!

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Hops Gegangen's picture
Hops Gegangen on Jan 22, 2015 2:13 pm GMT

 

If the tax is on emissions, someone has to look for the emissions. At that point, why not just have a fine?

Sometimes a fine works better than a tax. I mean, we would’t put a tax on deflated footballs…

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