Download The Social Cost of Coal

The Social Cost of Coal: A Tale of Market Failure and Market Solution*
Todd L. Cherrya
Department of Economics
The Appalachian Energy Center
Appalachian State University
Boone, NC 28608-2051
Jason F. Shogrenb
Stroock Distinguished Professor of Natural Resource Conservation and Management
Department of Economics and Finance
University of Wyoming
Laramie, WY 82071-3985
30 September 2002
*The authors would like to thank Harvard Ayers, Jamie Beard, Peter Frykblom and Matthew Wasson for helpful
comments on earlier versions.
a
phone: 828.262.6081, fax: 828.262.6105, email: [email protected]
phone: 307.766.2178, fax: 307.766.5090, email: [email protected].
b
Our demand for electricity drives our demand for coal. Coal-fired electric utilities
consume nearly 92 percent of domestic coal supply to cover about 52 percent of its electricity
generation. And while the coal market is the electricity market, the electricity market is not
necessarily the coal market. Utilities use a mix of other sources to cover the other 48 percent—
nuclear (22%), natural gas (15%), hydro (6.3%), oil (2.2%), biomass/municipal waste (1.9%),
and wind/solar/geothermal (0.5%). Each alternative source provides equivalent electricity to the
end-user and each entails different direct costs to the producer and external costs to society.
Relative to these alternative sources, we know coal is an inexpensive energy source—which we
like because that implies cheaper power to help us live more comfortable lives; but we also know
that coal is also a relatively dirty energy source—which we do not like because that implies
greater risks to the health of humans, ecosystems, and biodiversity.
So why do we, as a society, currently choose to use coal for electricity generation over
the alternative sources? Why might our current demand for coal not be the best choice for
society? And how may we most effectively converge our individual interests with society’s
interests?
The Power of Markets
Economics helps answer these questions of choice because it is a discipline of scarcity—the
study of how societies choose to structure their incentives and institutions to allocate their
limited resources. The goal is to understand how we structure society to do the best we can with
what we have—now and over time. Decisions under scarce resources are relevant for our
decisions about coal and alternative sources of energy. Throughout history, markets have
proven to perform extremely well in allocating limited resources among the unlimited demands.
People trust markets on a daily basis with some of the most valued and treasured aspects of life.
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The effectiveness of a market arises when it generates a price that accurately reflects the
tradeoffs faced by society; a price that accurately reflects all relevant information including all
costs, benefits, and the level of scarcity. The price provides the correct incentive for individuals
and firms to make choices consistent with society’s best interest. The price not only allocates the
resource so that it goes to the most valued use at the lowest cost, but it also reflects the scarcity
of the resource and correspondingly manages the level of consumptive and productive activity
related to that resource. As a resource becomes scarcer, the price increases—deterring
consumption and encouraging preservation and creation. Essentially, markets generate prices
that communicate both the laws of nature and the laws of man, motivating people and firms to
act according to society’s best interest.
The Failure of a Market
But markets can fail. If the market price does not reflect all relevant information, the price sends
mistaken signals to members of society. Inaccurate signals lead to regretful incentives, which
lead to ill-advised behavior and a misallocation of our limited resources. The use of a resource
will not yield the best outcome for society, i.e., there will be too little or too much economic
activity. A common reason that market prices fail to reflect society’s concerns are external costs,
or externalities—when a person or firm does not bear all the costs or receive all the benefits of
his or her action. An externality exists when the market price does not capture the social costs
imposed on society. A divergence exists between private interests and social interests, and the
greater the gap the more severe the consequences of the market failure.
Externalities are everywhere but in most cases, the divergence between private interests
and social interests are not significant enough to warrant costly intervention. Externalities
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related to environmental resources, however, are often substantial because of the significant
indirect costs individual actions impose on society. Coal-fired energy is a prominent example.
Today few of us use coal directly to heat our homes or to generate electricity. Rather we
demand energy from electric utilities, and some of them in turn demand coal as their input of
choice. Indirect coal users (e.g., households, firms, government) use coal-fired energy
according to their private benefits and their private costs (i.e., market-clearing price). If the
price of coal-fired energy fails to capture the external social costs incurred by society—such as
environmental and health effects, too much coal-fired energy is demanded. And if the market
price of coal or energy or both does not capture the social costs of coal use, individual coal users
face incentives that suggest more consumption than society desires relative to alternative sources
of energy.
A Market Solution
Even when markets are a problem, they can be the cornerstone of the solution. Market solutions
might not work for all cases, but when feasible they typically offer a superior outcome relative to
alternative schemes. While a regulatory approach may achieve the same end target, the market
approach provides the means to achieve the outcome at a lower cost—often substantially lower.
Market solutions provide the flexibility to provide more environmental protection at less cost.
Meeting a desired environmental target for the lowest cost matters to society because total
resources are scarce—lower costs means more resources to target other desirable social goals
like health care, education, species protection. One should view markets as our servant not our
master.
A market is a tool whose precision depends on how society defines the rules to regulate
its behavior. People and firms respond to incentives and will generally act in their best interest.
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If behavior is undesirable from society’s perspective, change the rules of the market. The altered
incentives will cause changes in household and firm behavior. Regulation can also change the
incentives but in addition to be more costly, regulation is less effective because of loopholes and
the ever-present unintended consequences. Examples of unintended consequences include the
requirement of clean coal stimulating the practice of mountaintop removal and the installation of
scrubbers substantially increasing the discharge of hazardous solid waste. When possible,
market prices offer a straightforward venue to alter the central incentive driving household and
firm behavior. If too much coal is being consumed from society’s perspective, make alternatives
more attractive with subsidies or make coal more expensive with taxes. The price adjustments
alter the relative prices, which then affect our incentives to reflect more accurately the actual
social tradeoffs of our choices. All sources of energy have their own set of potential social
costs—coal is not the exception. To reduce the risk of unintended consequences of wellintended policies, the environmentally responsible solution to energy use would consider a set of
energy subsidies and taxes for all energy sources—coal would not be treated in isolation.
We now summarize the answers to our initial three questions. First, we, as a society,
choose to largely use coal for electricity generation over the alternative sources because coal is a
relatively inexpensive source of energy, as priced by current market conditions. Relative prices
provide the incentives that drive the choices of households and firms. If relative prices make
coal the best choice for individual households and firms, coal will inevitably be the preferred
source of electricity. Second, our current demand for coal may not be the best choice for society
because coal is also a dirty energy source. Significant external costs exist with coal use,
including health and environmental effects. If the relative social costs of alternative energy
sources are not reflected in market prices, the relative prices provide the ‘wrong’ incentives for
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households and firms, and the resulting choices may be inconsistent with society’s best interest.
Third, we can address this failure of the market with market adjustments. While regulation may
achieve the same end, market adjustments reach the desired outcome at a lower cost while
avoiding loopholes and negative unintended consequences. By altering the underlying incentive
of prices with subsidies or taxes, relative prices can reflect society’s tradeoffs and households
and firms will voluntarily act according to society’s best interest.
The Social Cost of a Short Ton of Coal
Converging our individual interests and society’s interest involves closing the gap between the
price of coal and the social cost of coal. While the price of coal is readily available, deriving the
social cost of coal requires one to isolate the social damages from the net private benefits we
derive from coal use. We need to consider both the natural and social sciences to understand the
nature of the potential health and environmental costs—risks of more death and illness,
ecosystem damages, and risks to species. Translating these impacts into an exact cost figure is a
serious challenge. While the estimated damage does not have to be precise, the goal is to
continue moving the estimate in the correct direction—one that better reflects social costs. This
is the task of continued research.
Table 1 lists the key elements of the coal cycle—pre-mining, extraction, process and
disposal, transportation, utilization, and other costs. Each element of the cycle has both private
and social costs associated with coal, as illustrated in table. Pre-mining activities include the
permitting costs and land use, which implies lost productivity of land, lost opportunities for
carbon sequestration, loss of wildlife habitat, and increased risks from flooding. Coal extraction
involves several potential private and social costs including impacts of blasting, property
damage, water and air contamination, noise pollution and stress, accident, injury and death of
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workers, impact on aquifers, disruption of hydrologic balance, decreases in property values,
ground subsidence or collapse, and pollution of wetland, creek and stream drainage. The
processing and disposal of coal can affect the creation of sludge and impoundments and dams,
acid mine drainage, heavy metal leachates, 'synthetic' fuels in processing, permitting and
regulating costs, insurance costs for life of impoundment, damage to water quality from
impoundments, and the loss of habitat from impoundments.
The transportation of coal also creates private and social costs including damage to roads
and bridges, more barge and water transport, railroad construction and maintenance, additional
dust, more enforcement, and deaths from accidents. The use of coal for electricity generation
creates several impurities include air pollution from particulate matter, Nox, Sox, CO2, Mercury,
which can lead to more asthma and respiratory ailments, premature deaths, commercial and
recreational fisheries losses, and impaired visibility (e.g., recreation).
Note that this long list of potential effects include both private costs captured by market
prices and social costs left unpriced by the market. Market prices reflect the private costs of coal
use because markets already exist for land, inputs, energy use, insurance, and outputs. Markets
capture the marginal private costs and benefits associated with coal use. Therefore, the market
price of coal captures items such as permitting (cost of operations), lost market opportunities of
land use (opportunity cost imbedded in land prices), transportation risks and costs (costs
imbedded in insurance and taxes), and injury and deaths of workers (costs imbedded in risk
premium of wages). Further, in some cases, the costs associated with individual impacts in
Table I overlap, e.g., decreased in property values inherently captures the impact of noise
pollution, property damage, and local air and water contamination. However, the social costs are
unpriced by the market. Thus, the market price fails to capture items such as the non-market
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benefits associated with alternative land uses (e.g., carbon sequestration and wildlife habitat), the
uncompensated emotional harm to local communities, and the adverse health and environmental
impacts from pollution (e.g., asthma, carbon emissions, climate change, etc.) The goal is to
estimate the likely marginal social damage associated with coal use. Society’s goal is to
establish subsidies and taxes so private market decisions lead the system to equate marginal
benefits to society equal both the marginal social and private costs.
Consider now what economics and science has to say about the social cost of coal use.
Note that considerable work has been done estimating the “carbon tax” that should be levied on
all fossil fuels (including coal) as a tool to reduce carbon emissions (see the IPCC, 2001). The
estimates imply the social cost of carbon emissions but aggregates all fossil fuel use because
most global climate economics models do not separate out coal from the other fossil fuels. But
studies that do explicitly separate out coal from other energy sources provide a starting point.
For all the estimates considered, the reader should bear in mind that all external costs should be
taken in the context about the assumed population exposed, background ambient air quality
conditions, and meteorological conditions.
First, we examine a rough range of potential monetary damages associated with energy
use, including air pollution, water pollution, national security, and solid waste. Focusing on two
categories, Hall (1990) examines the marginal social costs of air pollution and acid rain, and
greenhouse effects from climate change. Using the traditional damage function valuation
method combined with obtainable data from existing models and several assumptions about the
form of dose-function relationships, estimates of the annual marginal cost of air pollution and
acid deposition range between $10.39 and $11.02 per ton of coal; and the marginal cost of
climate change due to coal at $0-4.50 million British thermal units (MMBTU). The air
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pollution/acid rain values were estimated based on reduced risk to human health, reduced
damages to materials (e.g., buildings), improved visibility, reduced damage to agricultural
production, and less impacts of forests. The range of greenhouse gas marginal damages were
based on the presumptions of no climate change to a carbon emission abatement cost of about
$50 per metric ton.
Based on these estimates and the cumulative costs associated with energy
sources, the estimates indicate the social costs of coal as a percentage of private costs range from
about 40 percent to 275 percent without and with considering climate change. In contrast, the
estimates for the social costs as a percentage of private costs are 12-95 percent for natural gas,
112-123 percent for oil, and 14-17 percent for nuclear. The energy taxes associated with these
percentages would alter energy choices and would raise billions of dollars for the general budget
or earmarked for environmental programs or to reduce other taxes (e.g., income tax). One
should consider the warning that these are rough estimates based on the limited data and back-ofthe envelope assumptions required to extrapolate to the entire nation. These are lower bound
estimates given the data limitations. The general equilibrium impacts, however, were not
addressed using this approach, which causes estimated marginal costs be biased upward—
adaptation to higher coal prices would lower the use and hence the marginal costs. Which bias
dominates in unclear.
Further research reveals insights offer the next step in the broad-based consideration of
environmentally responsible energy pricing. Assessing some of the non-climate change social
costs associated with energy sources, Viscusi and Magat (1994) provide insights by comparing
coal with various forms of petroleum (e.g., gasoline, diesel, aircraft fuel, heating oil, and natural
gas), and wood. The analysis focuses exclusively on the risks cause by pollution from
combustion and excludes wind, solar, and geothermal energy sources because of the low levels
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of negative environmental effects. Nuclear power is also ignored because of limited data
regarding risk assessment or comparable definitive analysis.
For each energy source including coal, the analysis considered seven pollutants that
create external costs—residual lead in gasoline, emitted particulates, sulfur oxides with and
without mortality impacts, ozone, visibility, and air toxics from motor vehicles. The goal is to
approximate the marginal damage per pollutant from each source. Every energy source, for
example, creates external costs from particulate emissions, estimated at 9 percent of the gasoline
price, 23 percent of the diesel price, 11 percent of aircraft fuel price, 6 percent of heating oil
price, less than 1 percent for natural gas prices, about 150 percent of wood price, and 25 percent
of the price of coal.
Assuming demand for energy source was constant, estimates suggest that
over two-thirds of the social costs would be attributable to coal—taxed at about $237 billion
annually. Looking at the social cost of coal, we see that external costs by pollutant range from a
high of 464 percent of the price of cost for sulfur oxides with mortality, 25 percent of price for
emitted particulates, 22 percent for visibility, 13 percent for sulfur oxides without mortality, 3
percent for ozone, and zero for the others. The results show that coal is by far the most underpriced energy resource: the price per ton of coal was about $30, but the external costs are nearly
$160. Also including climate change risks, the external costs would be about $190 per ton.
A main reason for the difference in the two estimates arises from the value of reduced
mortality risk associated with sulfur oxides. The monetary value of lives saved is the main
driver in external costs for nearly every debate in environmental, health, and safety regulation,
and coal is no exception. At the upper bound, the value of lives saved makes up about four-fifths
of the social cost of coal. Greater values increase the odds that the benefits of any given
regulation will be worth the extra costs. Reviews suggest that the most reasonable values are
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between $1.6-8.5 million and $3-$7 million, from the overall range of $100,000 to $10,000,000
(Fisher et al., 1989; Viscusi, 1993), the US Environmental Protection Agency currently uses a
value of $6 million per life saved as the value. And in fact, the relative importance of the value
of lives saved is also found in other non-coal studies. The value of lives saved generated nearly
90 percent of the total benefits (about $56 billion out of $60 billion in total) estimated by the
EPA in their recent review on the economic consequences of tighter regulations on diesel fuel.
Moving to a more thorough assessment of the external costs of the coal cycle, we see that
health effects associated with exposure to related pollution generate the largest external cost.
Data suggests the annual health effects from 7 million tons of SO2 and NO2 are more than
10,800 premature deaths; at least 5,400 incidents of chronic bronchitis; more than 5,100 hospital
emergency visits; and over 1.5 million lost work days. Impact analysis at the EPA suggest the
health and environmental benefits from a one ton reduction of SO2 at $7,300, while the cost is
less than $1,000. Oak Ridge National Laboratory and Resources for the Future (1994) confirm
that mortality risks arise as the biggest component on the external damages. All elements of the
fuel cycle that increase the risks of premature death create sizeable external costs, including
ozone exposure, and train and truck accidents. Estimates of the potential ecological impacts are
unquantified because of the lack of useful information on ecological dose-response functions.
Since few of the potential impact-pathways have sizeable external costs provides a reason why
researchers should focus on what is known and unknown about those impacts that do have a big
impact—like risks to human life and limb. It is not accurate to simply add up external costs
across the coal fuel cycle due to double counting of costs, not considering all secondary impacts,
the inability to reliably quantify some impacts, estimating damages but not externalities, and
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finally, adding independently measured willingness to pay estimates across different impacts
may overestimate total damages.
Conclusion
People in the United States use coal because it is a relatively abundant and inexpensive
source of energy. Today we use coal to meet about half of our electricity demand. But coal can
also be dangerous and dirty, which are downsides. More coal use can imply more particulate
matter in the air, carbon emissions around the globe, and sulfur dioxide in our lakes and streams.
And while the current tax per ton of coal is about 40 percent of the market price, estimates of the
environmental costs range from 300 to over 650 percent of the market price. For a price of $30
per short ton, that translates into an after tax price between $100 and $200 per short ton—the
midpoint being a conservative estimate of $150 per short ton. And we also see that the increased
mortality risks imposed by coal use is the most significant driver behind the high external costs
of coal—perhaps as much as 60 to 75 percent of the external costs. If we consider these as
conservative estimates of social costs as some observers have argued, the market price of coal
fails to reflect a significant portion of the social cost of coal. With incorrect relative prices,
households and firms face incorrect incentives to act in conjunction with society’s best interests.
This observation goes beyond coal. The market might have mis-priced the social costs
associated with coal use, but we can use the market as the mechanism to correct this discrepancy.
We can use a set of subsidies and taxes to adjust the relative prices so the market provides
incentives that more accurately reflect the environmental consequences of our energy sources.
Using market solutions to correct market failure captures the reality that the economy and the
environment are two inherently linked systems. Society use economic systems to allocate
resources within environmental conditions such that the workings of these systems are jointly
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determined. The systems affect each another through feedback, which means that economic
policy is environmental policy and visa versa. Policies that do not incorporate both the
mechanical underpinnings of the natural sciences and the behavioral underpinnings of economics
will ultimately be self-defeating. Policy that do address both can be more effective at providing
what we all want –more environmental protection at less cost.
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Table 1. Direct and External Costs of the coal fuel cycle
Stage
Direct or Indirect Impacts
1. Pre-mining
♦
Land Clearing
⋄ lost productivity of land
⋄ lost opportunities for carbon sequestration
⋄ loss of wildlife habitat
⋄ increased flooding
♦ Cost of permitting
2. Coal Extraction
♦
3. Processing and disposal of coal
♦
4. Transportation of Coal
♦
blasting
♦ property damage
♦ water and air contamination
♦ noise pollution
♦ worker injury and death
♦ disturbance to aquifers and hydrologic balance
♦ decreased property values
♦ ground subsidence or collapse
sludge and impoundments and dams
♦ acid mine drainage
♦ heavy metal leachates
♦ 'synthetic' fuels in processing
♦ permitting and regulating costs
♦ insurance costs for life of impoundment
♦ damage to water quality from impoundments
♦ loss of habitat from impoundments
Damage to roads and bridges
Barge and water transport
♦ Railroad construction and maintenance
♦ Enforcement
♦ Deaths from accidents
♦
5. Utilization (e.g., combustion)
Air Pollution
⋄ particulate matter
⋄ Nox
⋄ SOx
⋄ CO2
⋄ Mercury
⋄ asthma and respiratory ailments
⋄ deaths directly related to pollutants
⋄ impacts of pollutants on fisheries
⋄ impacts on viewsheds
♦ Solid Waste (post-combustion)
♦
♦
Worker Health and Safety
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