California drivers have been delighted to see gasoline prices dropping lately, down more than a dollar a gallon since early summer. It's no mystery what's causing it: Crude oil prices have fallen steeply, lowering the cost for refiners that process crude into gasoline. In the competitive refining business, when costs change, prices quickly follow.
That same relationship is going to drive prices up in January, though maybe not by enough for you to notice.
Under California's cap-and-trade program to reduce greenhouse gas emissions, after Jan. 1, wholesale gasoline distributors (mostly refiners) are going to be responsible for the emissions from their fuel. They will have to buy, and eventually turn over to the California Air Resources Board, one emissions allowance for every metric ton of greenhouse gases you emit when you burn the gasoline or diesel they sold you.
The calculation looks like this: When you buy one gallon of California gasoline, the seller will have to cover about 18 pounds of emissions. At the current price of allowances — about $12 per metric ton — that works out to about 10 cents per gallon of gas. So, in early January, the state's cap-and-trade program will increase our gas prices by about a dime.
Cap-and-trade creates a market for allowances, so the price can fluctuate. The idea is to let the market find the price that will give producers and consumers incentive to reduce their emissions to meet California's environmental goals while minimizing the economic cost to the state's economy.
In a study that I did with colleagues at the University of California and Stanford (with financial support from the air resources board), we found that the allowance price is most likely going to rise very slowly, in a range that would drive up gas prices about 14 cents per gallon by 2020, after adjusting for inflation. We found a small, but real, risk that the effect could be much greater a few years from now, but we also proposed changes to the program that would greatly limit that risk.
Unfortunately, as the date for expanding cap-and-trade to transportation fuels approaches, both the program's opponents and supporters have been exaggerating how much or little impact it will have on gas prices.
The oil lobby, which has fought for years against including gasoline in the cap-and-trade program, is claiming that the change will raise gas prices 16 to 76 cents. That range is based on two analyses that were done many years ago, before the program began and before a market price for allowances had been determined. The oil industry knows what allowances actually sell for today, and they know those allowances will raise gasoline costs only about 10 cents a gallon in January, a figure that isn't even in the range they are touting. But they are choosing to stick with the outdated — and scarier — estimates.
At the same time, some proponents of including transport fuels in the cap-and-trade program are saying that Big Oil is not required by law to raise its prices, so it will be its own choice if it does, not the fault of the cap-and-trade program. This is just as disingenuous as the oil company arguments.
Every analysis of cap-and-trade — or of a gas tax or, for that matter, of movements in the price of crude oil — finds that a change in the cost of selling gasoline, up or down, is quickly and fully passed through to consumers. The 10-cent change will show up at your neighborhood station within at most a week or two after Jan. 1.
So, how much will the increase affect you? According to the California Board of Equalization, Californians each day burn about 1.24 gallons of gasoline and diesel per person, including use in their own vehicles and indirect consumption through the businesses that serve them. That means an increase of 12.4 cents per person per day, or about $15 per month for the typical family of four.
That money goes to the state when it sells emissions allowances to oil refiners and other fuel wholesalers — about $1.7 billion a year at current prices. The plan is to spend it on clean energy and sustainability programs, including building the proposed north-south bullet train, subsidies for buying low-emissions vehicles and help for low-income households to afford energy.
But just as important, by establishing a price for emissions, California sends a signal to the rest of the country and the world that we recognize the risk of climate change and are willing to take actions to address it. The 10-cent increase isn't going to reduce gasoline consumption much, but it's a start. Cars and trucks put out 40% of the state's greenhouse gas emissions, so any program to address climate change must include transportation.
No one thinks California's climate change program alone will solve this global problem, but if advanced economies like ours aren't willing to step up, there will be no solution at all.
Severin Borenstein is an economics professor at UC Berkeley's Haas School of Business. He specializes in energy markets and regulation.