Economics: Methane Waste-Emissions Charge

Source: International Energy Agency

The First Welfare Theorem of economics asserts that, so long as there are proper market conditions, rational agents will produce the maximum general welfare for society. In environmental and resource economics, though, such conditions are the exception, not the rule. Because the atmosphere is an open-access resource—a public good that is non-excludable and non-rivalrous—there are several opportunities for externalities, and, subsequently, market failures.

The Inflation Reduction Act of 2022 seeks to redress some of these problems with prudent, market-based interventions. While much of the climate action measures in the bill involve “carrots,” or incentives, such as tax breaks and credit programs, there is one notable “stick” for the fossil fuel industry. The IRA includes an emissions charge on methane, which is the primary component of natural gas and the second largest cause of anthropogenic global warming. The fee, which starts at $900 per metric ton of methane in 2024 and increases to $1,500 after two years, applies to facilities that must have annual reported methane emissions exceeding 25,000 metric tons of carbon dioxide equivalent. The charge—the first federal tax on greenhouse gas emissions—will push producers to reduce emissions by installing better equipment, increasing monitoring, and capping leaks. Because of the near-term warming potential of methane emissions—that is, 80 times more potent than CO2 in its first 20 years in the atmosphere—the tax is not only one of the most cost-effective mitigation policies, but it will also play a critical role in staving off the worst impacts of climate change. This paper explores the economic effects of methane charges with regard to remediating environmental externalities, generating cost-effective solutions, and producing net benefits for society.

The chief purpose of the methane fee is to make polluters pay by internalizing the external cost of emissions. Absent an emissions tax, a firm will set its marginal benefit from extracting one unit one unit of gas equal to the marginal cost of extracting it. What is ignored, however, is that some of this methane gas routinely leaks during production, gathering, processing, transmission, storage, and distribution. Methane can leak because of faulty equipment or operational abnormalities, like open valves or corroded machinery. Methane is also intentionally spewed through venting or flaring, which occurs either for safety measures, or because companies deem the gas economically unfeasible to bring to the market. According to the Interagency Working Group on the Social Cost of Greenhouse Gases, each ton of methane traps enough heat to cause $1,500 worth of damage to agricultural capacity, worker productivity, and human health. Albeit the private incentive for firms to capture and sell the leaked gas, it falls short—specifically, the incentive is a meager 1/10th of its social costs. As a result, relative to the social optimum, industries do not exert sufficient effort to capture emissions from leaks, vents and flares.

Instead of allowing producers to impose these health and welfare costs onto society, a methane tax rightfully places costs onto polluters. With a methane fee in place, a firm will select a leakage rate that sets the marginal cost of keeping one unit of gas equal to the commodity value of that unit of gas, plus the avoided emissions tax. The policy reflects that, although the optimal level of pollution is not zero, the negative health and welfare impacts of methane emissions ought to be reflected in its market price.

A methane tax is economically sensible because, especially with regard to its heat-trapping capability, CH4 has a low cost abatement curve. According to the International Energy Agency, the value of the captured methane is already sufficient enough to cover the cost of abatement; in other words, a large portion of emissions can be reduced at no net cost. Additionally, engineering-based cost assessments have found that industry can prevent methane emissions without adopting new technology or assuming high costs; rather, firms can plug wells, boost leak detection and repair (LDAR) efforts, and improve maintenance. There are also affordable technologies on the market already, such as electric-powered pneumatic devices, velocity tubing, or low-emission valves. Overall, operators have found that many strategies have positive net present values, and that their rates of return meet firms’ investment criteria, because the value of recovered methane outweighs the incremental capital and operating costs. In comparison to other climate mitigation undertakings, therefore, methane is a low hanging fruit with regard to abatement costs.

In addition, the tax allows for flexibility and least cost decision-making. Technology standards can yield inefficient outcomes due to their inflexibility. For this reason, several institutions, like the World Economic Forum, champion a methane fee. Instead of a technology mandate, a methane fee allows firms to pursue the least costly abatement opportunities. Executives can choose firm-specific initiatives contingent on factors like its energy mix, geography, position in the supply chain, or its local policies. Lastly, the oil and gas industry has exhibited a proclivity for innovation, as demonstrated by the advent of hydraulic fracturing itself. The methane fee, coupled with the millions of dollars in grants, rebates and loans available in the IRA for mitigation development strategies, give the oil and gas industry strong incentives to explore solutions that reduce both their emissions and their expenditures.

The expediency of methane charge is reflected in its cost-benefit analysis. The costs associated with methane charges are minimal; economist Levi Marks found that, with an appropriate fee, “[emissions would fall] by 76 percent at a net cost of 0.93 cents per Mcf sold. As this is less than 1 percent of the wellhead price of gas anywhere in the country, natural gas is likely to remain competitive in a world where fugitive methane emissions are incorporated in climate legislation." Similarly, Jeff Rissman, Head of Modeling and Energy Policy Expert at Energy Innovation LLC, postulated that, over the next two decades, IRA’s methane charge would incur $90 billion in abatement costs and $43 billion in fee payments, which is only 0.77 percent of the industry’s projected $17.2 trillion revenues over that period. And, of course, as aforementioned, much of these expenditures will be reimbursed by the trapped methane itself. It is clear that the costs of this policy are negligible.

The benefits, on the other hand, are immense. The imposition of a methane fee comes with several co-benefits. First, the fee will reduce industrial emissions by 172 metric tons of CO2 equivalents per year by 2050, which is equivalent to 11 percent of today’s U.S. industry sector emissions. Because methane is potent, yet short-lived, this represents a fruitful lever for seeing an impact on climate change within our lifetimes. It can reduce the danger of facilitating pernicious feedback loops or accelerating climate tipping points, especially in the Arctic. Second, reducing CH4 emissions will also reduce the ambience of volatile organic compounds (VOC’s) and hazardous air pollutants. Because methane contributes to ground-level ozone, reducing emissions could reduce premature deaths, asthma-related hospital visits, and lost labor hours from extreme heat. Lower methane concentrations can also increase crop yields at a time of growing food insecurity. Evidently, the benefits of lower emissions are profuse.

The fee would also generate tangible benefits for the American economy. Modeling from Energy Innovation LLC suggests that investments in new equipment, as well as tax revenues generated from the fee, will add $250 billion to the U.S. GDP and create more than 70,000 jobs by 2050. Methane mitigation firms, including leak detection and repair, advanced data analytics, mitigation technologies, and strategic advisory firms are all increasing in size, with new locations and firms opening across the country. As such, abatement endeavors will create thousands of job opportunities in the trade, engineering, consulting, chemistry, geography, business and administrative fields. The benefits for the American economy are profuse, and are certain to grow with time.

There are few climate mitigation policies that are as opportune, both in terms of cost-effectiveness and environmental efficiency, as methane abatement. The introduction of methane pricing at a federal level is a strong step forward in climate policy; by employing market-based interventions, the government is spurring innovation, creating jobs, reducing waste, increasing human health, and mitigating climate change. It is also delivering greater economic returns for taxpayers, states, tribes and royalty owners. Any costs incurred to minimize methane emissions are far outweighed by the social, economic, environmental and health benefits of a cleaner atmosphere. The free market will not solve the methane problem on its own, but by harnessing simple economics, smart policies like the methane fee can solve the wicked challenge at hand.