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Keystone Pipeline and the Carbon Tax: A shotgun marriage that can work

David Zilberman, professor, agriculture and resource economics | January 26, 2015

We recently learned that Senators Pat Toomey (R-Pa.) and Dianne Feinstein (D-Calif.) suggested amending a bill that approves the building of the Keystone pipeline and abolishes the corn ethanol mandate. This is a very unwise proposal. If Congress needs a face-saving way to approve the Keystone pipeline, it should be done in a way that enhances the national interests rather than erode them.

I suggest an alternative amendment of a 50 cent gasoline tax (or better, an equivalent carbon tax) with the proceeds going towards infrastructure, reducing the burden of student loans, and/or reducing the burden of other taxes. In other words, keep the mandate and tax greenhouse gases.

There are interesting linkages between the Keystone pipeline, biofuel, and a carbon tax in my proposal. The Keystone pipeline that carries Canadian crude oils to the Gulf of Mexico is obviously unappealing. It provides a mechanism to move carbon-intensive petroleum and increases the profitability of producing oil from tar sands, and its existence is likely to enhance greenhouse gas emissions.

However, it is quite clear that the fuel will be utilized with or without it, and it will be shipped by means that are even ‘dirtier’ and more dangerous if it is not built. We recently witnessed a tragedy where 47 people were killed as a train full of fuel derailed in Quebec. The Keystone pipeline may decrease the likelihood of such events. Thus, from an environmental and public health perspective, the net benefit of the pipeline is questionable, even though I am quite sympathetic to those opposing it.

However it seems that if the pipeline is built to move, say, American oil produced from South Dakota to the Gulf, it probably would have been approved already. As I understand it, the legal system did not find the ‘smoking gun’ that justifies rejecting the pipeline, so the debate is political.

It seems that the U.S. environmental community and our administration are trying to impose standards on other countries that we cannot keep ourselves. We have to realize that we didn’t sign the Kyoto Protocol and the world remembers.

However British Columbia, a Canadian province, is the first region in North America that established a carbon tax, and we can learn from their example. Not supporting the pipeline might offend our Canadian neighbors for years to come. This stark political reality is likely to lead to an approval. The President has threatened to veto a proposed bill to allow the pipeline and he needs a face-saving way to justify not exercising the veto that will also satisfy the environmental community. But an amendment eliminating biofuel standards is the wrong choice. A carbon tax would be a real contribution to the health of the planet.

The investment in infrastructure to produce oil from tar sands, including the Keystone pipeline, was introduced because oil producers expected high oil prices. Such investments would be curtailed if expected future prices will be reduced–here is where the carbon tax becomes important. It will produce a wedge between the price consumers pay at the pump and price that producers receive, discouraging the expansion of GHG-intensive fossil fuels, and encouraging conservation and low-carbon alternative energy.

Corn biofuel has proven itself to be a viable alternative fuel. I was among the first who was alarmed by the food price effect of biofuel, and indeed food prices rose drastically around 2008. But, to their credit, corn producers adopted technologies that increased supply, and now with the mandate, the prices of corn have stabilized. If tomorrow the corn biofuel mandate is eliminated, the price of corn will plummet and politics will require introducing a heavy subsidy to the growers, and there will be new pressure to increase the price of oil.

Corn biofuel is not ideal from a GHG perspective (it reduced GHG emissions by 20 or 30% relative to gasoline), so it does not deserve a big subsidy, but still it makes a contribution. More importantly, the mandate encourages investment in renewable fuels because it is assured a market for the product, requiring oil refineries to use the fuel and potentially reducing their profits. Now there is evidence that the corn biofuel program has been effective and no longer needs an explicit subsidy, but the mandate provides protection against the producers of fossil fuels that represent their competition. While there is evidence that subsidies for some biofuels have been excessive, performance of corn ethanol assured investors that biofuels and renewables can be viable, and after a few years of support, they can stand on their own. I don’t expect the mandate to last forever, but it should be evaluated on its own merit within a larger context, rather than hastily written into a Keystone bill.

Because of biofuel and fracking, the monopoly power of OPEC has been reduced; this contributes to their reluctance to reduce oil production and to increase prices. When prices are low, there is no incentive to invest in production, but consumers may increase their demand, which will lead to an increase in future prices, spurring new investments in fossil fuels. A carbon tax will increase the price consumers pay, slowing their demand. Since consumers have become used to paying much higher prices for gasoline, their objection to a carbon price now will be much lower than if it was introduced during a period of high prices. Since cleaner fuel would be subject to a lesser tax (or be exempt altogether), it will give them an advantage in the market and encourage the energy sector to ‘think outside the barrel’.

If the country has to swallow the Keystone ‘pill’, we should use it as an opportunity. Some GOP lawmakers are rumored to support a carbon tax and tying it to the Keystone would provide additional political cover. So a bill approving the Keystone with a carbon tax amendment will maintain our friendly relations with Canada and benefit the environment.

Comments to “Keystone Pipeline and the Carbon Tax: A shotgun marriage that can work

  1. The Keystone only exists to take dirty tar sands bitumen from Canada to the Gulf of Mexico. There is only a minimal economic benefit for the US. This is no different than if a Canadian mining interest wanted to move asbestos through the US for their own economic well-being. Just say NO to Tar Sand Oil crossing the US border.

  2. Interesting reading people screaming about the Keystone pipeline and comments like the one above that claims there is very little economic benefit to the USA. Did you realize that most of the Tar Sands projects are owned by US interests?

  3. This is to Joes’ comment on gradualy raising the rate, or even any one who wants to raise taxes. This is just like the storie of the frog. If the frog is placed in a pot of boiling water, he sinces the danger and jumps out. However if you placed the same frog in a pot of cool water and then gradualy raise the temputure of the water to boiling, the frog will not notice the danger. He will let himself be boiled to death.

    Thay are trying to do this with the middle class.


  4. MORE TAX!? Im with Joe Potosky on this one. Lets face the facts that if we tax the oil industry they will just pass it on to the consumer like they did with obamacare, which ends up hurting the middle class…

  5. Regional Economic Modeling, Inc. did a study where a fee would be placed on carbon at the source (mine, well or border in this case). They started at $10/ton and increased by $10 each year.

    Returning revenue back equally to all households would allow the fee to be increased more rapidly without shocking the economy, and would specifically provide some protection for low- and middle-class families from rising energy costs.

    Would Keystone XL or further tar sands development make sense for investors with the price signal of this rising carbon fee?

  6. The Keystone only exists to take dirty tar sands bitumen from Canada to the Gulf of Mexico. There is only a minimal economic benefit for the US. This is no different than if a Canadian mining interest wanted to move asbestos through the US for their own economic well-being. Just say NO to Tar Sand Oil crossing the US border.

  7. Your blog contains several errors. Alberta, the source of the oil sands, has the carbon tax. It is charged to major emitters and the money collected has to be used for technologies to reduce emissions. This has been in place for some time; in fact Alberta was the first in North America to introduce a carbon tax.

    The oil that exploded in Quebec was oil from North Dakota. It exploded due to the additional chemicals introduced from fracking. The Keystone pipeline will also carry oil from North Dakota to the gulf coast refineries.

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