California’s Sustainability Agenda

World Energy Monthly Review

Author’s note: In 2002 California enacted vehicle efficiency legislation
requiring a reduction in tailpipe greenhouse gas emissions. In 2006 we
imposed a cap on statewide greenhouse gas emissions. And in 2007
we adopted a Low Carbon Fuel Standard that requires a reduction in
greenhouse gas per unit of energy from our transportation fuels. We
intend to meet these requirements without any diminution in economic
growth, and we believe meeting them will boost productivity, security
and quality of life. This essay explains why.

It is common wisdom that sustainability is an environmental
imperative. It is less universally understood that sustainability
is necessary for economic growth and security. Governor
Arnold Schwarzenegger of California recognizes the validity
of all three assertions and thus has made sustainable economic
growth a central theme in his administration.

Historically, economic development generally meant presenting
an environment that employers found an attractive location for
physical capital. Today, with California’s economy increasingly
more knowledge-based, economic development means presenting
an environment that is attractive to human capital. As a result,
clean air and water, abundant recreational activities, attractive
land use and other indicators of environmental quality are now
economic imperatives.

Similarly, California’s economy depends on energy, much
of it for the 24 million cars on our roads every day that are
critical to our economic well-being. Unless one considers the
funding and deployment of massive military resources needed
to protect access as “sustainable,” for economic risk one need
look no further than to our dependence on unstable and
faraway sources for 96 percent of our transportation fuels.
Likewise, sustainability is a security imperative. Worldwide
competition for raw materials, especially as China and India
grow, presents an increasing risk of military conflict.

Thus, the issue as the governor sees it is how California’s
economy can be converted into a sustainable growth engine.
This is a transformational task that will likely see the modification
of virtually every sector of our economy, one that generates
nearly $1.7 trillion of gross state product per year and has over
1 million employers and 17 million workers.

In Gov. Schwarzenegger’s view, this transformation will
occur only if and when suppliers and consumers fi nd it in their
own interests to engage in sustainable economic activity.
To date, few government policies have demonstrated many
successful paths in this regard. For example, federal government
policies over the past four decades have not succeeded in
reducing the United States’ dependency on oil. President
Richard Nixon called for conservation. President Jimmy Carter
sought to subsidize synthetic fuels. Others employed military
force to secure distant oil fields and subsidize corn ethanol.
Yet today the United States is still 97 percent dependent on
oil for transportation.

Cause for Optimism

Two examples, however, offer cause for optimism.

First, since 1980 California has nearly tripled its gross state
product per kilowatt-hour of electricity. As a result of policies
that decoupled utility returns from sales, provided incentives
for efficiency and established performance standards for
appliances and buildings, California has saved its citizens
more than $56 billion and avoided the cost of 24 power plants.
These steps cut both emissions and costs, thereby boosting
productivity and economic growth while improving the
environment. And we’re not done. Recently our public utilities
commission approved an even more aggressive energy-efficiency
incentives program.

Second, in 1990 President George H. W. Bush signed into law
legislation requiring a reduction in the sulfur dioxide emissions
from coal-fi red power plants that cause acid rain. That legislation
established performance standards but permitted flexible forms
of compliance, including trading. The net result was a dramatic
reduction in emissions at a fraction of expected cost. It was so
successful that President George W. Bush recently authorized a
further reduction in those types of emissions.

These examples illustrate the transformation that is possible
through the adoption of policies that match the size of the
problems being addressed and that harness market forces
in order to keep costs under downward pressure and induce
innovation and positive economic consequences. In the
governor’s view, a transformation to sustainability is not
possible unless governments employ policies that do the same.
In January 2007 the governor illustrated this transformational
approach when he established the world’s first Low Carbon
Fuel Standard (LCFS) for passenger vehicles. Transportation
is obviously critical to California’s economic growth, and with
cars accounting for 41 percent of California’s greenhouse gases,
California must reduce emissions from the transportation
sector if it is to succeed in achieving the strict greenhouse
gas limits the governor signed into law in 2006. The LCFS
does this by setting a greenhouse gas performance standard
for automotive fuels on a full life-cycle basis. It does not tell
suppliers how to meet that standard, however, and it allows
them to exchange credits with each other when they have
exceeded or fallen short of the standard.

By 2020, and without any financial assistance from the public
sector, the LCFS is expected to displace nearly 20 percent of
California’s gasoline consumption, increase the size of the
state’s renewable fuels market by three to five times, and boost
to 7 million the number of advanced-technology vehicles on
our roads. And that’s just the start.

We see the LCFS as a market-oriented “change agent” since
it creates an environment that induces technological change
but without limiting choice, providing subsidy, picking winners
or costing governments.

Promoting Alternative Fuels

Equally important, the LCFS fixes the principal reason why
already-invented alternative fuels have not caught on. Huge
amounts of financial and intellectual capital already have been
deployed into the research and development of alternatives
to oil, yet the United States remains 97 percent dependent
on it for its transportation needs. Even California, which has
devoted nearly two decades now to alternative fuels and is
a large potential market, is still 96 percent dependent on oil.
Why haven’t alternative fuels penetrated more of that market?

The principal reason has been uncertainty of demand.
Because oil prices fluctuate, no enterprise can be sure there
will be lasting demand for alternatives to oil. As a result, little
capital has been deployed into the expensive infrastructures
required to distribute those fuels. In turn, consumers and
car makers are justifiably leery of laying out capital for the
production or acquisition of vehicles that cannot be filled up or
serviced with as much convenience as a gasoline-powered car.

The LCFS changes this dynamic. Now everyone knows that,
regardless of oil prices, in California there will be sustainable
demand for alternatives. Indeed, the LCFS is expected to boost
annual demand in California for clean fuels by more than
$10 billion per year just by 2020 and escalate thereafter.

The policy is already transforming our fuels market. The
Wall Street Journal recently wrote about the new “gold rush”
in California as alternative fuel makers and distributors,
including well-established energy companies, compete to
penetrate our market with new or improved technologies.
Thus, in addition to transforming our fuels market, the LCFS
will boost the economy by increasing productivity and creating
a lasting market for clean-technology enterprises. Also, it
enhances national security by diversifying resource demand.

Underlying the LCFS is recognition by the Schwarzenegger
administration that the sharpest arrow in our policy “quiver”
relates to California’s massive demand for goods and services.
Pretty much every enterprise on the planet wants access to
our markets to satisfy our consumer demand. Accordingly,
tweaking that demand is a powerful way to induce change.
For example, by establishing an appliance efficiency standard
while leaving the competitive landscape untouched, we
modified demand but left it up to producers to battle it out and
consumers to determine the winners. Likewise, by establishing
a greenhouse gas performance standard, we leave it up to
producers and distributors to fight it out in winning customers.
As with any other product, producers and distributors still
have to win those customers with good quality, good prices
and good services, but they all have to leap over the same
hurdle to get to those customers.

By contrast, we see little evidence that “supply-side” approaches
have much of a transformational impact. On top of the fact
that money is not in excess supply at the government level, the money governments might be
able to provide is paltry in comparison to that amount needed to transform markets of these sizes. Worse, and as the current ethanol market demonstrates, government support on the supply side for select technologies, which in the case of ethanol takes the form of encouraging the supply of corn-based ethanol while discouraging the supply of cane-based ethanol, usually distorts markets to the detriment of the overriding goal. Thus, apart from university-level research and development spending, we do not see government support on the investment side as an effective change agent.

Needless to say, another virtue of a demand-oriented approach
is that it does not require government subsidies, tax breaks,
incentives or any other financial assistance from the public
sector. Instead it requires faith in capitalism. We have that
faith, provided there is no bar to competition.
Were the LCFS to be adopted by the United States,
businesses would be looking at a half-trillion-dollar alternative
fuels marketplace. Worldwide it is a trillion-dollar annual
market. Just imagine the exciting innovation and hard-nosed
competition as the world’s fi nest enterprises and minds
compete to win – and transform into something sustainable
– such a massive market.

A National Low Carbon Fuel Standard

So far 11 U.S. senators from both sides of the political
aisle have proposed legislation calling for a national LCFS
modeled on Gov. Schwarzenegger’s standard. The European
Commission has proposed an LCFS, and recently the newly
formed Midwest Regional Greenhouse Gas Reduction Accord
signed by 10 governors called for such a standard.

California is under no illusion that its sustainability agenda
can make the world sustainable on its own. For example, we
emit only 1 percent of the world’s greenhouse gas pollutants,
and that proportion is declining as the developing world picks
up steam. So we know that without the rest of the world as
a partner, we cannot defeat global warming. We also know
that the prospects for success in that regard are challenging
given that billions of our fellow world citizens are just now
emerging from poverty and presumably have little or no
interest in adopting measures that might slow down that
emergence. Thus, we believe continued and robust economic
growth is essential to success in bringing the world along in
our battle against global warming. Accordingly, California’s
most important role is very likely to be one of setting an
example for how to successfully transform to a sustainable
economy while maintaining robust growth.

David Crane is special advisor to California Governor
Arnold Schwarzenegger for jobs and economic growth.