Climate Change
March , 2014

Conferences come and go with a whimper, the supporters and detractors in agreement about disappointing results. But, clearly ambitions must be raised significantly if we are to hold the world to 2 °C variation in global temperature.

While many fail to agree global targets for carbon dioxide (CO2) emissions, I see this as an opportunity to regain entrepreneurial impetus in the approaches to address climate change. Science remains divided on technologies and the effectiveness of mitigation measures. As a result, business that seeks to commit funding to climate change investments – bearing any returns and risks – are looking for guidance that is of relevance to their decisions. Unfortunately, such clarity from science is unlikely to be available – not now or in the foreseeable future. Such is the degree of uncertainty that technologies that may prove effective in the next few years have yet to be developed.

In the face of this uncertainty, what are the options for business?

I do not see this uncertainty as an excuse for business not to take action. In fact, I see in the various strands of renewable energy technologies (RETs) cause for optimism that a CO2 free future is within our grasp. However, the route to this future may not rely on governments agreeing to implement global CO2 reduction targets, provide generous cash and subsidies, or create national champions out of known RETs. The solutions are likely to be local and driven by entrepreneurial prowess, rather than bureaucratic diktat.

Global climate debates are distracted from their economic merits by neo-Malthusian views on resource scarcity. For me, the aberration of a failed conference gives space for entrepreneurial impetus to reassert itself. We only need to be reminded of Stanley Jevons’ 1865 paper on The Coal Question. Jevons argued that British industrial pre-eminence was doomed to decline, given that coal could only be mined at ever greater depths and spiraling costs that would “cripple industries dependent on it”. He boldly declared that “it is useless to think of substituting any other kind of fuel for coal”. Since 1865, British industrial pre-eminence, while eclipsed by the United States, remains in the company of prosperous nations. Coal ceded its predominance to technology and fuels that did not exist in 1865.

Copenhagen Accord The Copenhagen Accord is a non-binding letter of intent to avert the catastrophic consequences of climate change. The signatories agreed to take note of the following: a) to recognise a 2 0C threshold for global temperature variation by 2050; b) a review in 2015 for possible downward revision of the target to 1.5 0C; and c) to create a US$30 billion Copenhagen Green Climate Fund. The Fund attracted most attention with donor countries offering to increase the size to US$100 billion by 2020.

The Fund seeks to assist the most vulnerable developing countries to adapt and mitigate the effects of climate change. To monitor progress, recipient countries undertake to communicate efforts every two years on implementing measures to limit CO2 emissions.

Supporters of the Accord point out that Copenhagen was a major step forward, in spite of its disappointing results. In the first place, the United States is fully engaged – which is in contrast to its disinterested (if not hostile) stance in the past. With the inclusion of China, India, Brazil and other South America countries, any post-Kyoto Protocol (i.e. included only 30 percent of polluters) agreement potentially includes all the major polluters in the world.

Why the 2 0C solution… and its consequences?

The framing of the Accord on reducing CO2 emissions to limit temperature variation to 2 0C is part of the problem. Science is divided on the impact of temperature variation, much less on a precise estimate for 2050. For reasons unknown, political debate zeroed in on 2 0C as an objective. For people accustomed to seasonal temperature swings, a 2 0C variation is no big deal. However, to sustain such a range over a long term average temperature, the costs can be horrendously expensive.

To achieve the 2 0C target, existing technologies would rely on energy conservation and innovation in power generation efficiency to deliver CO2 reduction. However, as higher reduction targets are implemented, the cost of reducing emissions becomes progressively prohibitive.

political commitments notwithstanding, the diverging dynamics of national interests may have been underestimated, if not ignored. During the preparatory meeting in Barcelona, Spain, The Climate Group presented their findings on the impact on long term GDP and employment growth, based on a number of policy scenarios. For example, the European Union (EU) going it alone would gain the most in additional GDP and employment growth (i.e. compared to no action). What stops the European Union from going unilateral, however, is the potential pain inflicted on other countries, such as the United States, Japan, China, India and Mexico. In contrast, global coordinated action benefits all countries – with China gaining the most.

The rub in this analysis, however, is in the significant degrees of error. Thus, while directionally, the results give policy makers some guidance, the pain for inaction is insufficient for countries to take urgent actions. Thus, we are in a stalemate – while the benefits of coordinated actions appear attractive, inaction does not inflict harm, thereby allowing countries the luxury to take a “wait and see” stance. In fact, this is the position most countries took giving rise to a paradox – apparently strong political and consumer support failing to translate into policy actions.

Combine this with the heavy commitment for the early movers; rational decision makers are bound to keep their options open. That is, while there appears to be a consensus on the virtues of a cleaner environment, investors cannot put their faith on an outcome that is so uncertain and so far off in time and benefits.

An alternative approach – taxation and technology choices

Erik Rasmussen, founder of the Copenhagen Climate Council, may have identified a way for entrepreneurs to regain the impetus. Over the past two decades, the accelerating growth in renewable energy was because of a combination of generous public support and subsidies, where technological innovation quickens its pace with greater deployment. Thus, Rasmussen observes that “reducing the emissions that will now have been so linked to our economic growth and betterment will be an enormous, unprecedented global challenge, but will also provide significant opportunities for sustainable growth, green jobs, development and innovation”.

While the vision identifies the attractive opportunities, the remedies proposed are less visionary. The six point agenda proposed by business leaders can be summarised as follows: More incentives (i.e. subsidies, price support) to increase deployment of low emissions technology; more funding for communities to adapt and mitigate; and performance based monitoring of emissions reduction by business.

Subsidies and support for specific renewable energy technologies, under a rapidly changing technological environment, represent a high risk strategy. Our ability to predict which technologies will win – and deliver over the course of the next decade – is limited by existing science. In itself, science’s ability to predict technological changes that can meet future emissions reduction more effectively than present technologies is doubtful.

What gives entrepreneurial impetus to “green” opportunities? In my doctoral research at Cranfield, England, I came to the view that getting the price of competing technologies to RETs is where we need to start. Specifically, coal, oil and gas emit CO2, with power generation and transport accounting for significant parts of emissions. However, CO2 emissions are treated as externalities, because there is no easy way of pricing them. As a result, the politically expedient approach is to subsidise RETs, rather than price CO2 emissions in oil, coal and gas.

This approach results in pricing distortions that favour coal, oil and gas. With society paying for its CO2, hydrocarbon based power technologies and transport are favoured because they are seen, mistakenly, as the cost effective alternative. To realise Rasmussen’s visionary aspiration, pricing CO2 forms the critical mechanics to exercise technology choices between RETs and hydrocarbon technologies.

While future RETs evolution is uncertain, backing technological champions with subsidies based on what is known today can be shortsighted. This is, in fact, the equivalent of Jevon’s Malthusian stance. That is, by subsidising known RETs explicitly, government is making a choice as to which technology will deliver the results in a decade. Unfortunately, just like Jevon’s coal argument, a number of known RETs could be replaced by more advanced and cost effective technologies that are yet unknown today.

For this reason, I propose we start with what we aim to achieve with policy interventions.

There is sufficient political consensus that clean environment is what we as a society prefer to have. Whether we believe this as part of a crusade for global salvation, or plain and simple business opportunity, we can agree on this premise. In effect, what we want is a clean environment (as an objective) with reducing CO2 emissions as the means to achieve this. Seen in this context, the 2 0C solution may indeed appear to confuse the means with the objective.

To achieve this carbon-free future, we know what power and transport technologies contribute to CO2 emissions. Hence, by penalising through taxation and appropriate CO2 pricing, the appropriate costs of CO2 emissions become internalised. In the process, with hydrocarbon technologies no longer looking as “cheap”, innovations to replace them with RETs are given impetus. This is where the entrepreneurs come in to lend a hand in translating technological innovations into commercial opportunities.

An impossible dream? Banning Chlorofluorocarbons (CFCs) spurred the development of a viable alternative – not the subsidies to develop replacement technologies. So, how much in taxation do we need to add to hydrocarbon based technologies?

This is answered by comparing the “levelised” costs of energy, a method of estimating the comparable costs of different technologies. At an oil price of US$60/bbl, onshore wind operated in areas with high wind availability can compete with gas. Compared to coal, on a fully taxed basis (i.e. CO2 emissions), onshore wind is more competitive. Interestingly, hydro, geothermal and nuclear, all non CO2 emitting power generation technologies, are more cost competitive than gas and coal. The carbon tax (or cost) needed to achieve RETs grid parity is less than the marginal cost of carbon.

Contrary to the anti-tax arguments, RETs, such as wind power, can compete effectively by applying indicative prices for CO2 emissions associated with coal, oil and gas. Taxation has the virtues of being transparent, certain – and hits the wallet were it matters. For large scale users of hydrocarbon based energy, taxing CO2 represents an effective way of encouraging the search for alternative technologies and ways of generating CO2 free energy.

Now, we just need to find an agile politician to sell this proposition to their constituencies.

Public/private cooperation Official consensus is inclined to “socialise” funding through subsidies and in the guise of employment creation. Deploying wide ranging tools – subsidies, portfolio standards, feed in tariffs, green certificates, incentives and taxation – governments have mixed records in delivering on their CO2 reductions under the RETs deployment. In fact, poor policy hinders rather than facilities adaptation. Examine for instance:

US periodic setting portfolio standards for RETs led to a boom/bust cycle in investments, given that regulatory uncertainly hinders commitments by firms looking for certainty.

  1. Demand, costs and capex remain uncertain, notwithstanding the US government’s ability to regulate power tariffs. US tax incentives, applied from 1978 to 1985 failed to increase energy conservation investments, given continued uncertainty on benefits that vary with power tariffs, costs, demands and capex (Dixit and Pindyck, 1994) – what Jaffe and Stavins refer as the “energy paradox”.
  2. RETs declining capex and subsidies pose a dilemma on the merits of an “early movers” advantage that delays investments, unless generous subsidies (or threat of their removal) encourage an earlier exercise of investment options.

Government subsidies, however, when used with supportive transformational strategies by firms, facilitates technology diffusion. Spain and Germany’s transformation as global leaders are attributed to supportive regulation that firms use as a backdrop for developing their capabilities for RETs. In contrast, the UK’s uptake of renewal energy by utilities was less enthusiastic, in spite of a similarly supportive package of incentives.

Far from a need for global consensus to turn into a legally binding agreement, governments can play constructive roles by adapting policies that facilitates technology development and deployment. When one talks of aid and support, the mechanics for delivering such intervention is the local government –-not a globally binding agreement.

After all, the conferences failure may prove to be the entrepreneurs’ gain. With local governments pursuing policies that matter to them, working with the private sector, we may yet accelerate achieving a carbon-free future by applying the discipline of the market as opposed to “socialising” investments, as governments are inclined to do.

 

 

 

 

 

Advertisements