Author Archives: Gernot Wagner

From climate finance to finance

IETA 2015 Making WavesClimate finance is lots of things to lots of people. For some, it’s the $100 billion “Copenhagen commitment”. For others, it’s Citi’s latest sustainable finance pledge of $100 billion. It’s Bill Gates’s $1 billion clean energy investment. It’s public and private monies; mitigation and adaptation; loans, bonds, equity stakes, high-risk ventures, Kyoto-style allowances, offset credits, and private and public grants. It’s all of the above. When it comes to carbon markets, climate finance is often about what happens with allowance revenue. That's important. But the primary goal is, or ought to be, appropriately pricing the climate externality.

It’s about nudging massive private investment flows from the current high-carbon, low-efficiency path toward a low-carbon, high-efficiency one. That, in turn, means focusing on the incremental dollars necessary to sway private investments. In the end, it’s all about the margin.

Righting the wrong incentives

The incentives facing many private actors today are clearly misleading. Benefits, for the most part, are fully privatised, while many costs are socialised. That goes in particular for environmental and climate costs. The ‘hidden’ costs of energy investments are large and negative. While largely invisible to those doing the polluting, these costs are all too visible to society as a whole: in form of costs to health, ecosystems, and the economy. In the United States, for example, every additional tonne of coal, every barrel of oil, causes more in external damages than it adds value to GDP. That calculation does not even consider the large carbon externality.

There, one of the more important metrics is the so-called ‘social cost of carbon’. The US government’s central estimate is $40 per tonne of CO2 released today. The true number is likely a lot higher, especially when considering the many ‘known unknowns’ not quantified (and sometimes not quantifiable). Regardless of the precise amount, it’s the cost to society — to the economy, health, ecosystems, the whole lot — of each tonne of CO2 released today over its lifetime.

The social cost itself is inherently a marginal concept. While all of us seven billion pay a fraction of a penny of the social cost for each of the billions of tonnes emitted today, few of those doing the actual polluting pay themselves. A price on carbon, through cap and trade or a carbon tax, ensures that anyone covered by the market forces faces the right incentives. Polluters face a direct cost of pollution and, thus, are driven to pollute less. The law of demand at work.

Incentives at work

One of the guiding principles of economics is that people are motivated by incentives. That’s not too surprising. It would be surprising if people were not motivated by what is designed to motivate them. When faced with a price on carbon, emissions go down, and investments change course.

At the level of individual businesses, solid evidence points to how existing carbon prices have incentivised investment in clean technology, research and development.

In places with no external carbon price, investments can be affected by internal carbon pricing. The Carbon Disclosure Project counts over 400 companies with an internal, ‘shadow’ carbon price, either independently or in reaction to an external market price. That price, in turn, figures into day-to-day decisions from where to site a new facility to how to source energy.

In 1999, the World Bank conducted a study to determine the impact of a shadow price for carbon on the Bank’s investments. At an internal price of $40, the highest evaluated price, almost half of the analysed investments would have had a negative net present value, and, thus, would likely not have been made. For the rest, profitability would have been significantly reduced.

Individual investments, if organised at a large enough scale, make the difference. Take the Clean Development Mechanism (CDM), a market-based mechanism that channels funding to emission reduction projects in developing countries. Countries and investors can invest in CDM projects as a way of meeting domestic reduction goals, or complying with domestic carbon prices. Through the CDM, hundreds of billions of private sector dollars have gone towards funding GHG mitigation.

With a government-imposed carbon price, reflecting the true cost of carbon to society, investment portfolios would change. Drastically. We’ve seen it in practice, but the current scale is not large enough to sway the majority of investments that matter. Today, in fact, much of firms’ investments towards mitigating climate change are made voluntarily.

From Climate Finance to Finance

Climate finance often is ‘concessional’ finance. That might be outright development aid. It also includes voluntary commitments like Citi’s $100 billion. Citi, of course, is not alone. Goldman Sachs committed $40 billion in 2012, Bank of America $50 billion in 2013, all made over 10 years. Meanwhile, these three banks alone underwrite hundreds of billions of loans every year. Total global Foreign Direct Investment is in the trillions.

These massive financial flows won’t be redirected overnight. But they do follow incentives. In fact, that’s all they follow.

Enter carbon markets. They ensure that anyone covered by the market faces the right incentives. The prevailing allowance price is one good proxy of the level of ambition of any particular market. It’s also what helps nudge investments into the right direction. In econ-speak, it’s all about internalising externalities. In English, it’s about paying your fair share and no longer socialising costs.

None of that renders what’s traditionally called ‘climate finance’ unnecessary. There are still plenty of uses for additional monies. In particular, carbon markets are all about mitigation. Adaptation might dovetail nicely on some forms of mitigation, but it’s not the primary goal. That’s where foreign aid as well as government and private grants come in. If anything, those amounts need to be scaled up, too.

But the true scaling happens on the investment front. That’s no longer “climate finance.” It’s simply “finance.” Re-channelling only 0.1% of total wealth under active management globally amounts to around a $100 billion shift. Efforts, of course, must not stop there. It’s about channelling the full $100 trillion into the right direction.

Gernot Wagner is lead senior economist at the Environmental Defense Fund, and co-author, with Harvard’s Martin L. Weitzman, of Climate Shock (Princeton University Press, 2015).

This article was first published in IETA's Greenhouse Gas Market 2015 report "Making Waves". Download the full text in PDF form.

Posted in Cap and Trade, International, Politics| Leave a comment

Biking and Renewables

Illustration by Kelsey King/Ensia

Illustration by Kelsey King/Ensia

There’s nothing quite like biking down clogged city streets, weaving in and out of traffic. For short distances, it’s faster than driving. It’s liberating. It’s fun.

It also makes it painfully clear that most roads aren’t made for bikes. Make one mistake, and you might end up dead. If you do everything right and the 4,000-pounder next to you makes a mistake, you still might end up dead. Few regular urban cyclists remain entirely unharmed throughout the years: A broken bone (“cut off by a van”), a scraped shin (“car door”), or perhaps simply drenched on an otherwise dry road (“I avoided the mud puddle; the car didn’t”).

Blame it on my day job, but as I was cut off by yet another driver fixated on his phone while cycling to work, I got to thinking that this is how wind and solar electrons must feel as they try to navigate the electric grid. There, too, the infrastructure and rules were designed for the conventional, fossil fuel-based generators, not their smaller, greener counterparts.

We need to get off gasoline-powered vehicles, the same way we need to get off fossil-powered electricity. Biking alone, of course, can’t eliminate fossil fuel-based transportation. It’s a niche alternative that chiefly works in densely populated cities filled with environmentally concerned citizens. What works in Berkeley, Boulder, Brooklyn and Boston won’t work everywhere. Neither can trains, by the way, another favorite of environmentalists. Most U.S. cities have a lot of catching up to do with their European counterparts, but, if anything, it will be electric vehicles that will truly help us make this transition.

Similarly, wind and solar can’t singlehandedly eliminate fossil fuel-based electrical generation. They have great potential, much more so than biking ever will. But there, too, are limitations — chiefly the (eventual) need for storage to eliminate all fossil fuel-based generation: coal, petroleum and natural gas.

Meanwhile, there are great benefits to pushing both green technologies. Biking helps get previously sedentary drivers to move, which, in turn, extends their lives and decreases societal health care costs, assuming injuries can be avoided by appropriate bike infrastructure. Every dollar invested in that infrastructure can pay for itself many times over.

Something similar holds for subsidizing infrastructure for renewables (and, for that matter, some energy efficiency measures). The reduction in the large and risky global warming externality typically offsets the costs of subsidies and other sensible policy interventions. Many of the right policies are indeed being put in place.

Still, some traditional utilities continue to fight the integration of rooftop solar and other renewables, the way New York City did with bikes in 1987 when it tried to ban them altogether from midtown Manhattan. Today, New York is decidedly friendlier to cyclists, with Mayor Michael Bloomberg adding over 300 miles of bike lanes to city streets, and a popular, still-expanding bike share program. Renewables, for their part, are increasingly welcomed onto the grid, with increased open access and grid management tools aimed at integrating intermittent renewable energy sources. Much more needs to be done.

Getting the Job Done

There’s one more parallel that might well dwarf all else: Biking for biking’s sake is fun on a sunny Sunday afternoon. On a Monday morning, when it’s about getting to a meeting on time and looking professional, transport choice comes down to getting there reliably, quickly, cheaply and without sweat stains.

Electricity is no different. Solar panels may be an interesting, even fun, choice for some. The feeling of energy independence and doing good is a bonus. But many times, it doesn’t matter where electrons come from, just that they do — reliably, cheaply and cleanly.

The ideal policy solution for energy is as clear as it is seemingly difficult to implement: Pay the full, appropriate price for electricity at the right time and place, including currently unpriced environmental costs. Once every electron comes with the appropriate price tag, the solar panel on your roof — or the solar farm down the road — may well carry the day. Or it might not. That’s OK, too. Having the right energy mix matters more than any one technology. The energy system is a system, after all.

Biking, too, is but one form of getting around. Appropriate gas taxes, congestion charges and parking fees help incorporate the full costs of gasoline-powered engines and encourage more alternative modes of transport — from electric vehicles to public transport and bikes. Meanwhile, outright subsidizing those alternative modes is surely the right step. Pushing those alternatives at scale is as sensible as pushing renewables, especially when it also means moving closer to the ideal pricing policies in the first place.

But pushing biking or any one form of alternative transport is no end goal in itself. At the end of the day, it’s about getting from A to B. That means — as it does for energy — getting the entire system right.View Ensia homepage

Published on on October 1st, 2015.

Posted in Energy efficiency, Technology| Leave a comment

Statistics 101: Climate policy = risk management

Bjørn Lomborg reviewed my book, Climate Shock (Princeton University Press, 2015), joint with Harvard's Martin L. Weitzman, for Barron's over the weekend. He started it by stating that "global warming is real."

So far, so good.

But the book is not about whether the climate is changing. It is.

The book is about whether we are getting the order of magnitude of its effects right. Weitzman and I argue forcefully — in prose in the text, supported by a significant amount of research going into the 100-page end notes — that it's what we don't know that really puts the "shock" into Climate Shock. Lomborg asks how we can know that, if apparently we don't.

The answer is simple, and it's a statistical point that can't possibly be lost on Lomborg, a former lecturer on statistics. The set of distributions that most directly represent climate uncertainty — the link between concentrations of carbon dioxide and eventual temperature outcomes — is inherently skewed. We know, and Lomborg agrees, that adding carbon dioxide increases temperatures. (Back to 19th century science.)

So we can very clearly cut off the distribution linking a doubling of pre-industrial concentrations to temperatures at zero. In fact, we can cut it off at least at around 1 degree Celsius (almost 2 degrees Fahrenheit). The world, after all, has already warmed by over 0.8 degrees Celsius (around 1.5 degrees Fahrenheit), and we haven't yet increased pre-industrial concentrations by even 50 percent.

Reprinted from Climate Shock, with permission from Princeton University Press.

Reprinted from Climate Shock, with permission from Princeton University Press.

That skewedness of the underlying distribution is real. It's important. The correct response, then, to those who are too sure about where the climate system will go isn't to say, "cool it." It's to take the uncertainties seriously. Those, sadly, are skewed in one direction.

Climate risk is not our friend. It ought to prompt us to rethink not just how we talk about climate change. It should also inform our response. The burden of proof clearly rests on those who argue against these statistical facts.

First posted on Climate411.

Posted in 1000 words, Climate science| Leave a comment

Climate Shock on FT McKinsey Business Book of the Year longlist

FT McKinsey Business Book of the Year 2015 longlist

"Business Book Award longlist: must-read titles of 2015" by Andrew Hill (Financial Times, 12 August 2015).

Posted in 1000 words, Climate science| Leave a comment

What we know — and what we don’t — about global warming

By Gernot Wagner and Martin L. Weitzman:

Two quick questions:

Do you think climate change is an urgent problem?

Do you think getting the world off fossil fuels is difficult?

This is how our book “Climate Shock” begins.

In fact, it’s not our quiz. Robert Socolow from Princeton has posed versions of these questions for a while. The result is usually the same: most people answer “Yes” to one or the other question, but not to both. You are either one or the other: an “environmentalist” or perhaps, a self-described “realist.”

Such answers are somewhat understandable, especially when looking at the polarized politics around global warming. They are also both wrong. Climate change is incredibly urgent and difficult to solve.

What we know is bad

Last time concentrations of carbon dioxide were as high as they are today — 400 parts per million — we had sea levels that were between 20 to at least 66 feet higher than today.

It doesn’t take much to imagine what another foot or two will do. And sea levels at least 20 feet above where they are today? That’s largely outside our imagination.

This won’t happen overnight. Sea levels will rise over decades, centuries and perhaps even millennia. That’s precisely what makes climate change such an immense challenge. It’s more long-term, more global, more irreversible and also more uncertain than most other problems facing us. The combination of all of these things make climate change uniquely problematic.

What we don’t know makes it potentially much worse

Climate change is beset with deep-seated uncertainties on top of deep-seated uncertainties on top of still more deep-seated uncertainties. And that’s just if you consider the links between carbon dioxide concentrations in the atmosphere, eventual temperature increases and economic damages.

Increasing concentrations of carbon dioxide are bound to lead to an increase in temperatures. That much is clear. The question is how much.

The parameter that gives us the answer to this all-important question is “climate sensitivity.” That describes what happens to eventual global average temperatures as concentrations of carbon dioxide in the atmosphere double. Nailing down that parameter has been an epic challenge.

Ever since the late 1970s, we’ve had estimates hovering at around 5.5 degrees Fahrenheit. In fact, the “likely” range is around 5.5 degrees plus-minus almost three degrees.

What’s worrisome here is that since the late 1970s that range hasn’t narrowed. In the past 35 years, we’ve seen dramatic improvements in many aspects of climate science, but the all-important link between concentrations and temperatures is still the same.

What’s more worrisome still is that we can’t be sure we won’t end up outside the range. The Intergovernmental Panel on Climate Change calls the range “likely.” So by definition, anything outside it is “unlikely.” But that doesn’t make it zero probability.

In fact, we have around a 10 percent chance that eventual global average temperature increases will exceed 11 degrees Fahrenheit, given where the world is heading in terms of carbon dioxide emissions. That’s huge, to put it mildly, both in probability and in temperature increases.

Climate Shock graph. There’s at least about a 10 percent chance of global average temperatures increasing 11 degrees Fahrenheit or more. Source: Climate Shock (Princeton 2015), reprinted with permission.

Climate Shock graph. There’s at least about a 10 percent chance of global average temperatures increasing 11 degrees Fahrenheit or more. Source: Climate Shock (Princeton 2015), reprinted with permission.

We take out car, fire and property insurances for much lower probabilities. Here we are talking about the whole planet, and we haven’t shown willingness to insure ourselves. Meanwhile, we can, in fact, look at 11 degrees Fahrenheit and liken it to the planet ‘burning’. Think of it as your body temperature: 98.6 degrees Fahrenheit is normal. Anything above 99.5 degrees Fahrenheit is a fever. Above 104 degrees Fahrenheit is life-threatening. Above 109.4 degrees Fahrenheit and you are dead or at least unconscious.

In planetary dimensions, warming of 3.6 degrees Fahrenheit is so bad as to have been enshrined as a political threshold not to be crossed. Going to 11 degrees Fahrenheit is so far outside the realm of anything imaginable, we can simply call it a planetary catastrophe. It would surely be a planet none of us would recognize. Go back to sea levels somewhere between 20 and at least 66 feet higher than today, at today’s concentrations of carbon dioxide. How much worse can it get?

Do we know for sure that we are facing a 1-in-10 chance unless the world changes its course? No, we don’t, and we can’t. One thing though is clear: because the extreme downside is so threatening, the burden of proof ought to be on those who argue that these extreme scenarios don’t matter and that any possible damages are low. So how then can we guide policy with all this talk about “not knowing”?

What’s your number?

We can begin to insure ourselves from climate change by pricing emissions. How? By charging at least $40 per ton of carbon dioxide pollution. That’s the U.S. government’s current value and central estimate of the costs caused by one ton of carbon dioxide pollution emitted today.

We know that $40 per ton is an imperfect number. We are pretty sure it’s an underestimate; we are confident it’s not an overestimate. But it’s also all we have. (And it’s a lot higher than the prevailing price in most places that do have a carbon price right now—from California to the European Union. The sole exception is Sweden, where the price is upward of $130. And even there, key sectors are exempt.)

How then do we decide on the proper climate policy? The answer is more complex than our rough cost-benefit analysis suggests. Pricing carbon at $40 a ton is a start, but it’s only that. Any cost-benefit analysis relies on a number of assumptions — perhaps too many — to come up with one single dollar estimate based on one representative model. And with something as large and uncertain as climate change, such assumptions are intrinsically flawed.

Since we know that the extreme possibilities can dominate the final outcome, the decision criterion ought to focus on avoiding these kinds of catastrophic damages in the first place. Some call this a “precautionary principle”— better to be safe than sorry. Others call it a variant of “Pascal’s Wager” — why should we risk it if the punishment is eternal damnation? We call it a “Dismal Dilemma.” While extremes can dominate the analysis, how can we know the relevant probabilities of rare extreme scenarios that we have not previously observed and whose dynamics we only crudely understand at best? The true numbers are largely unknown and may simply be unknowable.

Planetary risk management

In the end, this is all about risk management—existential risk management. Precaution is a prudent stance when uncertainties about catastrophic risks are as dominant as they are here. Cost-benefit analysis is important, but it alone may be inadequate, simply because of the fuzziness involved with analyzing high-temperature impacts.

Climate change belongs to a rare category of situations where it’s extraordinarily difficult to put meaningful boundaries on the extent of possible planetary damages. Focusing on getting precise estimates of the damages associated with eventual global average warming of 7, 9 or 11 degrees Fahrenheit misses the point.

The appropriate price on carbon dioxide is one that will make us comfortable that the world will never heat up another 11 degrees and that we won’t see its accompanying catastrophes. Never, of course, is a strong word, since even today’s atmospheric concentrations have a small chance of causing eventual extreme temperature rise.

One thing we know for sure is that a greater than 10 percent chance of the earth’s eventual warming of 11 degrees Fahrenheit or more — the end of the human adventure on this planet as we now know it — is too high. And that’s the path the planet is on at the moment. With the immense longevity of atmospheric carbon dioxide, continuing to “wait and see” would amount to nothing else than willful blindness.

First published by PBS NewsHour's Making Sen$e with Paul Solman. The accompanying NewsHour report aired on July 16, 2015.

Posted in 1000 words, Climate science, Politics| Leave a comment

PBS NewsHour: The economic options for combatting climate change

As greenhouse gases accumulate and global temperatures slowly rise, what can we do to insure against the catastrophes of climate change? Economics correspondent Paul Solman talks to the authors of Climate Shock.

Posted in 1000 words| 1 Response
  • About This Blog

    EDF economists discuss how to make markets work for the environment.

  • Get blog posts by email

    Subscribe via RSS

  • Categories