Selected category: International

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.

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When dealing with global warming, the size of the risk matters

Shortly after September 11, 2001, Vice President Dick Cheney gave us what has since become known as the One Percent Doctrine: “If there’s a 1% chance that Pakistani scientists are helping al-Qaeda build or develop a nuclear weapon, we have to treat it as a certainty in terms of our response.”

It inspired at least one book, one war, and many a comparison to the "precautionary principle" familiar to most environmentalists. It’s also wrong.

One percent isn’t certainty. This doesn’t mean that we shouldn’t take the threat seriously, or that the precautionary principle is wrong, per se. We should, and it isn’t.

Probabilities matter.

Take strangelets as one extreme. They are particles with the potential to trigger a chain reaction that would reduce the Earth to a dense ball of strange matter before it explodes, all in fractions of a second.

That’s a high-impact event if there ever was one. It’s also low-probability. Really low probability.

At the upper bound, scientists put the chance of this occurring at somewhere between 0.002% and 0.0000000002% per year, and that’s a generous upper bound.

That’s not nothing, but it’s pretty close. Should we be spending more on avoiding their creation, or figuring out if they’re even theoretically possible in the first place? Sure. Should we weigh the potential costs against the social benefit that heavy-ion colliders at CERN and Brookhaven provide? Absolutely.

Should we “treat it as a certainty” that CERN or Brookhaven are going to cause planetary annihilation? Definitely not.

Move from strangelets to asteroids, and from a worst-case scenario with the highest imaginable impact, but a very low probability, to one with significantly higher probability, but arguably much lower impact.

Asteroids come in all shapes and sizes. There’s the 20-meter wide one that unexpectedly exploded above the Russian city of Chelyabinsk in 2013, injuring mored than 1,400 people. And then there are 10-kilometer, civilization-ending asteroids.

Size matters.

No one would ask for more 20-meter asteroids, but they’re not going to change life on Earth as we know it. We’d expect a 10-kilometer asteroid, of the type that likely killed the dinosaurs 65 million years ago, once every 50-100 million years. (And no, that does not mean we are ‘due’ for one. That’s an entirely different statistical fallacy.)

Luckily, asteroids are a surmountable problem. Given $2 to $3 billion and 10 years, a National Academy study estimates that we could test an actual asteroid-deflection technology. It’s not quite as exciting as Bruce Willis in Armageddon, but a nuclear standoff collision is indeed one of the options frequently discussed in this context.

That’s the cost side of the ledger. The benefits for a sufficiently large asteroid would include not destroying civilization. So yes, let’s invest the money. Period.

Somewhere between strangelets and asteroids rests another high-impact event. Unchecked climate change is bound to have enormous consequences for the planet and humans alike. That much we know.

What we don’t know — at least not with certainty — could make things even worse. The last time concentrations of carbon dioxide stood where they are today, sea levels were up to 20 meters higher than today. Camels lived in Canada. Meanwhile global average surface temperatures were only 1 to 2.5 degrees Celsius (1.8 to 4.5 degrees Fahrenheit) above today's levels.

Now imagine what the world would like with temperature of 6 degrees Celsius (11 degrees Fahrenheit) higher. There’s no other way of putting it than to suggest this would be hell on Earth.

And based on a number of conservative assumptions, my co-author Martin L. Weitzman and I calculate in Climate Shock that there might well be a 10% chance of an eventual temperature increase of this magnitude happening without a major course correction.

That’s both high-impact and high-probability.

Mr. Cheney was wrong in equating 1% to certainty. But he would have been just as wrong if he had said: "One percent is basically zero. We should just cross our fingers and hope that luck is on our side."

So what to do? In short, risk management.

We insure our homes against fires and floods, our families against loss of life, and we should insure our planet against the risk of global catastrophe. To do so, we need to act — rationally, deliberately, and soon. Our insurance premium: put a price on carbon.

Instead of pricing carbon, governments right now even pay businesses and individuals to pump more carbon dioxide into the atmosphere due to various energy subsidies, increasing the risk of a global catastrophe. This is crazy and shortsighted, and the opposite of good risk management.

All of that is based on pretty much the only law we have in economics, the Law of Demand: price goes up, demand goes down.

It works beautifully, because incentives matter.

Gernot Wagner serves as lead senior economist at the Environmental Defense Fund and is co-author, with Harvard’s Martin Weitzman, of Climate Shock (Princeton, March 2015). This op-ed first appeared on

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“Naomi Klein wants to stick it to the man. I want to stick it to CO2.″

By Jonathan Derbyshire, Prospect Magazine's The world of ideas.

Jonathan DerbyshireWhy is it so difficult to get people to worry about climate change? After all, the science is pretty unambiguous—pace the climate change “deniers”. Part of the problem, according to a new book, “Climate Shock,” by the economists Gernot Wagner and Martin L Weitzman, is that while what we know about global warming is bad enough, there are “unknown risks that may yet dwarf all else.”

Wagner, who is lead senior economist at the Environmental Defense Fund in the United States, visited London a couple of weeks ago. I caught up with him while he was here and talked to him about the difficulties of mobilising public opinion around the threats and challenges of climate change. 

GW: The big problem, frankly, is speaking the truth and talking about what scientists actually know and what they don’t know, which in many ways is even scarier. Saying the latest science out loud is [often taken to be] akin to catastrophising. That’s the big conundrum: on the one hand, “climate shock” shouldn’t be all that shocking—we’ve known this for quite a while. The problem is finding a way to state the scientific facts in a way that does not turn people off immediately.

JDSo it’s partly a public relations or political challenge then?

It’s more than that. Political, certainly. But it’s also a science communications challenge.

You mentioned scientific uncertainty just now. The book is, among other things, an attempt to deal with the challenge of climate change and the policymaking challenges from an economic perspective. But it’s also, it seems to me, a work of epistemology, almost—it’s a reflection on uncertainty and the implications that uncertainty has for policymaking.

Most books are written about what we know. This book is about what we don’t know. We clearly know enough to act. We’ve known enough to act for years, decades. Now, the more we find out, the more apparent it gets that what we don’t know is in fact potentially much, more worse. Choose you favourite analogy here—Nassim Nicholas Taleb’s “black swans,” Donald Rumsfeld’s “unknown unknowns”. That’s what it’s all about. The things we don’t know will most likely be the things that bite us in the back.

This is one of the things that makes climate change a public policy challenge unlike any other.

Climate change is uniquely long-term. It is uniquely global. It is uniquely irreversible and uniquely uncertain. You could probably identify other policy issues that combine two of those four factors, but none that I know of combines all four like climate change [does].

Continue reading in Prospect Magazine.

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Climate Shock in under 90 seconds

Think of the atmosphere as a giant bathtub. There’s a faucet—emissions from human activity—and a drain—the planet’s ability to absorb that pollution. For most of human civilization and hundreds of thousands of years before, the inflow and the outflow were in relative balance. Then humans started burning coal and turned on the faucet far beyond what the drain could handle. The levels of carbon in the atmosphere began to rise to levels last seen in the Pliocene, over three million years ago.

What to do? That’s the question John Sterman, an MIT professor, asked two hundred graduate students. More specifically, he asked what to do to stabilize concentrations of carbon dioxide in the atmosphere close to present levels. How far do we need to go in turning off the faucet in order to stabilize concentrations? Here’s what not to do: stabilizing the flow of carbon into the atmosphere today won’t stabilize the carbon already there at close to present levels. You’re still adding carbon. Just because the inflow remains steady year after year, doesn’t mean the amount already in the tub doesn’t go up. Inflow and outflow need to be in balance, and that won’t happen at current levels of carbon dioxide in the tub (currently at 400 ppm) unless the inflow goes down by a lot.

That seems like an obvious point. It also seems to get lost on the average MIT graduate student, and these students aren’t exactly 'average'. Still, over 80 percent of them in Sterman’s study seem to confuse the faucet with the tub. They confuse stabilizing the inflow with stabilizing the level.

Watch this video to avoid making the same mistake:

Excerpted from Climate Shock.

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We need a climate insurance policy – now

Q&A with Karin Rives first published on EDF Voices.

Climate Shock

Before climate change gets so bad that we may be forced to “geoengineer” ourselves out of catastrophe, a new book—Climate Shock—suggests that we reframe the problem altogether.

Gernot Wagner, a lead senior economist at Environmental Defense Fund and co-author of the book, says we ought to look at climate change as a risk management problem and treat it as such. I had a chat with Gernot about the book he will release next week together with Martin L. Weitzman, a professor of economics at Harvard University.

Karin Rives: Many books have already been published on climate change. What’s new or different about Climate Shock?

Most everyone focuses on what we know about climate change. Our book is about what we don’t know.

Call it Nassim Nicholas Taleb’s “Black Swan,” or the Rumsfeldian “unknown unknowns”—a state of complete and dangerous uncertainty and unpredictability. Call it what you want, but it’s that tail that may yet wag us in the end.

What we know is bad. What we don’t know is potentially much worse. Climate, in the end, is a risk management issue. Just like homeowners take out insurance against fires and flooding, society needs insurance against climate change.

KR: So what do we know?

Last time the planet experienced as much carbon in its atmosphere as there is now, sea levels where up to 66 feet higher than they are today. Camels lived in Canada. That was more than 3 million years ago. The geological clock read “Pliocene.”

We certainly know enough to take reasoned action today. And almost everything we don’t know points in one and only one direction: that action is all the more urgent.

KR: Why do we need to read this book now?

The time to buy our insurance policy is now—while we still can. And I’m speaking both metaphorically and literally.

Insurance here, of course, is to avoid dumping carbon into the atmosphere. We pay to have our trash picked up instead of just dumping it for free onto our streets. We similarly need to pay to avoid dumping carbon into our atmosphere.

That’s not free, but it’s still relatively cheap to do—and much cheaper than experiencing the consequences of unchecked global warming.

KR: What should be my three most important takeaways from your book?

Scream, cope, and profit.

We need to get the right policies in place, and soon. That’s “scream.” Then there’s some global warming we can no longer avoid—and that we are already experiencing. Let’s prepare ourselves better for that.

“Profit” is, of course, what you would expect two economists to say, dollar signs in their eyes and all. All that starts with smart investment decisions. Green, clean, and lean isn’t just got for the planet. It’s also the right financial choice and we need to ensure that it is much more so going forward.

The main takeaway, in the end, is that this isn’t some artificial battle between capitalism and the climate. It’s not about sticking it to the man. It’s about sticking it to carbon.

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Correcting the maths of the "50 to 1 Project"

(This post first appeared on Climate 411.)

A nine-minute video, released earlier this fall, argues that climate mitigation is 50 times more expensive than adaptation. The claims are based on calculations done by Christopher Monckton. We analyzed the accompanying “sources and maths” document. In short, the author shows a disconcerting lack of understanding of climate science and economics:

  1. Fundamental misunderstanding of basic climate science: Pre-industrial levels of carbon dioxide (CO2) were at around 280 parts per million (ppm).[i] One of the most commonly stated climate policy goals is to keep concentrations below 450 ppm CO2. Monckton, oddly, adds 280 and 450 to get to 730 ppm as the goal of global stabilization efforts, making all the rest of his calculations wildly inaccurate.
  2. Prematurely cutting off analysis after ten years: Monckton calculates the benefits of the carbon tax over a ten-year time horizon. That is much too short to see the full effects of global warming or of the policy itself. Elevated carbon levels persist for hundreds to thousands of years.[ii]
  3. Erroneously applying Australian “cost-effectiveness” calculation to the world: This may be the most troubling aspect from an economist's point of view. Monckton first calculates the effect of the Australia-only tax on global temperatures, which is unsurprisingly low, as Australia accounts for only 1.2% of world emissions. Next, he calculates the tax’s resulting “cost-effectiveness” — defined as the Australian tax influencing global temperatures. No surprise once again, that influence is there, but Australia alone can't solve global warming for the rest of us. Then, Monckton takes the Australia-only number and scales it to mitigate 1ºC globally, resulting in a purported cost of “$3.2 quadrillion,” which he claims is the overall global “mitigation cost-effectiveness.” But this number simply represents the cost of avoiding 1ºC of warming by acting in Australia alone. Monckton has re-discovered the fact that global warming is a global problem! The correct calculation for a globally applied tax would be to calculate cost-effectiveness on a global level first. If Australia’s carbon price were to be applied globally, it would cut much more pollution at a much lower cost. And that, of course, is very much the hope. Australia, California, and the European Union are called “climate leaders” for a reason. Others must follow.

What’s the real cost of cutting carbon? The U.S. government’s estimate of the cost of one ton of CO2 pollution released today is about $40.[iii] That's also the optimal price to make sure that each of us is paying for our own climate damages. Any policy with a lower (implied) carbon price—including the Australian tax—easily passes a benefit-cost test.

With all due respect Lord Monckton, 3rd Viscount of Brenchley, your maths are way off.

[i] "Summary for Policymakers," IPCC Fifth Assessment Report, Working Group I (2013).

[ii] Results differ across scenarios, but a rough rule of thumb suggests that approximately 70% of the ‘peak enhancement level’ over the preindustrial level of 280 ppm perseveres after 100 years of zero emissions, while approximately 40% of the ‘peak enhancement level’ over the preindustrial level of 280 ppm persevered after 1,000 years of zero emissions (Solomon, Susan, Gian-Kasper Plattner, Reto Knutti and Pierre Friedlingstein, “Irreversible climate change due to carbon dioxide emissionsProceedings of the National Academy of Sciences 106, no. 6 (2009): 1704-1709). Note that this refers to the net increase in carbon dioxide in the atmosphere, not the exact molecule. Archer, David, Michael Eby, Victor Brovkin, Andy Ridgwell, Long Cao, Uwe Mikolajewicz, Ken Caldeira et al. "Atmospheric lifetime of fossil fuel carbon dioxide." Annual Review of Earth and Planetary Sciences 37 (2009): 117-134 discusses these two often confused definitions for carbon’s ‘lifetime,’ and concludes that 20-40% of excess carbon levels remain hundreds to thousands of years (“2-20 centuries”) after it is emitted. Each carbon dioxide molecule has a lifetime of anywhere between 50 to 200 years, according to the U.S. Environmental Protection Agency’s “Overview of Greenhouse Gases: Carbon Dioxide Emissions.” The precise number is under considerable scientific dispute and surprisingly poorly understood. (Inman, Mason, “Carbon is forever,” Nature Reports Climate Change 20 November 2008)

[iii] The precise value presented in Table 1 of the Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866 for a ton of carbon dioxide emitted in 2015, using a 3% social discount rate increased is $38. For 2020, the number is $43; for 2030, the number increases to $52. All values are in inflation-adjusted 2007 dollars. For a further exploration of this topic, see Nordhaus, William D. The Climate Casino: Risk, Uncertainty, and Economics for a Warming World. Yale University Press (2013) as only one of the latest examples summarizing this kind of analysis. Nordhaus concludes that the optimal policy, one that maximizes net benefits to the planet, would spend about 3% of global GDP.

Many thanks to Michelle Ho for excellent research assistance.

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