Market Forces

Not all fossil fuel subsidies are created equal, all are bad for the planet

By / Bio / Published: June 13, 2019

This is part two of a five-part series exploring “Policy Design for the Anthropocene,” based on a recent Nature Sustainability Perspective. The first post explored the intersection of policy and politics in the development of instruments to help humans and systems adapt to the changing planet.

A recent International Monetary Fund (IMF) working paper made headlines by revealing that the world is subsidizing fossil fuels to the tune of $5 trillion a year. Every one of these dollars is a step backward for the climate. That much is clear.

Instead of subsidizing fossil emissions, each ton of carbon dioxide (CO2) emitted should be appropriately priced. That’s also where it’s important to dig into the numbers.

It’s tempting to go with the $5 trillion figure, as it suggests a simple remedy: remove the subsidies. At one level, that is precisely the right message. But the details matter, and they go well beyond the semantics of what it means to subsidize something.

Direct subsidies are large

The actual, direct subsidies—money flowing directly from governments to fossil fuel companies and users—are “only” around $300 billion per year. That is still a huge number, and it may well be an underestimate at that. The International Energy Agency’s World Energy Outlook 2014, which took a closer look at fossil subsidies than reports since, put the number closer to around $500 billion; a 2015 World Bank paper provided more detailed methodologies and a range of between $500 billion and $2 trillion.

What all these estimates have in common is that they stick to a tight definition of a subsidy:

Subsidy (noun, \ ˈsəb-sə-dē \)

“a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public,” per  Merriam-Webster.

These taxpayer-funded giveaways are not only not “advantageous to the public,” they also ignore the enormous now-socialized costs each ton of CO2 emitted causes over its lifetime in the atmosphere. (Each ton emitted today stays in the atmosphere for dozens to hundreds of years.)

The direct subsidies also come in various shapes and forms—from some countries keeping the cost of gasoline artificially low, to a $1 billion tax credit for “refined coal” in the United States.

Indirect subsidies are significantly larger

The vast majority of the IMF’s total $5 trillion figure is the unpriced socialized cost of each ton of CO2 emitted into the atmosphere. Each ton, the IMF estimates conservatively, causes about $40 in damages over its lifetime in today’s dollars.

Depending on one’s definition of a subsidy, this may well qualify. It’s a grant from the public to fossil fuel producers and users—something the public pays for in lives, livelihoods and other unpriced consequences of unmitigated climate change.

The remedy here is very different than removing direct government subsidies. It’s to price each ton of CO2 emitted for less to be emitted. The principle couldn’t be simpler: “When something costs more, people buy less of it,” as Bill Nye imbued memorably on John Oliver’s Last Week Tonight recently.

 

https://twitter.com/GernotWagner/status/1128444583229186048

All that goes well beyond semantics of what it means to subsidize. One policy is to remove a tax loophole or another kind of subsidy, the other is to introduce a carbon price. The politics here are very different.

Unpriced climate risks might be much larger still

The $5 trillion figure also hides something else. By using a $40-per-ton figure, the IMF focuses on a point estimate for each ton of CO2 emitted, and a conservative one at that. The number comes from an estimate produced by President Obama’s Interagency Working Group on the Social Cost of Carbon. That’s a good starting point, certainly a better one than the current Administration’s estimate.

But even the $40 figure is conservative. It captures what was quantifiable and quantified at the time. It does not account for many known yet still-to-be-quantified damages. It does not account for risks and uncertainties, the vast majority of which would push the number significantly higher still.

In short, the $5 trillion figure may well convey a false sense of certainty.

In some sense, little of that matters. The point is: there is a vast thumb on the scale pushing the world economy toward fossil fuels, the exact opposite of what should be done to ensure a stable climate.

In another very real sense, the different matters a lot: Politics may trump all else, but policy design matters, too.

By now the task is so steep that it’s simply not enough to say we need to price emissions and leave things at that. Yes, we need to price carbon, but we also need to subsidize cleaner alternatives—in the true sense of what it means to subsidize: to do so for the benefit of the public. Whether that comes under the heading of a “Green New Deal” or not, it is a much more comprehensive approach than one single policy instrument.

This is party 2 of a 5-part series exploring policy solutions outlined in broad terms in “Policy Design for the Anthropocene.” Part 3 will focus on “Coasian” rights-based instruments, taking a closer look at tools that limit overall pollution to create markets where there were none before.

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Policy Design for the Anthropocene

By / Bio / Published: May 10, 2019

There’s no denying we humans are changing the planet at an unprecedented pace. If carbon dioxide in the atmosphere is any guide, that pace is increasing at an increasing rate. For those so mathematically inclined, that’s the third derivative pointing in the wrong direction.

Enter The Sixth Extinction, The Uninhabitable Earth, Falter, or simply the “Anthropocene”—us humans altering the planet to the point where the changes are visible in the geological record, ringing in a new epoch.

A team led by Earth systems scientists Johan Rockström and Will Steffen developed the concept of “planetary boundaries” in 2009. They identified nine major systems where humans are altering fundamental Earth systems—from climate change to land-system change to stratospheric ozone, and gave us now infamous spider graphs summarizing the all-too dire warnings (Figure 1).

Planetary boundaries, tipping points, and policies (Figure 1 from “Policy design for the Anthropocene”)

It is all the more significant, that both Rockström, now director of the famed Potsdam Institute for Climate Impact Research (PIK), and Steffen joined another large, multidisciplinary team ten years later to focus on “Policy design for the Anthropocene.” This team, led by EDF senior contributing economist Thomas Sterner, focused on the solutions.

The good news: there are many.

Table 2 summarizes the crowded field of approaches at the disposal of policymakers. It also shows the decisions to be made when deciding among them.

Policy instruments (based on Table 2 from “Policy design for the Anthropocene”)

How to choose?

Choosing among the many options available quickly moves from policy design to politics.

Take climate change as an all-too prominent example. For one, the obvious first step is to agree that there is a problem in the first place. Denying the problem is not going to get us anywhere near a constructive debate about policy solutions.

One big political decision then is to identify who benefits from acting—or conversely, who pays the costs. If the rights go to the polluter, it’s the victims who pay—all of us, in the case of climate change. If the rights go to society, it’s broadly speaking the polluters who pay. The difference is as stark as between permits on the one hand, and outright bans on the other.

Price or rights-based policies?

Often the decision how to act is among two broad buckets of policies: price or rights-based. The two are broadly speaking two sides of the same coin. Rights generate prices, and prices imply rights.

The difference plays out between carbon pricing and tradable permits. One fixes the price level, the other the amount of emissions. Cue endless academic debates about which instrument is better under which circumstances. Details, of course, do matter.

And this also brings us immediately back to politics. A big difference between price and rights-based policies, is that the latter implies that the political horse-trading doesn’t affect the overall quantity of pollution, at least to a first approximation. Whether tradeable permits are auctioned off—with polluters paying the full price—or whether they are given away for free doesn’t, at first, make a difference. Overall emissions reductions stay the same. I’m saying “at first,” because, any money raised could be spent intelligently on further emissions reductions.

Environmental effectiveness, economic efficiency, political efficacy

The larger point is that (almost) everything is possible. The problems might be dauntingly large. The solution space is similarly large. It’s also clear that no single decision criterion is enough.

Environmental effectiveness is key. Economic efficiency is similarly important.

Achieving the environmental goal is like building a train to the right station. That’s clearly the most important step. Economic efficiency is akin to building the fasted possible train. Just being fast doesn’t help, if the journey goes in the wrong direction. But efficiency implies that one can achieve the same goal at lower cost, or more at the same cost.

But smart policy design, of course, is not enough. It takes political will to get there. Designing policies that pass political muster is clearly one criterion, especially in a polarized environment.

Getting the policy minutiae right is important, but it’s also clear, of course, that politics trumps all. Policies don’t inspire action. Visions of a better future, and a just transition do.

This is party 1 of a 5-part series exploring these policy solutions outlined in broad terms in “Policy Design for the Anthropocene” in more detail. Part 2 will focus on “Pigouvian” price instruments, taking a closer look at fossil fuel subsidies and carbon pricing.

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Linking in a world of significant policy uncertainty

By / Bio / Published: January 10, 2018

This guest blog was co-authored with Thomas Sterner

And then there were three. As of January 1st, 2018, Ontario has joined California and Québec, linking their respective carbon markets. In a post-Paris world of bottom-up climate policy, linking of climate policy matters. It provides a concrete step forward on the Paris Declaration on Carbon Pricing in the Americas. It shows that, while the U.S. federal government is dismantling much-needed climate protections, states, together with Canadian provinces, are moving forward. Linking, if done right, can be a powerful enabler of greater ambition. It also raises important questions.

To be clear, there are real advantages to linking carbon markets: Linking of climate policies is a political affirmation of joint goals and a signal to others to move toward concerted carbon policies. It also shows the real advantages of market-based environmental policies. Bigger markets also afford greater cost-savings opportunities.

The textbook illustration of such savings is instructive. Take two jurisdictions, the high-cost abatement area (“H”) and the low-cost abatement area (“L”), with vastly different marginal costs (MC) of abatement. The total costs of abatement, the respective shaded areas in this graph, will be vastly different, too:

 

Now consider the idealized linked market. Total abatement (ΣX) will remain the same. The difference? Prices equilibrate across markets, with PL now equal to PH, lowering the total cost of achieving the same tons of carbon dioxide-equivalent (CO2e) abated.

 

Abatement costs clearly matter. The lower the costs of achieving the same goal, the better. All else equal, the two jurisdictions can now afford to abate more at the same cost.

Will all else indeed be equal?

It is clear the world needs to do a lot more to stabilize greenhouse-gas concentrations. That means quickly getting net emissions of carbon dioxide going into the atmosphere to zero.

There, too, the simple textbook case can be instructive. Linking implies sending money from country H to country L to pay for the cheaper abatement. This raises important questions of baselines, accounting, and transparency. Moreover, lower abatement costs are not the only objective of climate policies. Direct support for the deployment of new, cleaner technologies often tops the list. Given the political economy of reducing greenhouse-gas emissions in the first place, there are many competing domestic objectives and indeed real tradeoffs that need attention.

The big question then is what linkage does to the overall level of policy ambition. Lower costs imply the potential for more ambitious policies. That is clearly good but the devil is in the details. It is important to assure that coordination and collaboration among different jurisdictions really do raise the level of ambition, as the Paris Declaration pledges.

It is also clear that climate policy overall ought to have a balance of bottom-up and top-down policies. Linkage is one potentially important element in that equation. The ultimate measure, however, is tons of greenhouse gases abated from the atmosphere.

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The Atlantic’s year-end feature “Hope & Despair”

By / Bio / Published: December 29, 2015
Lucy Nicholson / Reuters / Zak Bickel / The Atlantic

Lucy Nicholson / Reuters / Zak Bickel / The Atlantic

Reason for despair: Climate change. It’s the perfect problem: more global, more long-term, more irreversible, and more uncertain that virtually any other public-policy problem facing us. Climate change is a lot worse than most of us realize. Almost regardless of what we do on the mitigation front, we are in for a whole lot of hurt.

On the policy front, we have now talked for more than 20 years about how we need to turn this ship around “within a decade.” Not unlike the ever-elusive fusion technology, that hasn’t happened yet. Global carbon emissions declined slightly this year—for the first time ever without a global recession—but the trends are still pointing in the wrong direction. Worse, turning around emissions is only the very first step. It’s not enough to stabilize the flow of water going into the bathtub when the goal is to prevent the tub from overflowing. We need to turn around atmospheric concentrations of greenhouse gases. That means turning off the flow of water into the tub—getting net emissions to zero and below. It doesn’t help our efforts that many people seem to confuse the two. A study involving over 200 MIT graduate students faced with this same question revealed that even they confuse emissions and concentrations—water flowing into the tub and water levels there. If MIT graduate students can’t get this one right, what hope is there for the rest of us?

Reason for hope: Climate change. Many signs point to some real momentum to finally tackle this momentous challenge.

The Paris Climate Accord builds an important foundation. It enables transparency, accountability, and markets to help solve the problem. Many governments are moving forward with pricing carbon: from California to China, from Sweden to South Africa, we see ambitious action to reign in emissions in some 50 jurisdictions. Meanwhile, lots is happening on the clean-energy front. That’s particularly true for solar photovoltaic power, which has climbed up the learning curve—and down the cost curve—faster than most would have expected only five years ago. That has also provided an important jolt for sensible climate policy. Then there’s R&D for entirely new technologies. Bill Gates leading an investment coalition with $1 billion of his own money is only one important sign of movement in that direction. The excitement for self-driving, electric vehicles is palpable up and down Silicon Valley, to name just one potentially significant example. In the end, it’s precisely this mix of Silicon Valley, Wall Street, and, of course, Washington that will lead—and, in part, is already leading—to the necessary revolution in a number of important sectors, energy and transportation chief among them.

Excerpt from The Atlantic‘s year-end feature on Hope and Despair: “Can the Planet Be Saved?“

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PBS NewsHour Making Sen$e with Paul Solman

By / Bio / Published: December 4, 2015

Q&A accompanying a re-broadcast of a PBS NewsHour segment featuring Climate Shock:

Everyone is talking about 2 degrees Celsius. Why? What happens if the planet warms by 2 degrees Celsius?

Martin L. Weitzman: Two degrees Celsius has turned into an iconic threshold of sorts, a political target, if you will. And for good reason. Many scientists have looked at so-called tipping points with huge potential changes to the climate system: methane being released from the frozen tundra at rapid rates, the Gulfstream shutting down and freezing over Northern Europe, the Amazon rainforest dying off. The short answer is we just don’t — can’t — know with 100 percent certainty when and how these tipping points will, in fact, occur. But there seems to be a lot of evidence that things can go horribly wrong once the planet crosses that 2 degree threshold.

In “Climate Shock,” you write that we need to insure ourselves against climate change. What do you mean by that?

Gernot Wagner: At the end of the day, climate is a risk management problem. It’s the small risk of a huge catastrophe that ultimately ought to drive the final analysis. Averages are bad enough. But those risks — the “tail risks” — are what puts the “shock” into “Climate Shock.”

Martin L. Weitzman: Coming back to your 2 degree question, it’s also important to note that the world has already warmed by around 0.85 degrees since before we started burning coal en masse. So that 2 degree threshold is getting closer and closer. Much too close for comfort.

What do you see happening in Paris right now? What steps are countries taking to combat climate change?

Gernot Wagner: There’s a lot happening — a lot of positive steps being taken. More than 150 countries, including most major emitters, have come to Paris with their plans of action. President Obama, for example, came with overall emissions reductions targets for the U.S. and more concretely, the Clean Power Plan, our nation’s first ever limit on greenhouse gases from the electricity sector. And earlier this year, Chinese President Xi Jinping announced a nation-wide cap on emissions from energy and key industrial sectors commencing in 2017.

It’s equally clear, of course, that we won’t be solving climate change in Paris. The climate negotiations are all about building the right foundation for countries to act and put the right policies in place like the Chinese cap-and-trade system.

How will reigning in greenhouse gases as much President Obama suggests affect our economy? After all, we’re so reliant on fossil fuels.
Gernot Wagner: That’s what makes this problem such a tough one. There are costs. They are real. In some sense, if there weren’t any, we wouldn’t be talking about climate change to begin with. The problem would solve itself. So yes, the Clean Power Plan overall isn’t a free lunch. But the benefits of acting vastly outweigh the costs. That’s what’s important to keep in mind here. There are trade-offs, as there always are in life. But when the benefits of action vastly outweigh the costs, the answer is simple: act. And that’s precisely what Obama is doing here.

And what steps should the countries in Paris this week take to combat climate change?

Martin L. Weitzman: If it were entirely up to me, I would have a very simple solution: negotiate one uniform price on carbon dioxide applicable to everyone. That doesn’t mean some imaginary world government would be in charge — not at all. Every country — every government — can implement their own policy, keep the revenue and decrease taxes elsewhere. But the price is universal across the world.

Gernot Wagner: Pricing carbon, of course, is indeed the answer. It’s the obvious one or at least it should be. Now, the negotiations themselves, of course, are messy, and there currently is no negotiation around a uniform, globally applicable carbon price. Instead, what’s happening is many large countries — the U.S., the EU, and chief among them China — are putting forward internal policies that will put a price on carbon and other greenhouse gases. That’s also where Paris comes in: putting a framework on all these country actions.

Are you hopeful?

Gernot Wagner: I am. The climate problem is, in fact, a lot worse than many people realize. The climate shock is real. But there are solutions. They work. They are getting better and cheaper by the day. And we are largely moving in the right direction.

Martin L. Weitzman: Climate change is an extremely difficult problem to solve, certainly among the most difficult I have seen in my lifetime. But I’m guardedly optimistic, yes.

Gernot Wagner: In the end, it’ll take Washington, Wall Street and Silicon Valley to make this right by pricing carbon, deploying clean technologies at scale and investing in research and development that will lead to new, even cleaner technologies we can’t yet even imagine. A lot is happening on all these fronts. A lot more, of course, needs to be done.

Originally published on the PBS NewsHour Making Sen$e blog, on December 3rd, 2015.

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From climate finance to finance

By / Bio / Published: November 19, 2015

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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