14th October 2009

Climate Policy given

Political ConstraintsStephen StrettonResearch AssociateCambridge Centre for Climate Change Mitigation Research (4CMR)Department of Land Economy http://www.4cmr.org

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1: Why?2: Political Constraints

3: Carbon Pricing4: Towards a Solution

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1: Why?

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Part 1: Why?

• Effects of Climate Change• Why? Committed Temperature Rises• Net Costs of Tackling Climate

Change

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Effects of Climate Change

Source: Adapted from Warren, R (2006)

(Present Day) – Some effects already seen

Oceans damaged

Greenland ice melts (raising sea levels eventually by 7m)

Amazon rainforest?Increases in

extreme weather (e.g. hurricanes)Agricultural yields fall

Tropical diseases spread

Hundreds of millions at risk from hunger & drought

CO2 released

from forests and

Soils

Methane released from peat

bogs & oceans?

Desertification of large parts of Earth’s surface

World ecosystems cannot adapt

Positive Feedback: Warming causes further release of greenhouse gases

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Why?

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World Income Under Different Stabilisation Scenarios

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50

100

150

200

250

300

350

400

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

2055

2060

2065

2070

2075

2080

2085

2090

2095

2100

Date

Gro

ss W

orld

Pro

duct

(U

S$2

000)

Baseline450ppmCO2only (c.550CO2e)500ppmCO2only (c.600CO2e)550ppmCO2only (c.650CO2e)

Net Costs of Mitigation are Small

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Part 1: Conclusions

• Climate change is a massive problem; requiring huge investment

• But it can be solved at low net cost• Very strong action to decarbonise

the economy over two decades is required immediately if we wish to prevent a large risk of massive damage to natural and physical capital

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2: Political Constraints

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Part 2: Political Constraints

• Tragedy of the Commons• Logic of Collective Action• Dual Causation?• Key Actors• Incentive v Wealth Effect• Tragedy of the Commons (2)• An ‘Artificial’ Tragedy?

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‘The Tragedy of the Commons’

• Incentives of individual actors considered separately differ from collectively rational solution

• Where a common resource is involved (e.g. the global atmosphere) this is often referred to as a ‘Tragedy of the Commons’– The cost of each individual’s pollution is shared over the

future– Incentive to ‘Free Ride’

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Logic of Collective Action

• “Tyranny of the Concentrated Interests”– Take a pragmatic approach: concentrated interests can

be harnessed for the interests of the climate

• Concentrated Interests:– Fossil Fuel Owners – Alternative Technologies: Renewables, Nuclear, Carbon

Capture & Storage – Reinsurance companies– Large nation-states (e.g. China)– Trading blocs – Clubs of countries– Institutions

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Dual Causation?

• Economic Structures depend on Government Policy and Government Policy depends on Economic Structures.

Government Policy

Structure of the Economy

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Key Actors

• Individuals/Voters? • Nation States? • Resource Owners?• Industry?

Can climate policy be framed in a way that is positive for these agents?

(Without making things too complicated)

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The Two Effects of Policy

1. Incentive Effect – higher prices encourage behaviour and technological change

2. Endowment (Wealth) Effect – change in value of assets

N.B.: the agents that might suffer the economic loss from strong climate policy (a change in endowment/wealth) are not necessarily the same ones that would be charged the tax or asked to buy permits. The economic incidence of a tax will generally fall on factors of production, namely: labour and owners of land, resources and already-existing capital goods, and differs from the ‘paper incidence’.

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‘The Tragedy of the Commons’ (2)

• I’ll argue here that there are in fact two tragedies:– Firstly, if it is costly for countries to reduce their

greenhouse gas emissions, then there is a ‘natural’ tragedy

– Secondly, there may be an ‘artificial’ tragedy; this is associated with the structure of the institutions we use to solve the problem

• I’ll argue that the ‘artificial’ tragedy is more significant than the ‘natural’ tragedy

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An ‘Artificial Tragedy’?Implications for Policy

• Current international agreements are based on flexibly-determined-quantitative targets.

• Under emissions trading, rights to emit carbon have a value

• In original negotiations, countries may seek to negotiate more value to their countries: i.e. more permits and therefore fewer reductions.

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Part 2: Conclusions

• Global policy suggestions need to take account of the interests and incentives of smaller scale actors (e.g. nation states)

• Structure matters!

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Part 3: Carbon Pricing

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Part 3: Carbon Pricing

• Definitions• Upstream v Downstream • What does a carbon price do?• Carbon taxes as fiscal instruments• How High?• Taxes and Cap-and-trade• Taxes versus Cap-and-trade• Conclusions

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Definitions

• An energy tax is a monetary amount charged by the government on the extraction, importation or use of fossil fuels.

• A carbon tax is an energy tax levied according to the fossil fuel’s carbon content

• A carbon price is a carbon tax or equivalent price for marketable permits.

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‘Upstream’ or ‘Downstream’?

C

C O

O

C O

O

C O

O

C

C

C C O

O

‘Upstream’ ‘Downstream’

£ € $

Fossil Fuels CO2 Emissions

£ € $

It is administratively simpler to cover all sectors with an ‘upstream’ carbon price

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What does a Carbon Price Do?

1.Reduce Demand

2.Encourage Alternatives

3.Raise Revenue £

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Price Elasticity and Tax Effectiveness

Emissions less sensitive to Price(Price Inelastic)

Emissions more sensitive to Price(Price Elastic)

Effectiveness of Carbon tax as climate policy

Low High

Effectiveness of Carbon tax as a tax

High Low

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Oil Price Fluctuations

Equivalent to $200/tCO2

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How High Does The Carbon Price Need To Be?

• Coal with Carbon Capture and Storage– $85-130/tCO2 for new demonstration plants

– $40-60/tCO2 in 2030 for commercialized plants (Naucler et al. 2008; €1=$1.4)

• Concentrated Solar Power– Carbon price needed: $115/tCO2 (Staley et al., 2009)

• Air Capture – Capture and Storage of Carbon Dioxide from Thin Air

– Carbon price needed: at least $140/tCO2 (Keith et al., 2006)

• $200/tCO2?

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UK Money:Effects of £100/tCO2

• 4p/kWh on gas electricity

• 10p/kWh on coal electricity

• 23p/litre on petrol

• Raise £60bn/yr initially*

• *£1000 citizens income or replace VAT*this will fall as the policy reduces emissions

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Taxes versus Quotas

1.Administrative Burden (Upstream v Downstream?)

2.Volatility – Investment?3.Immediacy?4.Do we know our budget?5.Ability to overachieve?6.Incentives for Countries to

Participate Globally?

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Part 3: Conclusions

• A price of >$200/tCO2 would be effective at reducing emissions in the long run, encouraging alternative sources of energy

• Upstream taxes have important advantages

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Part 4: Towards A Solution

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Part 4: Towards A Solution

• Governing the Commons• Global Solutions• Sub-global Solutions• Conclusions

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“Governing The Commons”Design Principles for Enduring Common-Pool-

Resource Institutions:

1. Clearly defined boundaries of common property resource

2. Congruence between appropriation/provision rules and local conditions

3. Collective choice arrangements – agents can participate in modifying operational rules

4. Monitoring5. Graduated sanctions6. Conflict-resolution mechanisms7. Rights to organize8. “Nested enterprises”

Source: Elinor Ostrom, “Governing the Commons”

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Global Solutions

• Global targets?• Global level institutions: forests

stocks, finance etc.• Measurement, legal structures,

contracts, institutions• Concrete action: “A carbon phase out

plan”

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Sub-global Solutions: “The Climate Club”

• ‘Climate Club’ of committed nations• Constant carbon price of ~$200/tCO2 on

fossil fuels• Issue of contracts guaranteeing this price

for international investors• Price embodied carbon in imports• Adopted by a ‘club’ e.g. EU, US and Japan

with open membership

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Part 4: Conclusions

• International negotiations must provide for credible commitments and global institutions whilst not preventing sub-global action

• Sub-global ‘climate club’ can take concrete action to reduce emissions now

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Discussion

Thank you for your attention!

Contact me:Stephen Strettonsjs53@cam.ac.uk

Links:http://www.4cmr.org

http://www.withouthotair.comhttp://www.zerocarbonnow.org

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Questions from the Audience

• Capital investment requires certainty – if you have different agreements in different parts of the world, will this be certain enough? – Purpose of plan is price certainty, which is what matters for

investors• R&D – technological progress

– Yes, much more expenditure on R&D is needed• Getting there – short term politics, fuel in the ground

– agents won’t cooperate?– Difficult and important questions: maybe we don’t have to

please all the agents all of the time?• CCS doubles cost of steel – is this accounted for in

model?– We do not model CCS in industrial sector, only in the power

sector. Yes, there will be knock-on costs of the price of steel for cost of infrastructure.