Complexity and Synthesis

For at least the last 35 years, it’s been a central dogma of energy pricing that markets can allocate resources more efficiently than mandated pricing systems. Even before the oil exporters’ cartel OPEC switched to market-related pricing, however, commodities have changed hands based on market principles.

The mechanisms used in the pricing of oil, and related commodities such as gas, assume that prices will adjust any imbalances between supply and demand. For example, a sudden shortage of supply caused by a geopolitical event will result – almost immediately – in a price spike that will encourage oil producers to pump more oil onto the market.

The trouble with this approach is that, while the commodity is in abundant supply, there is no economic incentive for potential competitors to develop to deal with future shortages.

The problem has been solved by subsidies, which underpinned the early growth of renewables. This led many governments to subsidise fossil fuels at the consumer level, leading to an uneven playing field.

 

An Uneven Playing Field

Subsidies have led to an uneven playing field with crippling economic costs. But while cheap energy encourages wasteful consumption, the fact that energy is essential to life makes subsidy removal painful and controversial.

The carbon markets are a different story. The European Union’s Emissions Trading System has been set up as a model for the pricing of “regulated” commodities, but for most of the period since it was incepted in 2005 the carbon price has been below that required to ensure a transition from heavily-polluting fuels to clean energy.

The Paris Agreement highlights the “important role” for providing incentives for carbon reduction through domestic policies and carbon pricing.

Carbon pricing has three main objectives: to penalise emitters of greenhouse gases; to encourage the transition to cleaner fuels; and to fund investment in carbon disposal. Three main methods have been devised by governments to achieve these goals: emissions caps; market-based mechanisms, such as the EU emissions trading system (ETS); and carbon taxes, including carbon price floors.

The vast majority of countries that have committed to carbon pricing in their Intended Nationally Determined Contributions (INDCs) – submitted to COP21 – have favoured market-based measures rather than carbon taxes. The World Bank estimated in 2016 that around 61% of global emissions would be covered by such schemes, including emissions from China, the United States, India, Brazil and the EU.

The trouble with these schemes is that, to date, they have failed to deliver the certainty needed to encourage low-carbon investment or carbon abatement on a large scale. Since its inception in 2005, the EU ETS has failed to deliver a high enough price either to encourage a switch from coal to gas in power generation, or – as it was intended to do – to fund carbon capture and storage (CCS) projects that would allow carbon disposal.

Many of the INDC commitments favouring the market approach are conditional, and tied to unspecified levels of financial and technological support. It seems unlikely these would meaningfully contribute to emissions reduction within the next decade, with the possible exception of China’s nascent National Emissions Trading Scheme.

Adaptation

Much less publicised than the Nationally Determined Contributions to mitigating climate change are the national plans for adaptation to the consequences for a changing climate. Given our projections that, even if we manage a transition from fossil fuels over the next 25-30 years, the earth’s climate will still warm by 3 degrees C, putting in place “common purpose” plans to adjust to the consequences of the temperature rise is essential.

The high-level consequences of global warming are well-known: iconic photographs of melting ice caps have popularised these so that they become a series of vignettes, each of which has a strong emotional resonance.

The trouble with the emotional appeal of such images, largely popularised by climate lobby groups to whip up resentment against corporations, is that they offer no solutions when they become realities. The emotional charge of an image is great at creating a sympathetic response but does not provide any engineering or economic solutions to the dangers it portrays. A picture paints a thousand words but does not create a consensus on what to do. Moreover the nationalistic approach to mitigating climate change makes a global response to adapting unlikely. The gradualness of the problem is also likely to create a slower response; the boiling frog dilemma means that the prompt and pre-emptive action required is not likely to materialise.

The consequences of climate change of 3 degrees C are likely to be as follows:

  • Rising sea levels
  • More extreme weather
  • Widespread desertification
  • Disappearance of snow
  • Changes in ocean currents

Each of these high-level changes will have specific consequences related to it, although these will vary from region to region.

The assumption has been that adaptation to climate change will only be needed if there is a planetary failure to deal with the challenge of mitigating the onset of climate change. The reality is that the need for both mitigation and adaptation will accelerate together, and that there will be competition demands from both challenges.

Adaptation

It’s realistic to envisage that global warming of 2-3 degrees C will occur over the next few decades. This will have enormous impact but the effects of climate change will be experienced unevenly around the world. Some poorer countries will be decimated; some richer countries may actually benefit.