Mitigation costs and strategies - A necessary update!
Dr. Ottmar Edenhofer, Potsdam Institute for Climate Impact Research, Germany, Member of IPCC Working Group III
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Thank you very much for the invitation to Prague.
While it is true that I have been also a journalist, I should start by saying that I am not really good at communicating these issues, in particular the economics of climate change to journalists, and I am always getting in trouble with them, for example, when explaining how emissions trading works. Nevertheless, I will do my job here trying to explain the economics of climate change.
A lot of interesting things are going on now in the climate change debate. Yesterday German Chancellor Angela Merkel made a very ambitious proposal. She requested that industrialized countries reduce their emissions to about 80% of current levels by mid-century, and she proposed that every citizen on earth should have the same right to emit carbon dioxide by mid-century as well. This is very ambitious.
Two weeks ago, together with German foreign minister Frank-Walter Steinmeier, I visited Governor Arnold Schwarzenegger at California. Arnold Schwarzenegger is now becoming sort of an ECO-Terminator on the planet, and we discussed a very interesting proposal with him to link the European Emissions Trading Scheme with the Californian Emissions Trading Scheme, which is planned to come into operation within the next three or four years. At the end of October, Arnold Schwarzenegger will visit a very important conference in Lisbon, where he will start negotiations to link both systems, and I expect that this negotiation will support the Bali negotiations in a very important way.
Also, yesterday a very important news magazine in Germany, Der Spiegel, published an interview with Bjorn Lomborg, a Danish economist. He says simply that it is not worthwhile investing in climate protection because it is too costly, and that we will benefit from the increase of the global mean temperature, so it is not worthwhile to do anything.
If I understood your President correctly, then Lomborg is of the same opinion as Czech President Klaus. It seems to me that it is therefore worthwhile to say a little bit more about the basics, about the economics of climate change. The first question is: Who is responsible for climate change? Humankind is responsible for climate change. At the global level, and also at the regional level, the increase of global mean temperature cannot be explained without including human impact on the natural system. The second question is:
Why should we care about an increase of the global mean temperature? What happens, and what are the impacts on human societies? We are really worried about th so-called tipping points. Tipping points are thresholds in the earth systems that lead to large-scale irreversibilities, such as melting of the Greenland ice-shield or dieback of the Amazon rainforest. The only thing I would like to argue here is that the tipping points in the earth’s systems are the most important reasons why natural scientists, and also social scientists, argue for applying a precautionary principle on climate policy. A precautionary principle means that it would be good to limit the increase of the global mean temperature to two degrees Celsius. This is a reasonable formulation of a precautionary principle because when limiting the increase of the global mean temperature to two degrees we have a very good chance of triggering tipping-points and thus avoiding dangerous climate change.
This is what sociologists and natural scientists would say about the problem, but most economists, in particular President Klaus, say the application of the precautionary principle is not appropriate in this case. I would like to explain a little bit why most economists believe the application of the precautionary principle is not appropriate. The richest countries are the USA, Europe, and Australia, while the former Soviet Union has been less successful in accumulating wealth and capital. The carbon debt is the accumulated stock of emissions over the last five decades, and it is very interesting to see that the richest countries, in particular the USA, the former Soviet Union, Australia and Europe, have accumulated a lot of carbon debt. In the end, we come up with a very depressing figure, which shows simply that when we increase per capita capital stock by one percent, we also increase emissions by one percent. This means accumulating wealth has alwaysed caused the accumulation of a carbon debt.
When all developing countries try to climb the traditional wealth ladder, this will increase global emissions considerably. In our historic memory (and humankind has a historic memory) it is deeply embedded that accumulating wealth has always increased carbon debt. There are thus two options for climate change policy. The first possibility is to forbid India, China and Bangladesh to become richer; the other is to ask Germany and the US to reduce their wealth. Neither option, in the end, is a realistic option. What most economists argue is that there is a trade-off between avoiding dangerous climate change and avoiding dangerous emissions reduction. Avoiding dangerous climate change means reducing the impacts of climate change, and avoiding dangerous emission reduction means having the option of reducing emissions without reducing our wealth. Over the last five decades, and I would say over the last 100 years, we have not seen any possibility for overcoming this trade-off.
However, this is only half of the picture. It is also true that climate change will particularly impact developing countries, such as Latin America, Africa, China and India. Here you have the moral dilemma of climate change: On the one hand you have huge emitters, (the USA, the former Soviet Union, Australia, and Europe), and you have Latin America, Africa, China and India, who are heavily affected by climate change. The moral dilemma is that those who cause climate change are not the same who will bear the main consequences. China and India are very important exceptions. These are the only two regions in the world where the main emitters and the people who are impacted by climate change are simply more or less the same.
If all countries try to climb the historic wealth ladder, we will see a rising “business as usual”emissions trajectory. What we need and would like to have is a falling emissions trajectory that is in accordance with the two degree Celsius target. Between the “business as usual” scenario and the “climate protection” scenario we have a huge mitigation gap. The key question in the economics of climate change is thus: how can we overcome the trade-off between dangerous climate change and dangerous emissions reductions? Do we have the technological means, the technological options at hand to overcome the challenging mitigation gap while ensuring global prosperity?
There are many ways to transform primary energy into final energy, and it is the energy system that has to be transformed in order to overcome the mitigation gap. However, most people, when talking about energy policy, always have one preferred option: Nuclear power. A lot of people believe this is the only “silver bullet” able to overcome the mitigation gap. In fact, however, there are many ways to overcome the mitigation gap. For example, we could use renewables - solar, hydro, wind, biomass. We could also use nuclear power. We could combine the use of fossil fuels with carbon capturing and sequestration, which means sequestering the carbon from large coal-fired plants and the carbon in geological formations. And we can increase the efficiency of energy usage. When we put all these options into a model, and try to calculate a solution that minimizes the trade-off between economic growth and climate protection (the costs of climate protection) we come up with the following solutions.
The first is improvement of energy efficiency. Energy efficiency is definitely a “low-hanging fruit”. In the final analysis it will remain quite important for the rest of this century. Energy efficiency means fuel switching, the improvement of housing construction, and so on.
The second solution is the use of fossil fuels in combination with carbon capturing and sequestration. In the transportation sector we see the use of biomass combined with carbon capturing and sequestration. After the second half of the century, renewables will become very important on the market (solar, wind and so on), and also it is very interesting that nuclear power, according to our model, will play only a very minor role, even though the model itself poses no limits on the use of nuclear power. It seems to me quite misleading to focus the debate about our technological options on nuclear power, because in the end it plays only a very minor role.
One important issue, which worries me a lot, is the role of capital markets and investors in this game. Investors and the capital markets can choose either a short-term horizon for their investments or a long-term horizon. If capital markets would choose relatively long-term horizons, they would invest a lot in renewables. Why? Because renewables in the future could become much cheaper; once we increase the installed capacity in wind, wind can become much cheaper in the future. However, this requires investment, and these investments will show returns only at the latest stage of the decision process. Therefore, a long-term horizon favours renewables, but a short-term horizon on the capital markets favours carbon capturing and sequestration and will postpone investment into renewables until the end of the century.
The time horizon of the markets, therefore, impacts not only the technological options, but also costs. This impact is definitely remarkable. If capital markets have a very short-term horizon, the costs of mitigation will increase, and if capital markets have a very long-term horizon, the costs of mitigation will decrease substantially. It is very important to understand this, because we need policy instruments and regulatory frameworks to support the capital markets in prolonging their time horizons.
Now let me come to another very important point. A lot of people, particularly in Germany, are in favour of renewables. I am also in favour of renewables. However, I would like to argue here that the most important environmental problem in the 21st century is coal. Coal is very abundant, and it is very cheap to extract. For hard coal, the former Soviet Union is the most important supplier, while the US is quite small, but China and India are also remarkable suppliers. Brown coal is plentiful and very cheap in the US, Europe, China and India. For these emitters, coal is an asset. If we impose a very ambitious climate or emissions-reduction policy on these emitters, then these assets will be devalued, and the likelihood that these players will participate in a climate protection regime will be reduced substantially.
As for the costs of the mitigation options, if coal and gas are expensive, the costs of mitigation are substantially below one percent, even below 0.5 %. If oil and gas are expensive, but coal is cheap, then mitigation costs are really very high, because the coal assets will be devalued due to climate policy. Nuclear power is obviously not a very important option in our model, because it calculates the same costs regardless of whether this option is included. Solar energy is much more important; it is very important if oil, gas and coal are cheap, and it is also important if oil and gas are expensive but coal is cheap. However, the most important option is carbon capturing and storage, because coal is quite cheap and abundant, and even if the oil and gas prices increase, mitigation costs will substantially rise if carbon capturing is not in the model. These are the options, and from my point of view, what we can say is that nuclear power is not a very important option in the long run, but coal and solar energy are.
One of the most important economic risks for climate protection is the evolution of the price of oil. There is a lot of debate about the oil price now. I believe it is one of the most realistic scenarios to expect that oil prices will remain very high. In the future oil and gas prices will be high, and the coal price will be very low.
What are the implications of this scenario for the mitigation options? Oil prices have a threefold impact on the economic system. A lot of people believe that high oil price could solve the climate problem, because the effect will be that we reduce our emissions because energy efficiency will become a much more important option. However, this is only one possibility: The other possibility is - and this is very important – that a high price will induce a lot of investment into the exploration of new oil fields. If the oil price increases, we will use not only OPEC oil, but also conventional oil resources, and also oil shells and tar sands, for example from Alberta in Canada. A lot of investment is now flowing to Alberta to explore and to extract these oilfields.
Another important option is that if the oil price is very high, other coal-based technologies become preferable and profitable on the market, in particular the coal-to-liquid option. In China the investment into coal-to-liquid is increasing substantially and will increase substantially over the next decade.
The net impact is that if we have cheap coal and expensive oil and gas, then emissions will be reduced a little bit (compared to the scenario where oil, gas and coal are all cheap); however - and this is much more important - we will also increase the use of coal and reduce the importance of renewables. A high oil price will not solve the climate change problem. Even with a high oil price, we have to rely on energy efficiency, carbon capture and storage, renewables and, to a lesser extent, nuclear power, which will also play only a minor role.
The costs of mitigation as pointed out by the IPCC are in accordance with what I have calculated, and this is not a surprise because the IPCC calculations are basically based on my research. Economists claim carbon cuts will not break the world’s bank, so I deeply believe we are on the right side here. With one percent or less we can indeed effect very ambitious emission reductions, based on a model comparison exercise where we compared about 20 international models of mitigation costs and mitigation options.
However, this will only happen if we do the right things, and it is not sufficient only to have technological options at hand. We also need effective institutions, which are very important from my point of view. At the EU level the Commission is trying to implement a reasonable energy policy. It is trying to reconcile climate protection with security of supply and competitiveness, and these are also reasonable and fine things, but for me the most important issue for Europe, and also for the Bali negotiations, is how to get and how to implement a reasonable carbon market, a reasonable market for trading permits for CO2.
Allow me to explain a little bit the current shortcomings of the European Emission Trading Scheme. I see three major issues: The first shortcoming is that we grandfathered the permits in the beginning instead of auctioning them; the second one, in Europe, is that basically only the power sector is included in the emission trading scheme; and the third one is that the regional scale of the emission trading scheme is too small. What we need is a worldwide market with wide sectoral coverage, with a reasonable price on CO2, which means about 20 -30 euros per ton of CO2.
The crucial question is: How to improve the European Emission Trading Scheme? The Commission decided to have auctioning during the next commitment period, which from my point of view means progress and is a very good step. We will include (or should include) many more sectors in the emissions trading scheme, in particular the transport sector, which is also a very good step. How can we enlarge the European Emission Trading Scheme regionally?
Now Arnold Schwarzenegger enters the scene. From my point of view, it should not only be California, but also the New England states and two Canadian states that try to link their emission trading schemes, and this could be a starting point for achieving a global CO2 market with a reasonable price. Until CO2 gets a price, energy efficiency and renewables cannot enter the marketplace. Without a reasonable price, none the mitigation options are competitive with the current options in the energy sector. From my point of view, this is absolutely crucial.
This could all be complemented by some of the technology programs proposed by George W. Bush, but in the end we need a carbon price, and a carbon price presupposes a reliable commitment to reduce emissions. Therefore, from my point of view, Chancellor Merkel is right when she argues that commitments are important, the enlargement of CO2 markets is important, and fair rules for allocating emission rights are important - these are the pillars of a reasonable global carbon market. We could become indeed the nucleus of a global carbon market when and if the European Emission Trading Scheme can be linked with the emission trading schemes emerging in the US.
In conclusion, I agree with my colleague Nicolas Stern, who said in his report: We have the time and the knowledge to act, but only if we act internationally, strongly and urgently. This is true, and I am quite optimistic for the negotiations in Bali, that a much stronger international climate protection scheme is on the way. This regime is affordable, and it is, from a purely economic point of view, a reasonable investment.
Thank you very much.