Great Carbon Arbitration | VOX, CEPR Policy Portal

Monday, May 2, 2022 Guardian “We live in hell” is an article on heatwaves in Pakistan and northeastern India, describing extreme temperatures reaching early spring:

The European Space Agency said in a statement on its website that “the warmest temperature recorded was 65C in the southeast and southwest of Ahmedabad with a maximum surface temperature of 65C.” The maximum demand in India reached an all-time high of 207,111 MW on Friday, according to official figures. (Baloch and Ellis-Peterson 2022).

It is a sad irony that India and Pakistan have immediately reacted to the heat wave by expanding power generation from coal-fired power plants, which will further aggravate the intensity of heat waves in the future.

How can we stop this hellish cycle of demanding more energy, emitting more carbon and moving to a warmer planet? As much as international negotiators have tried to reach an agreement to stop hard coal, and despite promises of historic progress at the United Nations Climate Change Conference (COP26) in Glasgow, so far all attempts to phase out the world’s coal have failed. .

Lack of public support for global carbon pricing means that the best policy to get rid of coal emissions via price signals has not yet been implemented (Kleinart and Hepburn 2018, Paulie and Van der Plug 2021, Duane and Fabre 2022). Most recently, in response to Russia’s war against Ukraine, even coal-fired countries are adjusting their positions. The biggest concern about phasing out coal is that it will be costly – replacing coal with renewable energy will be very expensive.

In a recent study (Adrian et al. 2022), we make a systematic quantitative analysis of this claim.1 To get an estimate of the net profit from this energy change we calculate the cost of coal replacement with renewable energy and the social benefits of phasing out coal. We include in the costs of replacing coal with renewable energy the capital cost of building a renewable energy capacity that is equivalent to burning coal, as well as the cost of compensating for future income from compensation when coal companies close. The benefits of phasing out coal are associated with less-than-expected future losses as a result of climate change. We calculate the current value of these facilities by estimating the size of the coal-fired emissions and applying the carbon value to those emissions. In this way, we get an estimate of the economic benefits of phasing out coal. When we subtract the current cost of coal replacement with renewable energy from the current value of these social facilities, we get a total total profit for the world in coal phases of 77 77.89 trillion as our baseline estimate. It represents about 1.2% of current world GDP per year until 2100. Far from finding that replacing coal with renewable energy would be too expensive, we uncovered a huge economic advantage by shutting down coal in phases, which we refer to as the ‘Great Carbon Arbitration’. . This huge social net benefit can be seen as a benefit from a cheap insurance policy: by paying a premium, one gets coverage for a potentially very large loss.

The flaw in the argument that coal is very expensive to extract is that it ignores the benefits of low carbon emissions. These benefits exclude all the benefits of real economic gain, economic activity, and innovation in the face of less-than-expected physical damage from climate change that would bring investment in renewable energy. Economic efficiency determines that the price of carbon should be set equal to the social cost of carbon (SCC). We have produced extensive literature on the Integrated Assessment Model (IAM) which provides quantitative estimates of the SCC to determine the carbon value to be applied to avoid emissions. If all carbon emissions are priced under an efficient global emission trading system (ETS), the equilibrium carbon price in this market will be equal to the SCC. It will then be possible to generate total revenue by shutting down coal equivalent to the SCC bar total evacuation emissions. By minimizing coal and replacing it in a renewable way over a long period of time, it would then be possible to create an arbitration benefit similar to the net social gain we have estimated by eliminating coal.

We calculate the avoidance of carbon emissions by subtracting carbon emissions from coal starting in 2024, which is a low carbon emissions under a business-normal scenario that would be generated if, instead, coal was phased out in line with Net Zero. 2050 Scenario of Network for Greening the Financial System (NGFS). Our baseline estimate of the social benefits of phasing out coal is equivalent to CC 75 per ton of CO to the SCC.2, Consistent with the lower-edge estimates of the SCC in Vernon et al. (2021) and less than the current value of the carbon allowance in the EU ETS.

Our analysis makes a simple but powerful observation: the periodic shutdown of coal is not the only urgent need to limit global warming to 1.5 degrees Celsius; It is also a source of considerable economic and social gain. The net economic benefits from coal depletion are so great that the implication of a general policy from our analysis is that efforts to reach a global agreement to phase out coal should be redoubled as soon as possible. Even in the face of “high transaction costs” and “poorly defined property rights”, to use the language of the Coase Theorem (Coase 1960), it is surprising that a cosine bargain of such proportions has not yet been exploited.

A global agreement to phase out coal in COP26 has not been reached. Only the 197 parties to the Convention can agree to accelerate independent efforts towards the phase-down of uninterrupted coal power. But what is needed is a more ambitious agreement to phase out coal: linking it to investing in renewable energy for coal replacement and financing this investment and compensating the coal companies for the lost profits. From a cosmological point of view, it is a reasonable economy to calculate the cost of capital required to replace energy from coal, to compensate for the periodic loss of coal and to set aside all these costs as opposed to the social benefits of avoiding emissions.

The implication of a broader policy from our analysis is that if compensation is made in phases out of coal phases, and the promised transfers for green investment in developing countries are conditional on phasing out coal, the social benefits from such an agreement would still be enormous. And the deal is much more likely to succeed.

To gain more insight into the size of transfers that may be required to pay for coal replacement with renewable energy, we further divide on a regional basis where these costs will be spent. We see that the current value of the total conditional climate financing required to finish the global coal is about $ 29 trillion, consistent with the need for an estimated renewable investment in other studies. This represents an annual global climate financing requirement ranging from half a trillion to two trillion dollars, with a front-loaded investment this decade, which we estimate to be up to $ 3 trillion. The cost of investing in the developed world to meet the needs of this global annual climate financing will be between 0.5% to 3.5% of the GDP of rich countries.

This obviously represents a big challenge. But our analysis shows that the social benefits from these investments far outweigh the costs. Some prominent commentators have argued that no government in the world has enough money to make such a large investment, and they have called on the private sector to raise the necessary funds for renewable energy investments. Most of the funding for these investments may actually come from the private sector, but a significant amount of public funding will still be needed to increase these investments (see Arezki et al. 2016, and Bolton et al. 2020). We provide a ballpark estimate of the required size of public funding if the āĻĢ 9 per dollar of public funds can be tapped through a mixed financing system and conclude that the overall strain on public finance is not unreasonable, especially in light of large sums of money. Social benefits from coal out of phases.

References

Adrian, T. P. Bolton and A. Kleinenhaus (2022), “The Great Carbon Arbitrage”, IMF Working Paper.

Arezki, R.P. Bolton, S. Peters, F. Sama and J. Stiglitz (2016), “Global Savings from Glut to Financing Infrastructure: The Advent of Investment Platform”, International Monetary Fund Working Paper WP / 16/2018.

Baloch, SM and H. Ellis-Peterson (2022), “‘We live in hell’: Pakistan and India are victims of the extreme heat of spring”, The Guardian, 2 May.

Bolton, P., X. Musca and F. Samama (2020), “Global Public-Private Investment Partnership: A Financing Innovation with a Positive Social Impact”, Journal of Applied Corporate Finance 32 (2): 31-41.

Douenne T and A Fabre (2022), “Public Support for Carbon Taxation: Lessons from France”, VoxEU.org, 01 May.

Kleinart D and C. Hepburn (2018), “Working to Carbon Pricing for Citizens”, VoxEU.org, 31 July.

Paulie, MC and R van der Ploeg (2021), “Recycling Revenue to Improve the Political Potential of Carbon Prices in the UK”, VoxEU.org, 4 October.

Endnote

1 A computational tool and additional analysis can be found at https://greatcarbonarbitrage.com.

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