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Economists price the ravages of climate change (FT)

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    Fw: [fuelcell-energy] ... Economists price the ravages of climate change By Scheherazade Daneshkhu and Fiona Harvey Published: February 2 2006 20:17 | Last
    Message 1 of 1 , Feb 2, 2006
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      Economists price the ravages of climate change
      By Scheherazade Daneshkhu and Fiona Harvey
      Published: February 2 2006 20:17 | Last updated: February 2 2006 20:17

      The price of the US's "addiction to oil" goes far beyond the
      dependence on politically volatile states cited by President George W.
       Bush this week. According to the world's leading climate scientists,
      reliance on fossil fuels is creating a global warming disaster that
      could end up costing the earth.

      Faced with these threats, rational people and governments might be
      expected to reduce their greenhouse gas output.

      But there is little appeal in taking costly action in the short term
      to stave off a long-term threat � especially one that, by its nature,
      is hard to calibrate.

      Persuading individuals and businesses to take the action necessary to
      tackle climate change caused by economic activity itself requires an
      economic argument. But how to put a price on the world's climate and
      the catastrophes that may follow from global warming?

      Attempts to fill a policy vacuum as the expiry of the Kyoto protocol
      in 2012 looms are suddenly turning environmental economics into one
      of the hottest areas of the discipline. The challenge is to find
      policies that will make the most efficient use of scarce resources
      and provide a rational basis on which to build an international
      consensus to address climate change among politicians and business

      It has taken some time for the economics of climate change to enter
      the mainstream. While scientific knowledge in this area has leapt
      ahead, economic advances have been much slower. You do not have to
      look far for the reasons. Most economics theory is designed to cope
      with issues that are relatively short term or national. Even
      international economics is ill-equipped to deal with trans-boundary

      Economists find it hard enough to make an accurate forecast one year
      ahead, let alone 100. Yet environmental economics must grapple with a
      plethora of uncertainties � scientific and political � over a
      dauntingly long timescale. Small wonder then that Michael Grubb,
      chief economist of the UK's Carbon Trust, a government-funded
      organisation that advises business, declares: "Understanding the
      economics of climate change is like trying to understand the Big Bang
      without Newtonian mechanics."

      Dieter Helm, a fellow of economics at New College, Oxford, adds: "The
      usual economists' toolbox looks puny against the scale of this
      challenge." Just as the experience of the unemployment of the 1930s
      required the reinvention of much of macroeconomics, so climate change
      needs new thinking too, he says.

      The drawback of the traditional approach notoriously emerged in the
      mid-1990s when economists, commissioned by the Intergovernmental
      Panel on Climate Change, used a cost-benefit analysis to assess the
      damage to the environment. There was an outcry when it emerged that
      the analysis involved valuing the life of an American at 15 times
      that of someone in the industrially less-advanced world.

      Another problem is that environmental goods � clean air and water, a
      stable climate � are rarely taken into account by standard economic
      analyses. For this reason, the United Nations has begun to promote
      the idea of "natural capital", as a way of valuing environmental
      goods so that they can be included in economists' equations.

      As Klaus T�pfer, executive director of the UN Environment Programme,
      describes it: "The goods and services delivered by nature, including
      the atmosphere, forests, rivers, wetlands, mangroves and coral reefs,
      are worth trillions of dollars. When we damage natural capital, we
      not only undermine our life support systems but the economic basis
      for current and future generations. Targeted investments in this
      natural capital have a high rate of return in terms of development."

      The UK can claim to be at the forefront of the debate, thanks in part
      to a decision by Gordon Brown, chancellor of the exchequer, to
      commission a review of the economics of climate change, headed by Sir
      Nicholas Stern, a former World Bank chief economist and senior
      Treasury official. Sir Nicholas's report will take a global view of
      the economic risks and possible benefits of climate change and assess
      the potential of economic instruments to address them. The findings
      will carry weight internationally since they will be part of the
      basis for UN discussions, due to begin this year, on the future of

      Sir Nicholas spoke publicly about his review for the first time
      earlier this week, in a lecture to the Oxford Institute for Economic
      Policy. Outlining some of the complexities of establishing economic
      solutions to climate change he went on: "It is an international
      collective action problem . . . The simple standard theory of
      externality" � on the spillover effects of production or consumption
      for which no payment is made � "is useful but not a fundamental
      answer to the problem".

      The first step, he said, was to convince all the governments involved
      of the need to take urgent action on climate change. The difficulty
      of achieving an international consensus is reflected in the history
      of the Kyoto protocol, which has been rejected by the US and
      Australian governments, and dogged with delays and disagreements (see

      Countries such as the US have decided that the costs of compliance
      are too high. As Mr Helm points out, climate change is a global
      public "bad", creating incentives for individual countries to free-
      ride on others' emissions reductions: if one country reduces its
      emissions, the effect on global warming will be negligible but the
      effect on that country's competitiveness could be significant.

      Jonathan K�hler, of the Department of Applied Economics in Cambridge,
      thinks it is not necessary for everyone to sign up to an
      international agreement for progress to be made on emissions
      reductions. Market forces will do some of the work, he indicates.

      "If you think climate change is a big problem and the world will have
      to do something, at some point there will be gigantic markets out
      there and big export opportunities for low carbon production
      technologies." He cites the example of Denmark, which captured a
      large slice of the market in wind turbines through its early
      investment in that sector.

      Policies to combat climate change need to take into account the
      impact of technological change on reducing the cost of renewable
      energy sources. Mr K�hler, who is also a manager at the Norwich-based
      Tyndall Centre for Climate Change Research, says economic models that
      take this into account suggest that the cost of switching over to a
      low carbon energy environment is not high compared with the cost of
      investment in energy systems that would anyway be needed. What is not
      clear is how quickly this would happen and how much government
      intervention would be required.

      The policy instruments available to governments traditionally include
      a carbon tax, limits on emissions and incentives to encourage the
      development of clean fuel technologies. Most economists favour market-
      based solutions as the most effective way to drive change in business
      practice (see below) and encourage the development of new technology.
      In an open letter to Mr Bush in December, 25 US economists, including
      three Nobel laureates, urged the president to control greenhouse gas
      emissions through mechanisms such as setting limits on the amount of
      carbon dioxide countries could produce and allowing them to trade
      carbon allowances with one another.

      Mr Helm believes that an alternative to subsidising a particular
      technology, such as nuclear fuel, in order to provide low carbon
      generation is to auction long-term carbon contracts. Under such a
      scheme, the government would auction carbon contracts for the supply
      of emission reductions over a long period � such as 20-30 years. The
      advantage for governments is that they are not obliged to evaluate
      industry claims about which technology is cheaper. Nor would they be
      obliged to sell a politically unpopular choice � such as nuclear
      technology � to a sceptical public. A similar scheme has been
      developed by the World Bank.

      But bedevilling attempts to provide an authoritative analysis of the
      economic impact of climate change, and thus the economic instruments
      necessary to address it, is the high level of uncertainty that
      pervades the subject. Although the scientific evidence points clearly
      to the conclusion that human actions are having an effect on the
      climate, many important questions remain unanswered: for instance,
      the extent to which temperature will rise smoothly or in jumps and
      the probability of "high-impact" events such as the Gulf Stream
      changing direction.

      Sir Nicholas believes his review, due in the autumn, will discover
      some of the answers. He said this week: "One of our key tasks is to
      find out whether you can be green and grow. There are a lot of
      arguments to suggest this is likely to be possible."

      But, he hinted, the road to knowledge would not be easy: To
      understand the issues, "you need all the economics you ever learnt �
      and more".

      Multinationals nudged into action

      Almost 2,000 company chairmen around the globe are this week being
      asked some searching questions about climate change. The quiz comes
      in a letter from the not-for-profit Carbon Disclosure Project � the
      latest salvo in a campaign to encourage businesses to take climate
      change seriously.

      Acting in the name of 211 institutional investors with $31,000bn
      (�17,400bn, �25,600bn) in funds under management, the organisation
      asked companies to disclose their assessment of the risks to their
      business from climate change and how much greenhouse gas they
      emitted. The project is just one of a large number of initiatives
      designed to alert businesses to their role in combating climate

      Karina Litvack, head of governance and socially responsible
      investment at F&C, the activist fund manager, says this makes good
      business sense. "Sooner or later we will have to pay the price and
      the sooner we move, the cheaper it will be to take corrective action."

      Fund managers have sought this information in order to build up a
      picture of the risks of climate change to companies in their
      portfolios, and an assessment of the liabilities those companies
      might face if their output of greenhouse gases were to be limited in
      the future.

      F&C prides itself on having had a hand in persuading General Electric
      to adopt a climate change strategy � its much-
      publicised "Ecomagination" initiative � through a five-year dialogue.
      In a letter to GE in November 2002, F&C warned that lagging behind on
      climate change and greenhouse gas emissions was a "serious business

      Under Ecomagination, GE will increase its research and development of
      technologies that reduce greenhouse gas output and double its
      revenues from such technologies by 2010.

      Other large companies have also been active. HSBC has just become the
      first "carbon-neutral" bank, offsetting its emissions through tree-
      planting and carbon trading.

      Meanwhile in 2004 BT, the telecommunications provider, became the
      world's biggest company to take all its energy from environmentally
      sound sources. DuPont, the chemicals manufacturer, has predicted it
      will save $2bn by reducing its greenhouse gas emissions by 65 per
      cent by 2010, relative to 1990 levels.

      Ms Litvack says the main stumbling block for business is the need to
      justify to shareholders the � sometimes large � investments needed to
      reduce emissions.

      For that, companies need assurance from governments that such
      investments will pay off. "At the moment there isn't enough incentive
      to cut emissions, which is why companies are becoming more vocal
      about their needs," she says.

      Most businesses that have taken up the cudgels over climate change
      have called on governments to take action using market-based
      mechanisms � such as emissions trading schemes � along with long-term
      policies and targets to reduce emissions.

      It is a rare company that goes looking for government regulation but
      in this instance some multinationals are doing just that. Without an
      international level playing field, they fear that rivals with
      operations in areas without restrictions will gain a competitive

      Rick Samans, managing director at the World Economic Forum, which
      last year convened a meeting on climate change between 24 leading
      companies and Tony Blair, UK prime minister, says: "What companies
      are seeking is certainty."

      Emissions trading provides a framework

      The Kyoto protocol came into force in February 2005, more than seven
      years after it had been negotiated in 1997 and only seven years
      before its provisions were due to expire. Its lengthy and tortuous
      passage illustrates the enormous difficulties of achieving
      international consensus on action to combat climate change.

      The UN-brokered treaty requires developed countries to reduce their
      greenhouse gas emissions by 2012 by an average of about 5 per cent
      compared with 1990 levels. But the US � the world's biggest emitter �
      and Australia have rejected the accord, arguing that it mitigates
      unfairly against them by placing no binding emission reduction
      targets on developing countries.

      Even if the terms of the treaty are met, the effect on overall global
      emissions will be small. Atmospheric concentrations of carbon dioxide
      will continue to rise, albeit at a slightly slower rate than they
      would otherwise. But proponents argue that the value of Kyoto lies in
      setting up a framework for international co-operation on emissions
      reduction. There is no other such framework: the only comparable
      alliance, between the US, Australia, Japan, China, India and South
      Korea, sets no targets or timetable for emissions reduction.

      Enshrined in the protocol is the concept of emissions trading. For
      instance, developed countries can meet their greenhouse gas reduction
      targets by financing projects in poorer nations that reduce emissions
      there. This has the added advantage of transferring low-carbon
      technology to countries that could not otherwise afford it. The UN
      estimates that �10bn ($12bn) in capital will flow from developed
      countries to poorer nations by 2012 as a result.

      A similar trading system was adopted by the European Union in January
      2005. Its greenhouse gas emissions trading scheme places limits on
      the amount of CO2 that businesses in certain energy-intensive
      industries may emit. Companies that emit less than their allowance �
      by increasing their efficiency or investing in low-carbon
      technologies � can sell their excess allowances for cash, while
      laggards can buy extra allowances on the open market. In successive
      phases of the scheme, the total amount of CO2 that businesses may
      produce is lowered.

      The price of emissions allowances under the EU system has risen
      markedly since it was introduced, reflecting rising gas prices. As
      gas grows more expensive, cheaper coal-fired power becomes more
      attractive.But as coal produces much more CO2than gas, generators
      need to purchase more allowances, pushing up their price.


      � Copyright The Financial Times Ltd 2006. "FT" and "Financial Times" are trademarks of the Financial Times
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