Today our understanding of the scale of the risks posed by climate change is much better developed and supported by seriously tested and globally accepted evidence. The IPCC report released on 27 September stated that warming of the climate system is unequivocal, and since the 1950s, many of the observed changes are unprecedented over decades to millennia. The report is also clear that it is extremely likely that human influence has been the dominant cause of the observed warming since the mid-20th century.
While governments need to start taking action now to put us on a pathway to achieve zero net greenhouse emissions globally in the second half of this century, our dependence on fossil fuels appears to be unshaken. We need to learn from the policies some countries are implementing to drive the investment and technology shift needed to break that dependence, and to highlight the stumbling blocks that will require strong political will to be overcome.
It would be hard to imagine a more complex risk management issue than that posed by climate change. But let me start by looking at how governments have recently managed another major risk. For the last five years, we – and many other institutions – have been trying to understand how developments in the financial sector managed to wreak havoc on the real economy and millions of lives.
The financial crisis has been estimated by the GAO to have cost the U.S. economy alone more than $22 trillion. Unemployment in OECD countries now stands at 49 million (8%). It is 16% on average for those under the age of 24 and still growing in some countries. Inequalities are also growing. The cost of reconstructing the financial sector has also been enormous. If you had asked, in advance, those who oversaw the system that led to this train wreck whether they were comfortable living with risks on this scale and would happily pay the costs should they materialise, I suspect their answer would have been no. The risks were either not understood, or ignored.
In parallel, over these same years, governments have also been grappling with how to cope with the risk of climate change. Here the time frames are much longer but, unlike the financial crisis, we do not have a “climate bailout option” up our sleeves. Interestingly, and despite all the press attention given to climate deniers, our understanding of the scale of the risk is much better developed than our understanding of the financial risks pre-crisis. It is not based on financial models but on several decades of extraordinary research and – here models do come in – trying to understand the consequences of how it may evolve.
We know how costly extreme events can be – Hurricane Sandy cost about USD75 billion or 0.5% of 2011 US GDP. Recent analysis by ourselves and research partners estimates that the flood exposure of coastal cities is going to worsen substantially, with the annual costs of flood losses expected to increase to over USD 50 billion per year by 2050. Even with massive new defensive investments of the type New York is now considering, the magnitude of losses when defences are breached is set to rise. Increases in the number of extreme events will involve costly change and adaptation.
In 2009 in Copenhagen, governments endorsed the view that the increase in global average temperature resulting from human activity should be kept below two degrees. That isn’t a costless threshold – it will still require some expensive mitigation and adaptation investments. But we think it remains – just – a manageable and affordable problem to deal with, and much less costly in human and economic terms than the alternative of unmitigated climate change.
Towards zero net emissions from fossil fuels
I’ve come here today to argue that whatever policy mix we cook up, it has to be one that leads to the complete elimination of emissions to the atmosphere from the combustion of fossil fuels in the second half of the century (I shall, from here on, use ‘zero emissions’ as shorthand, but it embraces technical solutions to capture some emissions through, for example, carbon capture and storage or CCS). We don’t need to get to zero tomorrow. Not even in 2050, although we should be a long way down the track by then. But sometime in the second half of the century we will need to arrive there. Why?
‘Zero emissions’ might sound extreme. Why not just lower emissions? The answer to that is physical. Carbon dioxide is a long lived gas. It hangs around. Of one ton of CO2 emitted this year, over 60% will still be in the atmosphere twenty years from now and 45% 100 years from now. Some will still be around after thousands of years. Even small on-going emissions will continue to add to the atmospheric concentration. We have an accumulation problem.
Am I saying a human population of 7 billion or more can live without any impact on the atmosphere? Of course not. It is a question of the extent. We have been interfering with the natural carbon cycle for thousands of years as we convert land to food and fibre production.
But if we’re going to feed a further 2-3 billion people and limit temperature increases we cannot gobble up all the atmospheric space with fossil carbon. But that is what we are doing. Carbon dioxide is the most important greenhouse gas produced by human activities. We are currently releasing over 30 billion tonnes of this gas annually. Of this, electricity and heat generation account for 41% and transport account for 22%. Further anthropogenic emissions come from agriculture and the way we use and alter land, together with some process emissions from industry.
Energy-related emissions make up the bulk and they are the only ones that could, based on existing technologies, be completely eliminated. For power generation, the wide range of existing clean energy technologies can be complemented by smart demand-side management. For transport, the challenge is greater but again, electrification or fuel cells can make the internal combustion engine obsolete.
We can energise the world without interfering in the carbon cycle. The solar flux reaching our planet – and the secondary flows it sets up in wind, waves and rain – is stupendously large. And there is potential in biomass and of course nuclear energy, provided safety issues related to nuclear power generation and waste management are properly handled.
After twenty years of negotiations and policy experimentation, one thing is abundantly clear: the world is nowhere near a trajectory that is consistent with the goal of zero emissions from fossil fuels in the second half of the century. That is true of OECD countries and non-OECD countries alike. Given their different stages of development one would expect them to be on different trajectories, but all those national trajectories will have to converge towards zero in the second half of the century.
Many countries have announced emission reduction targets for 2020 and even mid-century, some of them ambitious ones. Even more is needed: UNEP estimates that the pledges for 2020 get us only between a quarter and half way to where we need to be to keep the 2 degree goal within reach. And pledges need to be supported by credible policies that will achieve them. Thus, an awful lot of progress will need to be made over the next two or three decades starting immediately – not sometime after 2020.
There is, of course, a more immediately pressing reason to move away from fossil fuels and that is the local impacts on human health and the associated cost to the economy. In China, for example, approximately 1.2 million people die prematurely each year from exposure to outdoor air pollution. While some cities, such as London, have made huge investments in limiting some if the worst side effects from fossil fuel combustion, much more will need to be done in the mega-cities of the developing world.
I will turn in a moment to the policy mix that we think would provide the most credible platform for making progress. But before doing so, let me say a little about why, after twenty years of negotiations, this is all proving so hard, and why we need to ask some hard questions about the business as usual mode we seem to be stuck in.
Swimming against the tide on fossil fuels
Ending our reliance on fossil fuels was never going to be easy. Two thirds of electricity generation relies on fossil fuels. 95% of the energy consumed by the world’s transport systems relies on fossil fuels.
I want to be very clear that I haven’t come here to vilify fossil fuels. Much of what we regard as material and social progress has been built on the back of them. They are incredibly convenient. We’ve physically constructed our world around them, and to wean ourselves away from them will mean swimming against very strong tides.
A first tide is a shift to resource abundance. A few years ago, the tide of opinion was that scarce oil and gas would keep prices rising and make the switch away from fossil fuels inevitable. High oil prices lulled some into the belief that the push to decarbonise was running with the grain of resource scarcity and that policy seemed to be going with the tide. That has proved illusory. The tide has changed. We have moved from a world of threatened scarcity to one of potential abundance. US crude oil production is currently growing sharply and the country is expected to become a net exporter of natural gas by the early 2020s. Oil and gas production is being ramped up in Brazil, Canada and Kazakhstan, huge conventional reserves remain to be tapped in Iraq and Saudi Arabia together with huge recoverable shale resources in Russia, US, China, Argentina and Algeria, to name a few.
Certainly, rising costs of extraction pose a challenge but the recent advances in exploiting tight oil suggest that the technological opportunities for continued exploitation will almost certainly continue to surprise us. Listed companies alone spent USD674 billion in 2012 on finding and developing new sources of oil and gas. The fact is that there are more than enough reserves to raise temperatures way above levels that even the most reluctant climate regulator would feel comfortable about.
A second strong tide is the fact that low-carbon technologies are facing an array of incumbent technologies that have a huge advantage based on vast investments over decades. Those investments are very profitable and easily attract new capital. More than half of the new capacity in electricity generation installed in 2012 was still fossil fuel-based. According to one estimate by the World Resources Institute (WRI), around 1200 new coal-fired power plants (with a capacity of about 1400GW) are at the planning stage. Not all of those will come to fruition. But those that do will run for a very long time. And the owners of these assets aren’t going to take kindly to their value being impaired by policies designed to tackle climate change. The Carbon Tracker Initiative estimates that at the current rate of capital expenditure, the next decade will see over $6 trillion allocated to developing fossil fuels.
If policy makers cap carbon emissions, the risk of “unburnable assets” could have a significant impact on the valuation of some companies. It is worth recalling that the investors are in so many cases people like you and me. The Asset Owners Disclosure Project estimates an average of over 55 per cent of pension funds’ portfolios is being invested in high carbon assets or sectors greatly exposed to climate change physical impacts and climate change-related regulation. The looming choice may be either stranding those assets or stranding the planet.
The fact is that any new fossil resources brought to market – conventional or unconventional – risk taking us further away from the trajectory we need to be on, unless there is a firm CCS requirement in place or governments are prepared to risk writing off large amounts of invested capital.
A third very strong tide is what we call “carbon entanglement”. What does this mean? Basically, that governments everywhere on behalf of their citizens have major stakes in bringing fossil fuel to market and taking their share of the rents. OECD governments receive around USD200 billion per year from royalty payments, taxes and other revenue streams associated with upstream oil and natural gas rents. The share of such revenue streams in total government revenues is normally low – in the order of 1-4% -- but in countries like Norway and Mexico it gets up to around a third.
The absolute size of these revenues pales into insignificance alongside that of some emerging and developing economies. Russia alone receives around USD150 billion a year from oil and gas, amounting to 28% of total government revenues, while OPEC countries extract revenues of USD 600 to 700 billion a year. The reliance of these governments on fossil fuel revenues is overwhelming. They have a heavily vested interest in continuing these flows of income. It is scarcely surprising then that cash-strapped governments of all shapes and sizes worldwide are hoping to find and exploit new reserves of oil and gas, whether it be in the deep sea off-shore of Brazil or in the Arctic.
Carbon entanglement will not be easily undone and the very modest progress of climate policy over the last two decades is in part testament to that. These are some of the strongest tides that we have to confront. Now let me tell you where we see the main policy challenges.
The policy challenge
With a particularly important negotiating deadline approaching at the UNFCCC Conference of Parties in Paris in 2015, the question before us now is whether we can consolidate the modest progress made to date and turn it into a momentum that will lead to a transformed energy system and zero emissions; or whether we will cobble together a face-saving agreement in which countries can point to some actions while leaving the ‘carbon entanglement’ untouched.
If we are to succeed, every country should be able to explain how its policies will get it onto a trajectory that leads in the second half of this century to the elimination of fossil fuel emissions. Governments need to be held accountable. They decided, in Durban, to seek a global agreement based on national commitments that could be quantified and tested. Those commitments will reflect national circumstances and no two countries will be in a position to move in the same way at the same speed. But all need to move.
The end goal of zero emissions is achievable, but it will not be achieved if we continue with current policies. It will all depend on the way in which every country answers the following question: is our government contemplating a policy mix that is, over time, credible given the scale of the transformation we have to make? While answering this question, we recommend that our countries take a close look at the mirror and evaluate their progress in tackling four key policy challenges:
- A lack of strong, consistent carbon pricing signals. Where carbon prices have been imposed, exemptions and carve-outs combined with very low prices have meant that the impact has been marginal at best. In some cases, we also have overlapping policies that can create inefficiency.
- A lack of action on fossil fuel subsidy reform. You would think that twenty years into the climate debate we would at least have made more progress in removing subsidies to fossil fuels that actually encourage carbon emissions. These are not just subsidies for consumers (which often end up benefiting higher-income households) but also official support to oil and gas companies for exploration and exploitation of new fossil reserves.
- Mixed messages and stop-go policies when it comes to supporting renewable energy, which have seriously shaken investor confidence.
- And, finally, a failure to tackle regulatory and market rigidities that favour fossil fuel incumbency in the electricity sector and which undermine demand-side options that could empower consumers to choose clean energy.
All this adds up to a lack of credibility if we mean what we say about climate goals. This is much more than a political issue. It is a crucial economic issue. At the moment, most businesses don’t believe that governments are serious, and they are investing accordingly – thus perpetuating the carbon entanglement.
Policy progress in turn, will not be made through gestures – but rather by convincing all sectors of society that the path that has been charted is credible, sustainable over time and that it will deliver.
To swim against the strong tides and effectively address the main policy challenges, our countries will need an Action Agenda with clearly set goals and measurable deliverables. I want to take this opportunity to propose such an Action Agenda:
1. Putting a price on carbon
In our view, any policy response to climate change by any country must have at its core a plan to steadily make carbon emissions more expensive while, at the same time, judiciously giving non-fossil energy and energy efficiency an advantage at the margin. This is fundamental.
In addition, countries will need to do other things as well, such as promoting R&D, running public awareness campaigns and promoting energy efficiency standards, but always keeping a close eye on their cost-effectiveness. But without placing a clear and explicit priceon emissions we are, as they say, just ‘pushing at a piece of string’ when it comes to changing consumer, producer and investor behaviour.
What do we know about carbon pricing? There is a strong consensus that putting an explicit price on carbon is necessary for tackling climate change, either through a carbon tax or through an emissions trading scheme. The OECD is today releasing a report, Climate and Carbon: Aligning Prices and Policies, that summarises our latest work on the issue and provides an accessible guide on how to tackle carbon pricing.
The evidence is that politicians favour almost anything other than a tax. If it’s called a tax it seems to run into twice the political headwind as any other policy instrument. Partly as a result of this, emissions trading schemes (ETS) are becoming widespread. The EU ETS is the oldest and best known but similar (and in some cases more comprehensive) schemes are now in existence in California, nine states in the North-Eastern USA, Quebec, Australia and New Zealand. There are also pilot schemes being trialled in seven Chinese cities and provinces that cover over 20% of China’s emissions. These are important, but piecemeal, efforts. While the “flexibility” of ETSs has made them a politically-attractive option compared with carbon taxes, getting them legislated has involved all sorts of compromises. As a result, more needs to be done to improve their design and implementation to make them as effective as possible.
It is important to note that not all governments have shied away from explicit carbon taxes. Since Sweden introduced its carbon tax in 1991, an additional nine OECD countries have followed suit. We have learned a lot from these experiences on how to introduce carbon taxes. For example, introducing the taxes incrementally over time can allow households and businesses to make smooth, efficient adjustments. The implementation of British Columbia’s carbon tax is as near as we have to a textbook case, with wide coverage across sectors and a steady increase in the rate, from CAD 5 to CAD 30 per tonne over a period of five years.
But carbon pricing doesn’t stop there. There are many ways in which carbon is priced implicitly. For instance, there are many taxes on different forms of energy that can to some extent reflect a price on carbon, even if carbon reduction was not the original target of the tax. These vary significantly across countries. Our database of environmental taxes shows that energy and motor vehicle taxes in countries such as Denmark, Brazil, and Turkey amount to as much as 3.5% of GDP, whereas they are less than 1% of GDP in the US. In Mexico, energy subsidies outweigh the taxes.
In a publication earlier this year entitled Taxing Energy Use , the OECD delivered the first comprehensive analysis of what the landscape of energy taxes looks like when each tax is compared according to the carbon content of the fuel.
Some findings from the study highlight the inconsistency of energy tax policies. For instance:
- Coal, the most polluting of all fuels, is, strangely, taxed less than most other fuels used to generate electricity.
- Diesel, which emits around 18% more CO2 per litre of fuel than gasoline, is taxed a third less than gasoline on average. And diesel has significant impacts on local air pollution. In France, for example, diesel-related air pollution is estimated to kill more people each year than traffic accidents. A severe case of bad targeting, indeed!
Encouragingly, however, the report shows that energy taxes clearly affect energy consumption behaviour. Indeed, countries with higher average effective tax rates on CO2 tend to have lower carbon emissions per unit of GDP.
The same sort of analysis can be applied to other policy instruments. And we are just about to release a report that does this. While the “price” of a carbon tax is clear to all (which is one of the reasons they are easy targets for political opposition), other policy instruments such as technology standards also result in an implicit ‘carbon price’, reflecting the cost to households or companies in complying with these standards. Our new study estimates these prices, with fascinating results.
First, looking across the 15 countries in the study, which include OECD countries as well as Brazil, China and South Africa, it is clear that there are a number of policy instruments in place that impose an implicit carbon price, and in some sectors this price is very high. In some cases, this may reflect ambition. In other cases, it may be the result of excessively costly policies.
The large differences in the cost-effectiveness of the different policy instruments used within a sector and across sectors are clear. The study shows that economy-wide pricing instruments, such as emissions trading systems, are more cost-effective in reducing emissions in the electricity sector than feed-in tariffs or capital subsidies (with capital subsidies costing EU 176 per tonne of CO2 abated, feed-in-tariffs costing EUR 169 per tonne, and trading systems EUR 10 per tonne on average). Yet capital subsidies and feed-in-tariffs are much more commonly used! In the transport sector, fuel taxes are the most cost-effective instrument for reducing emissions and are widely used. Notwithstanding that, many countries have tax preferences and fuel mandates to support biofuels. Yet these are costly and often of questionable, if not negative, environmental value given their life-cycle impact. This new work clearly demonstrates that countries could achieve much higher levels of emission reductions for the same cost if they used smarter, market-based policy instruments.
What does all this add up to? It is clear that there has been a huge amount of taxing and regulatory action around carbon in many different jurisdictions. But the outcome to date is far from optimal. Depending on the country, carbon is priced in a multitude of ways. Sometimes the price is very high, often it is low to negligible. It is a chaotic landscape that sends no clear signal.
2. Reforming fossil fuel subsidies
To that we have to add a further round of distortions caused by what one might term ‘negative carbon pricing’ or, as they are more commonly known, subsidies. Once again it is the OECD and the IEA that have led the way in putting a spotlight on these practices. According to the latest IEA estimates, subsidies to fossil fuel consumers in developing and emerging economies totalled USD 523 billion in 2011. In many countries, these subsidies are used as a substitute for poverty relief. That is understandable since energy is one of the fundamental basic human necessities. But such subsidies are generally poorly targeted and instead end up being captured overwhelmingly by better-off households who can afford larger cars and houses that consume more energy. These subsidies are bad for the economy, bad for the environment, and also bad in terms of social justice. We need systems for social redistribution that protect people from energy poverty without hard-wiring a reliance on emissions-intensive consumption.
In recent years, the OECD has extended this analysis to make an inventory of support to both the consumption and production of fossil fuels in our own Member Countries. This is a major achievement that builds on the methodology developed over twenty five years ago to track support for agriculture. Again, the support we have uncovered is non-trivial - in the range of USD55-90 billion per year recently. Most of the support in OECD countries is quite opaque, particularly as it relates to production subsidies, lost in the details of taxing statutes. The figure is by no means comprehensive and our work is on-going. For instance, tax breaks for company cars can significantly increase the social costs of transport, through increased emissions, as well as more accidents and congestion. Preliminary findings of work we have currently underway suggest these tax breaks amount to over USD 30 billion per year across 25 OECD countries.
3. Incoherent and inconsistent policies
The net effect of the massive misallocation of resources arising from fossil fuel subsidies is to tilt the playing field in favour of continued reliance on fossil fuels. These policies actively undermine the carbon-pricing initiatives in some of the same countries and the economics of low carbon energy. Fossil fuel already has a huge advantage as the energy resource of choice. It doesn’t need more help. Moreover, the investment playing field is naturally attuned to channelling capital to mature, incumbent technologies that it understands.
Governments need to stand back and look across the entire range of signals they are sending to consumers, to producers and investors. If they are serious about climate change they can leave no stone unturned – all avenues to price carbon in a cost-effective way need to be explored and all conflicting policy signals eliminated. A critical element in this is financing the transition. There is no shortage of capital in this world. The question is whether non-fossil energy investments can currently compete in terms of their risk-return profile. In addition to pricing carbon, that means ensuring the right regulatory arrangements are in place and where appropriate, sufficient incentives for investors to redirect investment from fossil fuels to more climate-friendly alternatives.
To help them get a consistent picture and help countries compare their performance we’re going to make carbon pricing a key element of all our OECD Economic Surveys. By mid-2015 we will have a good idea of the progress that has been made – and remains to be made – in both OECD countries and key emerging economy partners. I want to stress again that we know the time-frames and ambitions won’t be the same – countries start from different places. But all need to be able to explain how their policy settings are consistent with a pathway to eliminate emissions from fossil fuel combustion in the second half of the century.
Managing the transition to zero net emissions
A clear, long term signal that the price of emissions will only go one way – up – would be the best path to put us on a trajectory towards zero emissions. But given the long life of many energy generation assets, and the fact that investors will inevitably question whether governments will stay the course, it may be worth considering complementary measures to accelerate transformational technological change.
Complementary measures are also required because vested interests and institutional inertia can delay the introduction of carbon pricing and inhibit its effectiveness. Let’s be frank: Governments are lobbied by those who face the highest costs of adjustment. And for these groups the costs are real. The very transparency of prices makes them an easy target for opponents. So a whole variety of less transparent regulatory interventions and subsidies are sometimes favoured to make progress. These are rarely cost effective. But if such policies can give producers and consumers the confidence that viable technical alternatives exist and their costs can be managed down, then they may be a justified means of making the transition to stronger carbon pricing.
The key point to stress is that, whatever is attempted, the whole range of price- and non-price- based measures must be mutually supportive. This may involve some hard questions.
A first hard question is: Should governments impose a moratorium on new coal-fired power stations?
Coal releases far more CO2 per unit of energy than oil or gas. Without CCS, continued reliance on coal-fired power is a road to disaster. I note that that the World Bank, the US Export-Import Bank, the European Bank for Reconstruction and Development and the European Investment Bank have severely limited the cases in which they will finance new coal power projects. This should be something every government considers for itself in terms of domestic developments and (for those countries that are donors) in respect of development assistance.
In some countries, today, coal is on the retreat as a simple result of market forces. Obviously I have in mind the United States where the exploitation of shale gas has changed the game. How should we regard the advent of shale gas in terms of the long term goal I have been talking about? For heavily coal dependent countries a switch to shale gas can reduce the carbon intensity of power generation (as in the USA). This is an improvement from a climate perspective (provided the gains are not off-set by vented and fugitive emissions). It will mean lower emissions, but not “no emissions.” The question then becomes: how do you ensure that gas is a transitional step towards an eventual goal of zero emissions? If we invest too much in dedicated pipelines and other infrastructure, the transition risks becoming a new and permanent dependency. Any new fossil resources brought to market – conventional or unconventional – risk taking us further away from the trajectory we need to be on, unless there is a firm CCS requirement in place or governments are prepared to risk writing off large amounts of invested capital.
Another hard question: Should governments regulate to ensure that new plants can be retrofitted for carbon capture and storage (CCS)?
Given the scale of our current dependence on fossil fuels and the scale of sunk investment in their extraction and use, CCS is will have to play a vital role. However, we should not over-estimate its potential in the coming decades nor rely on it as the “get out of jail free” card. The IEA notes that even if all currently planned CCS capacity were to be constructed, only 90 Mt CO2 would be captured per year. That would be equivalent to less than 1% of power sector CO2 emissions in 2012. The gap between where we are and where we need to be is huge but perhaps not surprising. Under current carbon prices, CCS is only commercially interesting for enhanced oil recovery!
Beyond CCS, we should see transformative zero-emission technologies as opportunities that will deliver a range of environmental benefits and economic opportunities. Once costs start to fall and the palpable local, public health benefits of zero pollution energy start to register in people’s minds, the building of a post-carbon world will offer some incredibly exciting economic opportunities. These are not just about fuel savings on the energy supply side. The applications of ICT to a world in which consumers can manage their own demand and choose their energy sources – including disengaging entirely from the grid – is likely to be a world reliant on a large number of products and services that currently do not exist.
Understandably, the cost of exiting from the status quo can appear daunting. The transition to a zero emissions economy will not be a costless one. Governments must be frank about the costs of this transformation. But if we are equally realistic about the costs climate change could impose, we should see transformative zero-emission technologies as opportunities. Every one of them will be part of a new growth dynamic.
“History is a race between education and catastrophe.” These words by HG Wells can be a guiding light to address the difficult choices that are knocking on our door. We are on a collision course with nature, and we need to take bold decisions to change that path. We must help governments identify ambitious but achievable goals, and then to achieve them in the most cost-effective manner. Our efforts have so far been a fraction of what is required. We are neither on track to achieve internationally agreed goals nor managing to execute even the existing policies in a cost effective way. This is placing human well-being at risk.
There is only one way forward: governments need to put together the optimal policy mix to eliminate emissions from fossil fuels in the second half of the century. Cherry-picking a few easy measures will not do the trick. There has to be progress on every front, notably with respect to carbon pricing, and that is what peer review and learning from best practice should help achieve. The OECD is dedicated to assisting countries in that process in order to design, promote, and implement better policies for better lives!
Watch the lecture Lecture by the OECD Secretary-General, Mr. Angel Gurría here: www.youtube.com/watch?v=Dwjqkb3MOvI
Please visit: www.oecd.org/env/cc/
©OECD July 2013