The argument that Europe and China need a complementary approach to set a economic price for carbon

by Dr Eddie O’Connor, CEO Mainstream Renewable Power tBrussels Branch of The Institute of International and European Affairs

at the Irish Embassy in Brussels, on Wednesday 11 June 2014. 

 

Mr. Chairman, Excellencies and Members of the Institute.

Climate change is the greatest challenge facing the world community.  It is caused by human activity in producing energy from fossil fuels.

Expressed in these terms there is a simple question to answer: how do we get people to stop burning coal, oil and gas and switch to other forms of energy that are free of carbon?

I believe the answer is to put a price on what is killing the planet; put a price on carbon and let markets respond as they always do to price signals.

The Key Message

In this presentation I will argue that the Europe and China should develop a complementary approach to setting an economic price for carbon and jointly adopt a leadership role at COP21 next year in pursuit of a global agreement on carbon pricing.

If this is achieved then the switch from fossil fuels to renewable energy will be assured and, if the price is high enough, will be achieved in full by 2050. That would prevent the rise on global temperature from going beyond two degrees celsius by the end of the century and so avoiding irreversible damage to the planet.

At present, the conditions for a complementary European/Chinese approach to carbon pricing are being created.

The lead has been taken by China in devising a cap and trade scheme that is currently being tested in seven major cities and regions.  If successful, as is expected, it will be applied nationally, no doubt as part of the 13th Five Year Plan due to commence in 2016.

Within Europe, there is widespread recognition that the Emissions Treaty Scheme needs major revision and that the price of carbon must act as a market signal spurring the transition to a low carbon society.

With intensified dialogue between the EU and China their respective policies could be aligned and presented to the rest of the international community as the template for a global agreement

In the light of the recent IPCC AR5 reports such an agreement must be speedy and effective because time is of the essence.

I do not believe the COP negotiating process possesses either of these essential requirements and, on the basis of its repeated failure, I will argue that it needs to be replaced by a new negotiating framework and given a completely new orientation.

In summary, my approach is to use carbon pricing as the economic means of achieving a political end. The rationale is straightforward: a high carbon price will lead to a low carbon economy.

An Economic Approach

I take this approach because, while there are a number of ways to tackle greenhouse gas emissions, carbon pricing has many economic and political advantages over alternative schemes.

From the economic perspective, the following are the most decisive.

The first is the power of the market to motivate change.

We have to motivate ourselves into taking common on reducing emissions against a background

–          Where there is mutual distrust between the developing and the developed world,

–          Where the emphasis is on differentiated responsibilities,

–          Where the US would not even sign the Kyoto Protocol,

–          Where other countries are dragging their feet,

–          Where vested interests can sabotage Europe’s feeble attempt at an Emissions Trading Scheme, and

–          Where the atmosphere at the last COP was described as poisonous.

We can use price signals as the means of creating change in human behaviour:  put a price on carbon and let the markets react by doing what they always do when price differentials are changed.

Resources will be allocated to those sectors in which it is profitable to invest and withdrawn from those where it is not.

I say this as a businessman who is investing in markets all over the globe: I believe in the motivational power of the market, and want to put it to good use.

The second economic benefit is that the social or external costs of burning fossil fuels would be incorporated into the price of coal, oil and gas.

The present failure to do so distorts the pricing of competing energy sources and results in a subsidy for the very forms of energy that are destroying the planet.  Current subsidies for fossil fuels are calculated to be circa €600,bn per year.

It would be hard to conceive of a more warped way of managing our affairs.

What we have to do is put the polluter pays principle into force and stop polluters free-riding on the environment.

A further advantage is that markets react with speed to price changes.

If allowed to operate freely in response to a level playing field, the market will complete the transition from fossil fuels to renewables on time.

And we need speed of reaction if we are to meet the 2050 deadline.

Technical Innovations

Within that timeframe three major technical innovations are needed to effect the energy transition to renewables.

They are: big grids, utility grade and distributed storage and demand side management.

Big grids are necessary because wind and solar resources are widely dispersed, usually at long distances from the centres of power consumption and this would be particularly true of offshore wind, which will provide the bulk of Europe’s electricity in a low carbon world.

The other reason for big grids is the geographic portfolio effect.  In capturing a storm along its length the big grid delivers a less variable electricity output.

By way of a technical solution, I have proposed the building of a Supergrid which will not only cover the seas around our coasts but also the great continental land mass of Europe and incorporate solar PV from the Mediterranean regions, as well as onshore and offshore wind.

The Supergrid and SuperNode

Think of the the Supergrid as the foundation of the renewables world ahead.

It will collect, transmit and distribute the electricity generated from the wind and the sun.  Most of the technology already exists, like High Voltage Direct Current cabling, which is capable of transmitting power over huge distances with only negligible transmission losses, unlike the High Voltage Alternating Current cables that most people are familiar with.

But wind and solar power have to be collected over wide geographic areas, then converted from AC to DC and distributed to to the load centres where demand is concentrated.

For this complex process to take place, a new piece of technology is needed, which does not yet exist.

It is called the SuperNode.

In practical terms, the Supergrid will operate on the basis of hundreds of these SuperNodes meshed together, thereby linking generation and distribution on a continental scale.

A model of the SuperNode has been built by my company, in conjunction with the Dublin Institute of Technology.

Here it is. This is the first time it has been unveiled outside of Ireland. For me it is a proud moment.

Prices Drive Markets

Mr Chairman, I have taken time to elaborate on the connection between markets and innovation because of a business reality that is too easily overlooked

Prices drive markets and markets stimulate innovation, providing they are allowed to operate free from distortion.

We in Mainstream are ahead of the curve in that we believe the transition from fossils to renewables is inevitable, that big grids are essential and the SuperNode indispensable.

We are responding to the future by becoming first movers in a technology that will be absolutely fundamental to the electricity era ahead.  The enhanced era of electricity has arrived and we intend to be leading it.

Similar developments are essential in building utility grade storage capacity, allied to distributed car batteries, to account for the variability of wind and the particular characteristics of solar.

Parallel developments are equally necessary in creating a real time demand management system based on smart grids and smart devices. This is a huge challenge for the IT sector, which I’m sure will be overcome.

The trend in patent applications proves that business is anticipating fundamental change in the generation, distribution and sale of electricity and it is interesting that China heads the league table in the number of patent applications.

From the perspective of stimulating entrepreneurship, what’s needed now is for the right price signals to be given.

No Losers

The logic inherent in carbon pricing is another big advantage.

If the price is sufficiently high to induce real change then carbon prices will tend to converge over time in terms of purchasing power parities.

As a result, a global price range will emerge which will be broadly neutral in terms of its effects on national economies, which will neither penalize nor benefit different countries.

Economies will be put on the same price path and there will be no big winners and no big losers from a common pricing policy, except those who bet on a fossil fuel future.

On the other hand, the perceived absence of neutrality is a political weakness in the current approach to negotiations. Invariably it produces winners and losers.

This is inevitable because it is the task of governments to protect the national interest and the problem inherent in inter-governmental negotiations is that the parties are never equal in terms of bargaining power.  That is the cloud hanging over the COP process. Carbon pricing disperses it.

By way of an aside, Mr Chairman, it will be recalled that because of his experience in the League of Nations and in organising the Allied war efforts in two World Wars, Monnet instinctively distrusted inter-governmentalism as a way of doing business.

The Scale of Investment

But like good wine I have kept the best reason to the last.

The International Energy Agency estimates that the cost of the transition from fossil fuels to renewables will come to $40 trillion over the next forty years, an average of $10 trillion every decade, or a trillion every year.

That sort of capital will not be mobilised by any international agreement, no matter how watertight nor well it be organised and deployed by administrative decree, no matter how well intended.

It will only be mobilised by the prospect of economic returns sufficient to remunerate the capital over the long term.   For that to happen, freely operating markets and a functioning legal system are required.

There is nothing in that insight: it is how the business world works. But these two preconditions are of particular importance for infrastructural projects  where it could two or more decades to recoup the investment.

If a trillion a year is going to be invested on average every year for the next forty years then the markets had better function efficiently, and there is no better way of making that happen than allowing the pricing mechanism to determine the allocation of resources on the basis of returns.

Business believes that the capital is available at the scale required, particularly the sort of capital that is patient and oriented to the long term.  But it needs to be unlocked or put to productive use.

I have no doubt that carbon pricing is the key to that future.

All the national targets for emissions reductions will be of no avail if the capital to finance the energy transition is not forthcoming.  That chilling observation is perhaps the most potent argument of them all for adopting carbon pricing as the best way forward.

Summary

In summary, the six major economic advantages of carbon pricing are:

-The efficient allocation of investment resources;

-The creation of a level playing field between fossils and renewables;

-The stimulation of technical innovation;

-The encouragement of entrepreneurship;

-The neutrality of its economic impact on different countries, and

-The power to mobilise capital in the quantities required..

Political Advantages

In addition to these economic advantages, carbon pricing has a number of political strengths as a negotiating framework.

It gets us away from the failed intergovernmental approach in which ministers, bureaucrats and technical experts try to work out a global agreement as to which country should do what in terms of emission reductions.

This was the approach taken in Copenhagen, which by common consent is regarded as a diplomatic disaster.  Subsequent meetings were no better. The most recent, COP20 in Warsaw gave little hope for progress and much cause for concern.  It is no surprise that the expectations for next year’s conference are so low.

Now, Einstein is supposed to have said that madness consists of trying the same thing over and over again but expecting a different result each time.

It is a good rule in life that more of the same will produce more of the same.

Bilateral or even multilateral burden sharing has been proven not to work, so let’s get on with a global agreement to which the great majority can subscribe.

Otherwise, temperatures will keep on rising.

Carbon pricing would get us away from a failed approach and open the door to progress by changing the context for devising a solution.

It was Monnet who advised that the way to find a solution to a political impasse is to change the context – he didn’t believe in the madness of endlessly repeating a failed formula.

I’m also struck by the fact that Monnet was a practical businessman who understood how to do a deal.

World Opinion

The second political advantage arises from the fact that world opinion is actually moving in the direction of carbon pricing.

Since it is always a good negotiating rule to reinforce the positive and build on what is common, let us concentrate on what unites instead of focusing on what divides.

What unites the world community is the common threat caused by burning fossil fuels.  This realisation has produced at least three encouraging developments of late.

The US

I start with the United States because it has been the the biggest obstacle to an international agreement: it couldn’t sign the Kyoto Protocol because of opposition in the Senate, which also blocked a domestic Cap and Trade Scheme in 2010.

But because of recent extreme weather events, the US is now in a different frame of mind than it was in Copenhagen.

Only last week President Obama made a proposal to cut Greenhouse Gas emissions from power plants by 30% from their 2005 level by 2030, which the “Economist” magazine described as “the biggest step an American president has taken to curb climate change”.

Also last week, in a New York Times interview, he said “If there’s one thing I would like to see, it’d be for us to be able to price the cost of carbon emissions….  Let’s go ahead and help the marketplace discourage this kind of activity”.

A number of states and cities have done just that and introduced their own carbon reduction measures, including cap and trade schemes.

Change is in the air, as has been confirmed by the climate change talks that recently took place in in Washington between the US and China, which one Chinese negotiator described as having made good progress.

The process was helped by John Kerry’s commitment to combating climate change.

The World Bank and UN

At the international level, the World Bank has explicitly called for greater international cooperation in bringing forward carbon pricing policies, and for strengthening them where they already exist.

This follows on from its ground breaking report, “Turn Down The Heat”, published late last year and which the Bank had commissioned from the Potsdam Institute for Climate Change Research.

Just a month ago the Bank issued a draft statement entitled “Putting a Price on Carbon”, in which it said that “the latest report from the IPCC makes clear the importance of putting a price on carbon to help limit the increase in global mean temperature to two degrees Celsius above pre-industrial levels”.

Nothing could be clearer than that.

Furthermore, the impetus for carbon pricing has been strengthened by the UN Secretary General’s decision to convene a Climate Summit this September to build what he calls “a solid foundation for successful negotiations on reducing emissions”.

Using unusual language for an international diplomat, he has challenged world leaders to come to the Summit with “bold pledges and concrete action that will close the emissions gap”.

The Summit is not to be part of the current negotiating process, which is a clever manoeuvre on his part.   Rather he wants it “to help the world shift towards a low carbon economy”.

China

But the strongest political argument in favour of carbon pricing is that it aligns with a series of measures recently taken by the Chinese government.

The most significant initiative was the introduction of a cap and trade scheme on an experimental basis in five cities and two regions, which together account for about 30% of the country’s emissions.

This is of profound importance because it means that the Chinese authorities have chosen a cap and trade scheme as their preferred policy instrument for reducing carbon emissions.

Now, those who have studied China have a further reason for regarding this move as significant. They know that an experimental approach is the way China always prepares for a major shift in economic policy: it is their unique planning methodology, an example of which was the creation of the Special Economic Zones as prelude to market reform.

The Chinese authorities have indicated they will apply the lessons of these experiments to the whole of the economy.

That expectation should be taken at face value because it follows from a prolonged period of policy gestation. The Chinese authorities have long signaled their concerns about environmental damage and incorporated ambitious measures to combat climate change in the current Five Year Plan.   Preparatory work on the 13th Five Year Plan indicates that this will be one of the top priorities for China over the next three to four decades.

As I said in previous lectures to the Institute in Dublin, the Chinese planning system is unique in terms of the way it mobilises the collective intelligence of a society and applies it to devising and then implementing long-term development strategies.

Putting it simply, if the Chinese authorities decide on a course of action and commit themselves to stated goals it should be accepted that the necessary resources will be mobilised, measures will be implemented at the required scale and policy goals will be achieved.

That is what the history of the past thirty-five years tells us and let’s take that lesson as our starting point rather than doubting the bona fides of the Chinese authorities.

On this point, China has an image problem, as the “Economist” recently explained, in that “Western journalists and politicians express strong opinions about a country that few have visited and even fewer understand”.

Commissioner Connie Hedegaard has said she is impressed by the action China is taking domestically to cut emissions.  This is the proper starting point for the proposal I am making.

But let’s say there are some delays in introducing a national scheme cap and trade scheme; that’s not important.  What is important is that China has chosen its pathway to a low carbon economy.

Since it is already the world’s largest economy when measured in terms of purchasing power parity, that decision has created an irreversible momentum in favour of emission trading schemes.

According to the World Bank, countries operating cap and trade schemes, predominantly the EU, already cover 22% of world emissions. And that figure will rise to over 50% when they are joined by China. In other words, a world price for carbon is already in the making.

EU and China Acting Together

For example, there is consensus within Europe that the carbon price needs to be around €40 per tonne to act as an effective market signal.  Within China, the price emerging is around €23 per tonne.  These figures are not that far apart when differences in purchasing power are taken into account.

My proposal is that the EU and China should build on this policy convergence and develop a common approach to COP21 based on a shared cap and trade framework.

We Europeans should take China’s political commitments on carbon reductions at face value and enter into a strategic partnership with the aim of jointly providing global leadership at COP21 on an agreement to which most countries could subscribe.

For reasons of history, China is reluctant to play a leading role at the global level and clearly does not wish to take unilateral action that would make its domestic targets binding internationally.

On the other hand, the US, Japan and Canada won’t move unless China does so simultaneously.

The way to address this impasse is for Europe to propose to China that the two engage in common action in Paris.

It is open to question whether Europe has sufficient credibility with the Chinese authorities for them to accept such a proposition but in my view the potential exists for concluding a long-term partnership.

Europe has a strong starting position: France will chair the conference. Europe will be negotiating as an entity and already has an ETS in place, even if it’s imperfect.  Europe is the global leader in combatting climate change and its credentials are not suspect.

These are good reasons for approaching the one world power that could help turn COP21 into a success rather than another installment of global failure.

If a European/Chinese accord gathered momentum then it would strengthen the hand of those who, like the US administration, would wish to become a party to a new agreement in Paris.

Conclusion

I know this would mean abandoning or seriously modifying the negotiating architecture in place since the first COP.  I know this would be a huge rupture, which many will think impossible.

But the economic route to securing political objectives was pioneered by Monnet, as was strategy of finding solutions by changing the context.  Europe can apply the Monnet method by proposing carbon pricing as the most effective means of fighting climate change.

Monnet famously said that nothing happens without individuals but that nothing endures without institutions.

In this instance, Europe can be the individual who makes things happen. And if COP21 were to be a success then a new international institution would emerge in form of a global cap and trade scheme, one that would endure for decades ahead.

But we have little time to make all this happen. Already the carbon concentration in the atmosphere has gone beyond 400 ppm.  It is increasing at an annual rate of about 2½ ppm, which leaves us with about twenty years before the threshold of 450 ppm is reached.

Beyond that point, the damage to our planet will be catastrophic and irreversible. The best way to prevent it is to put a price on the thing that is killing the planet.

Put a price on carbon, and let human ingenuity do the rest.

Thank you for listening.

 

 

 

 

 

 

 

 

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