Friday, 9 January 2009

From Credit Crisis to Carbon Crisis

The original version of this article appeared in the November 2008 (No. 68) issue of The Environmentalist

As governments across the globe find a new role shoring up troubled financial institutions, those of us who advocate bold moves towards a sustainable energy transition have taken notice. The USA and the UK committed more than $700 billion and £400 billion, respectively, to the financial bailout. Consider the benefits if equivalent amounts were committed to securing a lower-carbon future.

When the Invisible Hand Gets it Wrong
There has been a major upheaval in the relationship between government and the private sector. The worldwide financial crisis has been sudden, systemic, and severe. The deep-seated belief that competition and free markets led by Adam Smith’s “invisible hand” will promote society’s interests has been shaken.

What happened? Economists argue that the invisible hand does not do a good job handling externalities – situations where private actors pay the cost and society benefits, or vice versa. In these situations government needs to step in. This was the case during the lending freeze, with banks afraid to lend to one another and the credit market on the brink of collapse. With no other solution in sight, governments stepped in to try and rescue the world’s financial system.

While the financial meltdown has been sobering (or punitive depending on your personal stake), the policy flip side is that we have witnessed how quickly events can catapult governments into concerted and coordinated action.

Past Precedents
The energy sector is no stranger to support from governments. Nuclear energy currently comprises about 17% of the UK’s electricity mix, and serves as an interesting example.

Put plainly, the economics of nuclear power would be questionable without governments’ financial support. In both the US and the UK, governments have artificially limited private companies’ legal liability for nuclear accidents. Despite concerns in some circles about another Three Mile Island or Chernobyl, in the US a nuclear power plant’s annual insurance bill might only run to $400,000. This is because Government shoulders much of the burden for catastrophic accidents.

Similarly, the cost of disposing of waste from the UK’s existing nuclear reactors is likely to cost £74 billion, discounted over a whopping 130 years (that's easily more than half a trillion pounds if you don't discount the cost to future generations). These environmental costs clearly fall outside of the time horizon for private sector investment. As a result, most nuclear power plants would never have been built without governments’ pivotal role taking on future liabilities.

Climate change is another area where governments have a critical role to play. Climate change - a “negative externality” from fossil fuel use - has been partially addressed through emissions-trading schemes that allow CO2 to be priced in a regulated market [see our article “Emissions Trading – Going Global?” in the environmentalist issue 60, 16 June 2008].

However, global emissions continue to rise, evidence that the market price of CO2 is not yet high enough and stable enough to encourage significant private investment in abatement measures. Similarly, renewable energy remains a small percentage of the UK’s and America’s energy mix, even though there are compelling environmental reasons and a strong economic basis to increase its use.

According to the Stern Review, the cost to limit severe temperature increases is estimated at 1% of global GDP. Inaction has far greater costs –Stern estimates damage costs from climate change exceeding $70 trillion over time. At an estimated $3.5 trillion, the cost of the global financial bailout looks like loose change in comparison. But private firms lack the incentive and ability to make the required investments on their own.

Investing in a low-carbon future
What would it look like if we could invest even a fraction of the global bailout amount into rapidly building a low-carbon economy? Here are just a few hypothetical examples of what could be done.

In the USA, about 40 million households rely on electric water heaters. For a $282 billion investment, the US government could replace all of these inefficient electric heaters with solar water heaters at no additional cost to homeowners. This investment would reduce CO2 emissions by 48.7 million tonnes each year. Moreover, each household would save about $220 per year, pumping an additional $9 billion per annum into the economy. These savings would likely increase as the price of electricity rises over time.

In the UK, the government has made a commitment to expand the use of wind power to generate electricity. Installing 33 GW of offshore wind would meet 20% of the country’s electricity needs. This measure would cost about £30 billion – a fraction of the British financial bailout – and reduce the need for a new generation of coal fired power plants. Government funding would mean firms would not need to raise expensive venture capital, and could pass the savings on to utility customers in the form of lower electricity bills. Moreover, with most renewable energy projects employing more people per GW of installed capacity than coal and nuclear power plants, such an initiative would boost jobs growth and provide broader benefits to the UK economy.

For an investment of just over $740 billion (1/5 the cost of the global bailout) the US government could target all families earning less than $35,000 and replace half their old vehicles with plug-in hybrids – for free . This investment would reap huge environmental, economic, and social benefits. Each family would save about $840 annually in petrol costs. Fuel savings from this initiative would total nearly $24 billion each year, and would be recycled into the economy. In addition, it would reduce annual CO2 emissions by over 65 million tonnes. With this level of increased household income and reduced emissions, such a government investment provides a reasonable pay-off, while achieving other sustainability objectives.

Meanwhile, in the developing world, two billion people – roughly 400 million families – cook over primitive wood stoves. For an investment of less than $10 billion (about £6 billion), we could replace every traditional cook stove in the world with efficient and cleaner burning models. This move would reduce labour burdens, improve health, help protect the world’s forests and reduce global CO2 emissions by over half a billion tonnes each year.

For these examples, we assumed that governments would pay the entire cost and give the product – electricity from wind turbines, household solar water heaters, hybrid cars, and cook stoves – away for free. We chose this assumption to show that even such radical measures cost less than the recent financial bailout. In reality, even partial subsidies could drive a massive shift towards a low-energy future.

In today’s challenging economic climate, the private sector has neither the resources nor the appetite to even contemplate this scale of investment. Nevertheless, the public benefits - cost savings, job creation, combating climate change, and reduced dependence on imported fossil fuels - are huge. Because governments enjoy a longer time horizon, they can realise these benefits by acting creatively on a grand scale.

The financial bailout was justified because the threat to private banks put the entire global economy at risk. But we face other threats as well. The social, environmental and economic risks from climate change are vast. The measures we have proposed here are merely illustrative, but they show that we have the means to make fast and meaningful reductions in global greenhouse gas emissions.

What we need now is the will.

Suzy Hodgson, AIEMA, is a principal consultant and Jamal Gore, AIEMA is the managing director at specialist carbon management company, Carbon Clear Limited.