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Financing Climate Change

Friday, December 26, 2014

The purpose of the global financial system is to allocate the world’s savings to their most productive uses. When the system works properly, these savings are channeled into investments that raise living standards; when it malfunctions, as in recent years, savings are channeled into real-estate bubbles and environmentally harmful projects, including those that exacerbate human-induced climate change.

The year 2015 will be a turning point in the effort to create a global financial system that contributes to climate safety rather than climate ruin. In July,  the world’s governments will meet in Addis Ababa to hammer out a new framework for global finance.  

The meeting’s goal will be to facilitate a financial system that supports sustainable development, meaning economic growth that is socially inclusive and environmentally sound. Five months later, in Paris, the world’s governments will sign a new global agreement to control human-induced climate change and channel funds toward climate-safe energy, building on the progress achieved earlier this month in negotiations in Lima, Peru. There, too, finance will loom large. 

The basics are clear. Climate safety requires that all countries shift their energy systems away from coal, oil, and gas, toward wind, solar, geothermal, and other low-carbon sources. We should also test the feasibility of large-scale carbon capture and sequestration (CCS), which might enable the safe, long-term use of at least some fossil fuels. Instead, the global financial system has continued to pump hundreds of billions of dollars per year into exploring and developing new fossil-fuel reserves, while directing very little toward CCS. 

Many investments in new fossil-fuel reserves will lose money – lots of it – owing to the recent fall in world oil prices. And many of the fossil-fuel reserves that companies are currently developing will eventually be “stranded” as part of new global climate policies. The simple fact is that the world has far more fossil-fuel resources than can be safely burned, given the realities of human-induced climate change.

Though market signals are not yet very clear, this year’s more successful investors were those who sold their fossil-fuel holdings, thereby avoiding the oil-price crash. Perhaps they were just lucky this year, but their divestment decision makes long-term sense, because it correctly anticipates the future policy shift away from fossil fuels and toward low-carbon energy.

Several major pension funds and foundations in the United States and Europe have recently made the move. They have wisely heeded the words of the former CEO of oil giant BP, Lord Browne, who recently noted that climate change poses an “existential threat” to the oil industry.

More governments around the world are now introducing carbon pricing to reflect the high social costs inherent in the continued use of fossil fuels. Every ton of carbon dioxide that is emitted into the atmosphere by burning coal, oil, or gas adds to long-term global warming, and therefore to the long-term costs that society will incur through droughts, floods, heat waves, extreme storms, and rising sea levels. While these future costs cannot be predicted with precision, recent estimates put the current social cost of each added ton of atmospheric CO2 at $10-100, with the US government using a middle-range estimate of about $40 per ton to guide energy regulation.

Some countries, like Norway and Sweden, long ago introduced a tax on CO2 emissions to reflect a social cost of $100 per ton, or even higher. Many private companies, including major oil firms, have also recently introduced an internal accounting cost of carbon emissions to guide their decisions regarding fossil-fuel investments. Doing so enables companies to anticipate the financial consequences of future government regulations and taxation.

As more countries and companies introduce carbon pricing, the internal accounting cost of carbon emissions will rise, investments in fossil fuels will become less attractive, and investments in low-carbon energy systems will become more appealing. The market signals of CO2 taxation will help investors and money managers steer clear of new fossil-fuel investments. Carbon taxes also offer governments a crucial source of revenue for future investment in low-carbon energy.

With international oil prices dropping – by a whopping $40 per barrel since the summer – this is an ideal moment for governments to introduce carbon pricing. Rather than let the consumer price of oil fall by that amount, governments should put a carbon tax in place. (Todays Zaman)

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