For Want of a Price... A Climate was Lost

Much of the focus and cause of the non-result in the Copenhagen climate negotiations has on the “how” of climate change and opposed to the “what” in terms of targets. (We Have It Backwards - Dec 21, 2009). Focusing exclusively on reductions from historical emissions has greatly hampered the negotiations thus far, but is in fact only half the problem. While targets may satisfy the need on the policy side of the issue, they do not satisfy the need on the market side. A price signal in needed to make the market work, but way the negotiations are going now, the markets must wait for the political process to set pricing on carbon. Focusing on energy as a driver of climate change, the lack of pricing hampers mitigation efforts in three profound and related ways in terms of production, distribution and consumption.

First, on the consumption side, the lack of a price on carbon is leaving the low hanging fruit of energy efficiency investments still hanging on the tree. The now famous Mckinsey study demonstrates approximately 40% of the emission reductions could be achieved by conservation/efficienty investments that have a positive NPV. (Left half of Exhibit 1 below.) While these investments currently have a positive NPV without carbob porcing, setting a price for carbon will give consumers a complete picture of the true cost of their energy, demonstrate even shorter payback periods and should drive more rapid adoption of conservation/efficiently measures. At the same time, it will justify investment in the information infrastructure necessary support this implementation of these systems.

Source: McKInsey Study "Unlocking Energy Efficiency in the U.S. Economy"

Second, the economic uncertainty surrounding investments in new technologies, be they wind, solar, electric vehicles, carbon sequestration or others, is a significant barrier to investment in the potentially beneficial technologies. Here again, carbon pricing establishes true cost and allows industry players to develop confidence in their risk-adjusted return models for investments in these areas. A price on carbon makes investments on the right side of the chart (Exhibit 1) more attractive.

Finally, lack of discussion on carbon pricing has greatly hampered negotiations on climate commitments form the standpoint of developing countries where the uncertainty about the future and the cost is greatest. Carbon pricing offers a transparent and verifiable assurance of the comparability of effort across countries and incorporating price-based commitments into the treaty along with an emissions goal also establishes a basis for compliance during, as well as after, the treaty has expired. Ultimately, carbon pricing would clearly establish a leapfrogging strategy to clean emerging technologies in developing countries would be a clear advantage while diminishing the need for aid or new financing mechanisms beyond traditional sources from the World Bank/IMF.

Moving forward, a price-based framework has several advantages over the historical emissions based approach. It would get investment moving now rather than later, could break the log jam in the current negotiations and be enacted by COP16 in Mexico City next year.