Sunday, February 11, 2007

Dealing with climate change at low cost

One way of thinking about the economic policy problem associated with climate change policy is to think of trying to move economies toward more sustainable levels of carbon emission at low cost. Despite some alarmism about the costs of dealing with climate change the consensus is that the costs should, in fact, be quite low. John Quiggin has suggested that dealing with climate change satisfactorily will cost 1-3% of GDP.

Without endorsing this specific figure I agree with the general notion that dealing with climate change can probably be accommodated at low cost. Moreover, the economic task is to make this cost as low as possible and, I would argue, market processes can help achieve this objective. As I suggested, in a recent post, capital markets are already oriented to assessing the costs and benefits for individual firms of climate change – markets are supporting those that are well prepared for dealing with hefty carbon regulations and penalizing those firms that are not. The implied resource reallocations from this reorientation of sentiment - this favours firms which are well-prepared - will smoothe the impact of climate change on the economy by producing lower adjustment costs.

The Weekend AFR 10-11/2/07 (19-21, 42, 62 subscription required) takes this analysis further. It argues that a technological revolution akin to the internet revolution will help to ‘cool the planet’. This revolution will reflect both the threats and promises of climate change and should dominate world capital markets for the next 25 years. The task is to accommodate a 50% growth in global energy demands while reducing dependence on fossil fuels by drawing on new technologies, nuclear power, geothermal power and other renewables. This is complicated by the fact that there are pent up demands for energy as companies have delayed new projects partly because of policy uncertainty and, partly, I suspect, because of fossil fuel price uncertainty.

Just as with the internet boom a lot of money will be out there chasing winners. A lot of this will be ‘old energy’ money seeking to adapt to a new world but some will be the hard-earned savings of John Doe's, like your scribe, trying to make a buck. Motivating this greed is an important development that can help resolve the climate change problem.

Among the equity-market bets you can place in Australia that might do well out of climate change problems are:
  • Babcock & Brown Wind – wind generation.
  • Energy Developments – gas, coal, methane, landfill power.
  • Ceramic Fuel Cells – ceramic fuel cells.
  • Transpacific Industries – waste management.
  • Viridis Energy Capital – gas from landfill.
  • B&B Environmental – green power, biodiesel, recycling.
  • Dolomatrix – liquid waste technologies.
  • Quantum Energy – energy efficient hot water systems.
  • Geodynamics – geothermal energy from hot rocks. (Tim Flannery has a small investment!)
  • Envirozel – water storage and treatment.
  • CO2 – malle carbon sequestration.
  • Agri-Energy – ethanol production in the US and Australia.
  • Phoslock Water – water treatment.
  • BlueScope – plans cogeneration & (regrettably) seeking protection from government.
  • OneSteel – seeking to reduce emissions. Increasing use of recyclables.
  • AGL – about 41% generating capacity is emissions free.
  • Origin Energy – focus on renewables. Has 15% of Geodynamics.

The prospects for these alternatives improve dramatically if a carbon trading scheme or carbon tax is set in place. Their prospects will not be improved by a nonsensical ‘free market’ approach to dealing with global warming discussed at Catallaxy on the basis of enforcing property rights on local pollution problems. Markets work only when externalities have been internalised and global warming is the 'mother of all' externalities.

The best policy approach is make the greed instinct work is to embed in the entrepreneurial consciousness the notion that using carbon-based fuels with current technologies will shortly involve greatly increased future costs. This needs to be done clearly now. Waiting for others to act is a foolish 'defect' strategy in a global Prisoners' Dilemma where a possible outcome is that future life on earth might be very difficult. Current actions to implement a carbon trading scheme are a useful start. Such moves, if they enforce a high enough price on carbon emissions, provide the right price signals for:

  • Evaluating and investing in nuclear, geothermal and other alternative energy technologies as well as waste disposal technologies.
  • Developing cleaner coal and fossil fuel burning technologies in power generation.
  • Encouraging firms to invest in energy conservation in cars and other energy-using consumer durables.
  • Encouraging consumers to exercise appropriate conservationist constraint in using energy.
  • Conducting energy technology and economic research.

All these things interact to drive the greed instinct in the direction of dealing effectively with climate change. Of course one must deal with idiot politicians who value a position of power at low pay rather than dealing effectively with an urgent issue. The Labor Party should throw into the basket of foolish ideas its policy that allows others to use nuclear power based on our uranium resources but not us. Furthermore, State governments which respond to pressures from energy providers to give them exemptions from carbon controls as a precondition for carrying out new investment (as NSW as done for BlueScope) should be exposed for their shameless lack of principle and not re-elected.

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