John FitzGerald: Raising the price of dirty fuels drives investment in greener technologies

To avoid catastrophic climate change, the world needs to change. Economic research suggests the cost of decarbonisation is quite limited over the long run and dwarfed by the costs of failing to act.

However, the costs and benefits of tackling climate change are likely to be unevenly distributed across the world and this is a real obstacle to co-ordinated global action. The cost to Europe of acting on climate change is fairly modest, while the economic impact of decarbonisation is much higher for fossil fuel producers like Saudi Arabia or Russia. This differential cost of climate action to different societies makes it much more difficult to reach global agreement to act together.

As far back as 1992, a study by John Martin and Organisation of Economic Co-operation and Development (OECD) colleagues underlined that the transition to a greener world would be particularly painful for oil producers in the Middle East, while the cost of early action would be limited elsewhere. Similar conclusions have been reached in a recent study by Dawn Holland and colleagues at London’s National Institute of Economic and Social Research (NIESR).

A century ago, economist Arthur Pigou argued that the price paid for goods and services needed to reflect the wider costs to society involved in their production and consumption

It’s not surprising then that, over the last 30 years, oil-producing countries have been an obstacle to reaching agreement in international forums on concerted climate actions. Over that period, our understanding of the consequences of climate change has been enhanced. While the key mechanisms to address climate change have long been known, it is only in recent years that significant action is being ramped up.

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A century ago, economist Arthur Pigou argued that the price paid for goods and services needed to reflect the wider costs to society involved in their production and consumption, and he set out the “polluter pays” principle. If the price for polluting fuels is below the cost of their damage to the planet, we will over-consume them — as the world is doing. That’s why carbon taxes are needed to make switching to cleaner fuels and technologies the most economical choice for firms and individuals.

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While the primary role of a carbon tax is to “green” consumption, the NIESR study emphasises the importance of how the tax revenue is used. While some revenue should be deployed to protect low-income households, much of the carbon tax revenue should be invested in rolling out new technologies, minimising the cost to society of the transition.

The study also highlights how carbon taxes would affect the price received by fossil fuel producers. Widespread carbon taxes would raise the price of fossil fuels to consumers, but some of the burden of the tax would shift to coal and gas producers, who would get a lower price. That means that energy-poor regions like China, Japan and Europe would pay less for the energy they import.

China’s dramatic economic development means it relies more on imported oil and gas rather than its own coal deposits

The OECD study of 30 years ago estimated that the costs of decarbonising would be higher for China than for Europe and the US, because of Chinese dependence on coal. This helps explain the initial reluctance of China to take significant action.

Today, China’s dramatic economic development means it relies more on imported oil and gas rather than its own coal deposits. The recent NIESR study shows that, as a result, the reduction in import prices from a global carbon tax would almost offset the costs of greening the Chinese economy. The changed energy profile means that while China remains reluctant to be tied into international agreements, it is beginning to transition to a greener model.

In addition, China has invested heavily in developing new technologies, from wind turbines to electric cars. In reducing the cost of production of these key elements of infrastructure, China is also making a contribution to decarbonising the world. Although traditional carmaking countries see the growth of Chinese motor manufacturing as a threat, China’s success is driving competition in the car industry, and accelerating greener output from European and US car plants.

The prospect of ever-increasing prices of fossil fuels has driven investment in better clean technologies, from cheaper more efficient solar panels to electric cars

South Africa and India have been slower to transition to a greener economy. In both cases, high dependence on coal is a significant factor, with higher potential cost of adjustment. Nevertheless, India’s investment in coal-fired generation has been less than expected over the last decade, because the cost of solar power as an alternative fell so rapidly.

The prospect of ever-increasing prices of fossil fuels has driven investment in better clean technologies, from cheaper more efficient solar panels to electric cars. Raising the price of dirty fuels is a strategy that works. However, because of their potential losses, oil producers will continue to obstruct urgent action on climate change at the UN Cop28 conference in December.