Pricing a key tool to encourage carbon-neutral energy

The UN conference on climate change that has just opened in Paris holds out the promise of a major step forward in tackling the huge problem of climate change.

In the past, the problem was that only a limited number of countries, covering a minority of the world’s population, was prepared to commit to action. This time, a majority of countries, covering the bulk of the world’s population (and of its greenhouse gas emissions), acknowledge the importance of tackling the problem.

The individual national commitments will not, on their own, halt global warming, but they represent a major step towards developing a successful worldwide response.

The key to tackling global warming, which is caused by man-made emissions of greenhouse gases, primarily from energy, is to find energy sources that are “clean”.

While there are already opportunities to generate a significant part of our energy needs from clean sources, these are, as yet, very expensive. The implementation of a wide programme of renewable energy in Germany has added 6.5 cents per unit to the cost of electricity for households. While Germany is able to afford this cost, and the resulting negative impact on households’ living standards and national competitiveness, it is not a solution that will be easily replicated elsewhere.

This means that, even for rich countries, a switch to clean energy today could prove very expensive. For developing countries, at today’s prices, such a switch could only occur at the expense of a serious reduction in already low living standards and future development.

Cheap option

However, the cost of clean energy has already fallen a long way from its exceptional level in the early 1990s, when the urgency of tackling climate change first appeared on the world’s agenda. The key to finding a solution to the problem of climate change is to make clean energy the cheap option. If that goal can be achieved, emissions of carbon dioxide from burning fossil fuels will fall dramatically.

A two-pronged strategy is required: first, invest public funds in research and development to bring down the cost of clean energy; second, raise the cost of pollution, reflecting the damage done to the environment, to encourage the necessary private sector investment.

While technological development through research and innovation can potentially provide a solution, there is no guarantee that a particular investment programme will succeed. The EU, over a number of decades, has spent about €10 billion of public money in the hunt for clean energy from nuclear fusion. However, to date this has proved to be something of a wild goose chase.

This highlights the problems we face. It is likely that a very large budget will be needed to invest in the necessary research and development, representing a significant burden for taxpayers across the developed world.

However, governments are not good at picking winning technologies. Probably the best approach is to move on many fronts simultaneously, experimenting with different technologies. In the case of Ireland, some of our public research budget is going on wave energy, in spite of the fact that it does not look likely to be economic in Ireland. However, because one cannot be certain about its economics, it is valid to allocate some of the limited research budget to this field.

John Hicks was one of the leading economists of the 20th century, winning the Nobel Prize for economics in 1972. As early as 1932, he explained how raising the price of a good, such as energy, will induce successful research that will eventually reduce the need for that expensive factor.

In the 1970s oil prices rocketed, causing major economic disruption to OECD economies. The result was a huge amount of research across the world by companies, large and small, into ways to save energy. A decade later this research paid off for many companies and consumers, resulting in a major increase in energy efficiency. The fuel efficiency of cars was dramatically increased in the 1980s, as was the efficiency of electricity generation.

Innovation

This shows that when prices rise, companies smell future profit from successful innovation. The bigger the market for that innovation the bigger the potential pay-off and the bigger the potential research effort by companies.

Because the price of oil rose for the whole world, the potential pay-off from successful research was huge in the late 1970s. This example also shows that, instead of relying purely on taxpayer-funded research, the successful development of clean energy is likely to rely heavily on investment by the private sector.

A decade ago the EU embarked on an ambitious programme to tackle climate change. Among other policies, it was intended that the cost of emitting greenhouse gases would rise substantially. Instead, the policy failed to raise the price of pollution as expected, disappointing investors in clean technologies.

Clean energy

Paris may well see a welcome worldwide substantial increase in government-funded investment in research into clean energy technologies. However, to be fully successful, the EU, and hopefully some other major trading blocs, will need to take effective measures to raise the cost of emitting greenhouse gases.

Higher prices will discourage us from using polluting energy and, in addition, as Hicks suggested, it will signal to private sector investors that there is a lot of money to be made from saving the planet.

The medium-term cost of this strategy will obviously be higher costs for households. In the long term, however, if cheap, clean technologies are developed, future generations, whether in Ireland or the developing world, will benefit from cheaper clean energy. It could also save the planet from global warming.