There is a broad
consensus among economists that, globally, over time, reaching net zero greenhouse
gas emissions by 2050 will cost less than not reaching net zero.[1] In
that very broad, long-term, high-level sense, it is clear that there is no
conflict between carbon neutrality and economic interests. But if everybody
thought it was already in their economic interests to aim for net zero today,
we would probably not be so far off track from achieving that goal as we
currently are.[2]
Researchers
working within the framework set by the Intergovernmental Panel on Climate Change
(IPCC) have mapped out four indicative pathways to net zero.[3] They
all involve at least halving global consumption of fossil fuels by 2040. That
is not quite the future that most oil majors, and governments with a stake in
the industry, seem to be planning for.[4]
Others argue that net zero in 2050 is compatible with fossil fuels still
dominating the global energy sector at that time, but that this would depend on
massive shifts in investment – for example, into new technology to reduce the
carbon footprint of fossil fuel extraction, hydrocarbon supply chains and use
of fossil fuels. The majority of the industry is as yet not visibly committed
to such shifts.[5]
To persuade
people to take action that seems to be against their economic interests, at
least in the short term, you need to change the balance of incentives.
Again, the economists have a straightforward answer: you put a price on carbon. You make it more expensive to produce and/or consume fossil fuels and products with a heavy carbon footprint. People then pay up front for the otherwise unpriced damage caused by their emissions, which means that they have a reason to choose lower carbon products and forms of energy.
There is no
shortage of support for the principle of carbon pricing, which has been
endorsed by royalty, the European Commission and senior bankers, to name but a
few.[6] However,
in practice, existing carbon price mechanisms have had limited effect, and
there are serious risks in seeking to decarbonise with policy instruments that
could impose significant costs on those least able to afford them. Any tax
based on consumption risks having a regressive effect, and people with
proportionally more carbon-intensive lifestyles often lack the financial means
to switch to lower carbon options. The gilets
jaunes protests in France began with an increase in carbon taxes.[7]
Carbon pricing
may take the form of a straight tax on emissions, or of an emissions trading
scheme. The former is arguably the better approach. For example, setting a tax
rate is not always easy, but it is easier to make adjustments to a tax than to a
market mechanism, where it can be difficult to recover from an initial
miscalculation of the optimum number of emissions allowances to issue at the
outset, as in the case of the EU Emissions Trading Scheme (EU ETS).
The ideal carbon
tax would be economy-wide, and have three further key features.
- The price of emissions would
start considerably higher than in most current carbon pricing schemes, and
increase over time in a carefully calibrated way.[8] - To ensure popular support, government
would pay back some or all of the tax receipts in the form of a “carbon
dividend” in a fiscally redistributive way.[9] - To make it possible to start
with a national, rather than a global version of the tax, and to avoid exporting
the taxing country’s emissions to countries without a carbon tax, it would be
necessary to charge a “border carbon adjustment” tariff on goods
imported from jurisdictions with no equivalent tax.
Such an approach
has plenty of heavyweight intellectual support.
- Just over a year ago, the Wall
Street Journal carried a self-styled “largest public statement of
economists in history” in which no fewer than 3,558 US economists espoused
something along these lines that was proposed from a US perspective. This is
the “Baker-Schultz” plan, re-branded in February 2020 as the
“Bipartisan Climate Roadmap”.[10] - In October 2017, leading UK
regulatory economist Dieter Helm put a carbon tax at the heart of his report to
the UK government on how to address the rising cost of energy in the context of
its climate change policy goals.[11] - In July 2018, the UK think tank
Policy Exchange produced The Future of
Carbon Pricing: Implementing an independent carbon tax with dividends in the UK,
with a foreword jointly authored by a former Labour Chancellor of the Exchequer
and a former Conservative Foreign Secretary.[12]
Of course, any
attempt to implement such a tax would need to address a great many issues, both
in terms of high level design and practicalities.
- Do you just tax fossil fuels,
or do you also tax products in whose manufacture fossil fuels have been
consumed? In the case of fossil fuels, at what point(s) in the chain between
the upstream producer and the final downstream user should the tax be levied? For
example, you could impose a tax on upstream hydrocarbon producers or refinery
operators that was based just on the emissions from their activities, rather
than from the presumed activities of end-users of refined petroleum products, such
as electricity generators or motorists. - At whatever point(s) a tax is
applied, at what rate should it be levied? What assumptions about the emissions
intensity of downstream processing and/or use should underpin the calculation
of that rate? How do you ensure that the imposition of the tax, and any
increase in the rate, has the desired effect of incentivising changes in
behaviour (i.e. shifts to lower carbon technology)? Will taxing the ultimate
consumer more heavily incentivise the upstream or midstream operator to reduce
emissions from flaring or fugitive methane? If I fill up my car with fuel from
a retailer who promises to offset the emissions that my driving will cause,
should I get a rebate on the tax element of my purchase? - Tax law has a natural tendency
to become complicated. Take for example the Climate Change Levy (CCL) legislation,
that supplements the EU ETS in UK domestic law. In outline, this is quite a simple
scheme: electricity and certain fossil fuels are “taxable
commodities” and a levy is charged on “taxable supplies” of
them. But quite quickly, the desire to incentivise, protect, or discourage
particular activities turns the scheme into an abstruse and intricate mesh of
exemptions, exclusions, and exceptions from exemptions or exclusions. - Both fossil fuels and products
manufactured using them are traded internationally, but carbon taxing is
currently national (or in the case of the EU ETS, regional), and is likely to
remain so for the foreseeable future. In order to encourage other countries to
adopt similar regimes, and to stop its domestic industry being undercut until
they have done so, a taxing country will want to impose a carbon border
adjustment on imports. This may involve charging tax at a point further down
the value chain than would be the case with domestic industry. For example: you
apply a domestic carbon tax on electricity, which increases the costs of
aluminium smelters, so you need to apply the carbon border adjustment to
imports of aluminium from a country that does not levy a similar carbon tax on
electricity or aluminium production. - But suppose there are two
aluminium producers in the aluminium exporting country: one powered entirely by
renewable energy, and the other by a coal-fired power station. And suppose that
some of the aluminium that reaches the aluminium importing country arrives in
the form of finished products. If two identical stepladders are imported, one
made of “brown” aluminium and the other of “green”
aluminium, the tariff charged on the latter should be lower.
This prompts
some further reflections on the kind of system that is needed.
- To work well, our hypothetical
carbon tax needs to be very granular. That means handling a lot of data, and
mining that data for insights – for example, about how particular applications
of the tax affect the behaviour of particular groups or economic sectors. - You will also need to be able
to keep records. Suppose somebody is awarded a rebate but it turns out they
should not have had it. Suppose you want to allow people to borrow against
their future carbon dividends in order to invest in making their homes more
energy efficient. You may well want to track supply chain emissions – including
for the oil & gas industry itself. - Very soon, you are looking at
information flows that are too numerous and diverse to be managed by a central
counterparty. - This points to a system that
can facilitate large numbers of transactions automatically, within set
parameters – in other words, smart contracts. - That system must be very
secure, and capable of encouraging parties who do not have direct contact with
each other to trust each other. - Above all, you need a system
that records, in immutable form, every transaction that is made within it.
This sounds like
a job for some kind of distributed ledger technology (sometimes, but strictly
inaccurately, referred to by the generic label “blockchain”). No
jurisdiction in the world has yet implemented the ideal version of a carbon
tax. But if and when they do, it should arguably be a data-rich, deeply
digitalised, regime that can be integrated with smartphones and the internet of
things: capable of tracking individual products through the supply chain, and
perhaps distinguishing between hydrocarbons from different sources on the basis
of the emissions intensity of the processes by which they have been extracted,
transported and refined.
The Policy
Exchange paper referred to above highlights the role of “blockchain”
in this regard. It also points out that the UK’s withdrawal from the EU provides
it with a potential opportunity to strike out on a new course in terms of
carbon pricing. Research by the UK energy regulator Ofgem shows that even the
UK’s existing carbon pricing tools, the much-criticised EU ETS and its domestic
supplement, the Carbon Price Support element of the CCL, have been the single
most effective regulatory driver of decarbonisation in the UK power sector.[13]
However, a government
consultation issued in May 2019 on the future of UK carbon pricing was
essentially focused on how to replace the EU-derived existing regime with
something similar but UK-only.[14]
It made no reference to the kind of ideas put forward by Policy Exchange, the
3,558 US economists, or Prof. Helm as regards a carbon tax. It is to be hoped
that the new government will be prepared to reconsider this approach and look
seriously at some of those ideas.[15] At
the same time, the UK government will need to think how to respond to the EU’s
plans, as part of the European Green Deal proposals of the new European
Commission President, Ursula von der Leyen,[16]
to establish an EU border carbon adjustment to avoid “carbon leakage”
through the importing of cheaper products of energy intensive industries from
countries with weaker carbon emissions controls.[17]
In the energy
sector, distributed ledger technology, smart contracts and related innovations
are not just of interest to wonkish proponents of better carbon pricing. Oil companies
and others in the sector have a keen interest in all these developments, because
they have the potential to save them huge amounts of money.[18]
- By exploiting existing sub-surface
data, upstream oil and gas players can make the exploration process less
hit-and-miss by identifying good prospects and likely dry holes before drilling.
Earlier this year, the UK Oil & Gas Authority released 130 terabytes of
data about the North Sea. They think that making good use of this data could
reduce exploration costs by 20%.[19] - Using blockchain and smart
contracts they can reduce the costs and cost-overruns of building new infrastructure
– some would argue, by up to 50%. - There is potential to make
upstream facilities operate more efficiently by making better use of all the
data they gather. Wood MacKenzie
estimate that US shale producers could reduce operating expenses by 10% and add
$25 billion of value by putting mature wells on smart production management
systems.[20] - Physical oil and petroleum
product trading can be made much more efficient by replacing the old
paper-based trade finance system with a distributed ledger.[21]
It is perfectly
possible to find oil and gas industry veterans who are sceptical of these
developments. But their reason is not that they doubt the technology. Their
response tends to be more along the lines of: “It sounds great, but when
the oil price is high, we don’t need to cut costs, and when it’s low, we have
other things to worry about”.
However, a
digitalised carbon tax could provide the constant, incremental pressure that is
needed to get the industry to exploit the power of digitalisation to
decarbonise.
And the industry
needs to do this, because it faces all sorts of other challenges. By some
measures, its energy return on investment is declining.[22]
It may become vulnerable to climate change litigation. It may face competition
from lower carbon alternatives that are cheaper and more effective substitutes
for what it offers than are currently available.[23] But
if the industry saves costs, it will become less risky, and it will be more
able to invest in areas where its expertise will be crucial, like hydrogen and
carbon capture and storage, that can give it a longer-term future.
Bring on the
smart carbon tax of the future, then, and everyone should be a winner. In the
meantime, even if the fully digitalised and personalised kind of platform
outlined above lies too far in the future to be relied on as the only way
forward, there is still plenty of scope to make more widespread use of carbon
pricing, at higher and therefore more incentivising levels, and with
redistribution and carbon border adjustment elements – and there is a strong
case for doing so urgently.
The author is
extremely grateful to the World Energy Council (Austria) and the Organisation
for Security and Co-operation in Europe for inviting him to speak on the
subject of “carbon neutrality vs. economic interests” at the 2nd
Vienna Energy Strategy Dialogue in November 2019 (which was themed around
“The Impact of Big Data in Energy, Security and Society”). This
article is a version of his contribution on that occasion.
[1] The proposition that, as regards climate
change, mitigation of undesirable outcomes before they materialise is cheaper
than adaptation to them once they have arrived, was authoritatively stated in the
Stern Review of the Economics of Climate Change, commissioned by the UK
government and published in 2006. The UK government’s independent advisory body
on climate change, the Committee on Climate Change, found in its 2019 report recommending the adoption of a “net
zero” target for UK greenhouse gas emissions in 2050 that this would not cost any more than the
previous statutory target of an 80% reduction against 1990 levels (itself
partly triggered by Stern’s conclusions).
[2] The gap between the emissions trajectories
of current and announced policies and what is needed to avert unacceptable
adverse impacts of climate change has been highlighted in many places, including
the IPCC’s 2018 special report on Global Warming of 1.5ºC and the UN Environment Programme’s 2019 Emissions Gap
Report.
[3] See page 90 of the Committee on Climate Change report on net zero for graphics and full citation.
[4] See for example The Production
Gap Report
(2019), produced by the Stockholm Environment Institute and others.
[5] See for example the International Energy
Agency’s 2020 report, The Oil and
Gas Industry in Energy Transitions, and a number of publications by consultancy Thunder Said Energy.
[6] See for example the article by Gillian Tett
in the Financial Times, UK edition for 24 January 2020, “The world needs a
Libor for carbon pricing”.
[7] See for example the article by Philip
Stephens in the Financial Times, UK edition for 24 January 2020, “How
populism will heat up the climate fight”.
[8] See the Report of the High-Level Commission
on Carbon Prices chaired by Joseph Stiglitz and Nicholas Stern (Carbon Pricing
Leadership Coalition, May 2017): https://www.carbonpricingleadership.org/report-of-the-highlevel-commission-on-carbon-prices. Among the Commission’s conclusions: “Countries may choose different instruments
to implement their climate policies, depending on national and local
circumstances and on the support they receive. Based on industry and policy
experience, and the literature reviewed, duly considering the respective
strengths and limitations of these information sources, this Commission
concludes that the explicit carbon-price level consistent with achieving the
Paris temperature target is at least
US$40–80/tCO2 by 2020 and US$50–100/tCO2 by 2030,
provided a supportive policy environment is in place.” (Emphasis added.)
[9] For an analysis of the different ways of
implementing a “carbon dividend”, see D. Klenert, L. Mattauch, E.
Combet, O. Edenhofer, C. Hepburn, R. Rafaty and N. Stern, “Making Carbon
Pricing Work for Citizens”, Nature 8 (2018), 669-677.
[10] The “Economists’
Statement on Carbon Dividends” was signed by, amongst many others, 4 former
Chairs of the Federal Reserve, 27 Nobel Laureate Economists and 15 Former
Chairs of the Council of Economic Advisers. See now also https://clcouncil.org/Bipartisan-Climate-Roadmap.pdf.
[11] Helm’s report was commissioned by the then Secretary of State for
Business, Energy and Industrial Strategy, Greg Clark. At the time of writing, the
government had yet to issue a substantive response to it.
[12] See https://policyexchange.org.uk/wp-content/uploads/2018/07/The-Future-of-Carbon-Pricing.pdf.
[13] Ofgem, State of the
Energy Market 2019,
page 129 (figure 5.10).
[14] See https://www.gov.uk/government/consultations/the-future-of-uk-carbon-pricing.
[15] At the time of writing, a government
response had not yet been issued in respect of the majority of this
consultation.
[16] See https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.
[17] For commentary, see Sandbag’s report, The A-B-C of BCAs An overview of the issues around
introducing Border Carbon Adjustments in the EU. The ultimate relationship between the UK
as a whole and the EU ETS remains to be determined, but the agreement between
the UK and the EU on the UK’s withdrawal from the EU requires the EU ETS rules
to continue to be applied in Northern Ireland as part of the basis for
continuing the operation of the Single Electricity Market on the island of
Ireland. If the EU border carbon adjustment is implemented as part of the EU
ETS regime, the UK may be under pressure to adopt a similar measure.
[18] For a general survey of the distributed
ledger technology and its potential applications in the energy sector, see https://www.dentons.com/en/insights/guides-reports-and-whitepapers/2018/october/1/global-energy-game-changers-block-chain-in-the-energy-sector.
[19] See https://www.ogauthority.co.uk/news-publications/news/2019/the-oil-and-gas-authority-launches-one-of-the-largest-ever-public-data-releases/.
[20] See https://www.woodmac.com/press-releases/digitalisation-in-us-lower-48/.
[21] There are various
examples in the publication cited in note 19 above, but see also https://www.gazprom-neft.com/press-center/news/gazprom-neft-and-s7-airlines-become-the-first-companies-in-russia-to-move-to-blockchain-technology-i/.
[22] See https://www.sciencedaily.com/releases/2019/07/190711114846.htm.
[23] See https://www.climateliabilitynews.org/2019/12/23/climate-litigation-threat-financial-filings/.
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