Attempts to phase out coal have faltered amid fears that the transition to renewable energy would be too costly. By comparing the present value of avoided emissions with the present costs of replacing coal with renewable energy, this article estimates that the world can realise a net gain of $77.89 trillion by shifting to renewable energy. The benefits from ending coal are so large that carbon pricing and the other financing policies discussed here merit sustained attention.
By Tobias Adrian, a financial counsellor at the IMF, Patrick Bolton, a professor at Columbia University, and Alissa Kleinnijenhuis, a research scholar at Stanford University
Cross-posted from VoxEU
Photo: David Shirreff
On Monday 2 May 2022, The Guardian published an article on the heatwave in Pakistan and North-Eastern India titled “We are living in hell”, with this description of the extreme temperatures reached in early spring:
“‘The hottest temperatures recorded are south-east and south-west of Ahmedabad with maximum land surface temperatures of around 65C’, the European Space Agency said on its website. The high temperatures have been putting unprecedented pressure on power demand in India and Pakistan, where people have had to endure hours of cuts amid the crippling heat. On Friday peak demand in India touched an all-time high of 207,111 MW, according to official figures.” (Baloch and Ellis-Petersen 2022).
It is a tragic irony that India and Pakistan immediately responded to the heatwave by expanding electricity production from coal-fired power plants, which will only worsen the intensity of future heat waves.
How can we stop this infernal cycle of more energy demand leading to more carbon emissions and a hotter planet? As hard as international negotiators have tried to reach an agreement to phase out coal, and despite the promise of a historic breakthrough at the UN Climate Change Conference in Glasgow (COP26), so far all attempts to get the world to phase out coal have failed.
A lack of public support for global carbon pricing has meant that the best policy for getting rid of coal emissions through price signals has not yet come to fruition (Klenert and Hepburn 2018, Paoli and van der Ploeg 2021, Douenne and Fabre 2022). More recently, in response to the war that Russia started against Ukraine, even countries that had given up on coal are revising their stance. The most commonly voiced concern with phasing out coal is that it would be costly – that replacing coal with renewable energy would be too expensive.
In a recent paper (Adrian et al. 2022), we undertake a systematic quantitative analysis of this claim.1 We calculate the cost of replacing coal with renewable energy, and the social benefit from phasing out coal, to obtain an estimate of the net gain from this energy transition. We include in the costs of replacing coal with renewable energy the capital expenditure costs of building a renewable energy capacity equivalent to that from burning coal, as well as the costs of compensating coal companies for lost future earnings when they are shut down. The benefits from phasing out coal are related to the lower expected future damages from climate change. We calculate the present value of these benefits by estimating the size of avoided emissions from phasing out coal and by applying a carbon price to those emissions. In this way, we obtain an estimate of the economic gain from phasing out coal. When we subtract from the present value of these social benefits the present value of the costs of replacing coal with renewable energy, we obtain as our baseline estimate a net total gain for the world from phasing out coal of $77.89 trillion. This represents around 1.2% of current world GDP every year until 2100. Far from finding that replacing coal with renewable energy would be too expensive, we uncover a huge economic benefit from phasing out coal, which we refer to as the ‘great carbon arbitrage’. This enormous social net benefit can be seen as the gain from a cheap insurance policy: by paying a premium, one gains coverage for potentially very large damages.
The flaw with the argument that phasing out coal is too costly is that it ignores the benefits from lower carbon emissions. These benefits are real economic gains in terms of lower expected physical damages from climate change, leaving aside all the attendant benefits to economic activity and innovation that the investments in renewable energy will bring. Economic efficiency stipulates that the carbon price should be set equal to the social cost of carbon (SCC). We build on the sizeable literature on integrated assessment models (IAM) that provides quantitative estimates of the SCC to determine the carbon price to apply to avoided emissions. If all carbon emissions were priced under an efficient global emissions trading system (ETS), the equilibrium carbon price in this market would be equal to the SCC. It would then be possible to generate a total gross revenue from phasing out coal equal to the SCC times total avoided emissions. By shorting coal and going long on replacement renewables, it would then be possible to generate an arbitrage gain similar to the net social gain we have estimated from phasing out coal.
We calculate avoided carbon emissions from phasing out coal starting in 2024 by subtracting from the carbon emissions under a business-as-usual scenario the lower carbon emissions that would be generated if, instead, coal were to be phased out in line with the Net Zero 2050 scenario of the Network for Greening the Financial System (NGFS). Our baseline estimate of the social benefit of phasing out coal takes the SCC to be equal to $75 per tonne of CO2, in line with the lower-end estimates of the SCC in Vernon et al. (2021) and lower than the current price of carbon allowances in the EU ETS.
Our analysis makes a simple but powerful observation: phasing out coal is not just a matter of urgent necessity to limit global warming to 1.5°C; it is also a source of considerable economic and social gain. The net economic benefits from ending coal are so large that a general policy implication from our analysis is that efforts should be redoubled to achieve a global agreement to phase out coal as soon as possible. Even faced with “high transaction costs” and “poorly defined property rights”, to use the language of the Coase Theorem (Coase 1960), it is surprising that a Coasian bargain of such proportions has not yet been exploited.
A global agreement to phase out coal was not reached at the COP26. The 197 parties of the convention could agree only on accelerating independent efforts towards the phase-down of unabated coal power. But what is needed is a far more ambitious agreement to phase out coal: linking investments in renewable capacity to replace coal along with financing these investments and compensating coal companies for lost profits. From a Coasian perspective, it is sound economics to compensate losses incurred from phasing out coal to account for capital expenditures needed to replace the energy from coal, and to set all these costs against the social benefits of avoided emissions.
A broad policy implication from our analysis is that if compensation was built into an agreement to phase out coal, and the promised transfers for green investments to developing countries were made conditional on phasing out coal, the social gains from such an agreement would still be enormous and the agreement would be far more likely to succeed.
To gain further insight into the size of transfers that may be required to pay for the replacement of coal with renewable energy, we further break down on a regional basis where these costs would be incurred. We find that the present value of total conditional climate financing needed to end coal globally is around $29 trillion, in line with renewable investment needs estimated in other studies. This represents an annual global climate financing need between half a trillion and two trillion dollars, with a front-loaded investment this decade, which we estimate to be up to $3 trillion. Investment costs for the developed world to cover these global annual climate financing needs would be in the range of 0.5% to 3.5% of rich countries’ GDP.
This clearly represents a major challenge. But our analysis shows that the social gain from these investments far exceeds the cost. Some prominent commentators have argued that no government in the world has enough money to make such sizeable investments and they have called on the private sector to steer the required funding to renewable energy investments. Most of the funding for these investments can indeed come from the private sector, but a significant amount of public money to enhance these investments will still be needed (see Arezki et al. 2016, and Bolton et al. 2020). We provide ballpark estimates of the size of public funding required if for every dollar of public funds, 9 dollars of private financing can be tapped through blended finance arrangements, and conclude that the overall strain on public finances is not inordinate especially in light of the large social benefits from phasing out coal.
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