Carbon pricing triggers divestment

Overall carbon emissions would be reduced if carbon pricing is announced in a strong, clear and credible manner, according to a new study. These findings overturn the assumption that carbon reduction policies could in fact drive emissions up.

Economists and climate scientists alike have been debating whether the anticipation of strong carbon reduction policies could – in what is called a ‘green paradox’ – in fact drive up emissions, as fossil fuel owners accelerate resource extraction to maximize profits before the regulations kick in.

Offsetting this concern is the theory that investors would stop putting their money into coal power plants so as to prevent their assets from becoming stranded.

Now for the first time a team of energy economists have studied both effects. On balance, they found that divestment can overcome the green paradox if substantial carbon pricing is announced in a credible manner – that is, the policymakers can commit to introducing strong climate policies several years into the future and investors believe the policymakers will do what they say they will do.

“We find that ten years before carbon pricing policies are actually introduced, investors start pulling their money out of the coal power sector,” said lead-author Nico Bauer from the Potsdam Institute for Climate Impact Research (PIK).

“They shy away from investing in fossil fuelled power plants as they realize that the lifetime during which these plants will make money will be curtailed by the future climate policy. We find this divestment reduces emissions by between 5 to 20 per cent, depending on the strength of the climate policy, already in the time before the climate policy gets implemented.”

Coal is particularly susceptible to carbon pricing, as adding a carbon price of $20 per tonne of CO2 doubles the cost of using coal, explains co-author Christophe McGlade from University College London (UCL) and the International Energy Agency (IEA).

“Power sector investors see that coal power plants will become uncompetitive under carbon pricing and so shift their portfolios towards low-carbon sources of electricity.”

Oil, in contrast, is much less sensitive to carbon pricing and the green paradox effect is more likely to emerge in oil markets, with major oil resource holders boosting oil production out of fear that their resources will be left stranded.

The team of economists ran several computer simulations with a variety of carbon pricing levels and a number of different delays in introducing the taxes. Only if carbon pricing starts very late, for example not before 2050, and then at a very low level was there an increase in CO2 emissions instead of a decrease.


Image credit: Ian Britton via Flickr

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