Lecture 12: OPEC + climate

the energy trilemma

Note: Unlike the Monetary Policy Trilemma, This is not a strict trilemma:

It's hard but not impossible to obtain all three

Stable energy supply

• Our economies don’t really function if we don’t have reliable energy

• Want stable energy supply

• Energy is a good that is more fundamental to our economies and lives than almost any other. We need it to:

  • Power production

  • Fuel most forms of transportation

  • Heat our homes

  • Supply Electricity to our homes

• Abundance of reliable, cheap energy fuels economic development

• Lack of reliable, cheap energy can cause deep economic crises

Institutions governing energy policy

• No ONE institution or agreement governing energy policy

• Main Institution Oil Exporters: Organization of Petroleum Exporting Countries (OPEC)

• Main Institution Oil Importers: International Energy Agency (IEA)

• A lot of others related to energy:

  • UNFCCC (global climate change framework, more on that later)

  • IRENA (International Renewable Energy Agency)

  • IAEA (International Atomic Energy Agency)

  • World Bank → Govern the switch to renewable energy

OPEC history

• First half 20th Century: Oil production dominated by the "Seven Sisters"

  • Now: Exxon, Shell, BP. Chevron

• 1960: 5 countries (Saudi Arabia, Iraq, Iran, Kuwait, Venezuela) form OPEC to "stabilize prices" and "ensure a fair return on capital for investors"

  • = trade union to negotiate with oil companies

  • More negotiation power

• 1970s: OPEC asserts power, oil embargo

  • Causing inflation shock

• From 1980s: Mandatory production quotas for members to keep supply steady and prices high

  • = OPEC becomes a "cartel"

• 2016: OPEC+ (coordination with Russia and others)

OPEC: oil embargo 1973

• By 1973: OPEC's production of oil at over 50% world share

• 1973: Yom Kippur War

• Arab members of OPEC impose an oil embargo on US & Netherlands and cut production

  • To punish the west

• Result: Price of imported oil to US quadruples, double-digit inflation

  • Price of oil goes up, the price of a lot of things goes up

OPEC: oil cartel and oil prices

• OPEC negotiates to curb production through quotas, keep prices high for everyone

• E.g. oil price drop after 2008 financial crash - OPEC countries jointly reduce output

• BUT: coordinated output cuts hard to maintain - Prisoners' Dilemma

• Some argue that Saudi Arabia - OPEC's biggest producer - tries to uphold discipline through tit-for-tat

  • If you break the quota, the Saudi breaks the quota —> if they break it has a big effect bc they are largest producer

Prisoners dilemma OPEC

• As a single OPEC member you prefer others to cut their production while you are able to drill and sell more for the high price the cut creates —> preference for all single OPEC members

OPEC

• 13 member countries of OPEC

  • 10 more members part of OPEC + that they coordinate with

    • Since 2016

• Still accounts for more than half of world's crude oil

• Shale boom in US and Canada has undermined OPEC's influence in North America

  • US starts fracking

    • OPEC biggest effect on global oil price but can’t control price within US

IEA: an organization for oil consumers

• Created 1974 under OECD framework (= only developed country members)

• Goal: Reliable energy supply, avoid future oil shocks

• Measures:

  • Emergency stocks & collective oil emergency response ; Promote energy efficiency and diversification

  • Research into energy markets & consulting

  • (today) Promote Clean Energy Transition

    • Switching to renewal energy will make them less reliable on OPEC and the prices they set 

Prisoners Dilemma: climate change

Prisoners dilemma: climate change Nash equilibrium

• Nash equilibrium: D

  • Country 1s number one: B (they keep emitting, country 2 cuts)

    • can’t control what others do though

  • If country 2 keeps emitting, your best choice now is D (keep emitting)

  • Keep emitting is the dominate strategy

International Climate negotiations

• 1992: countries agree on UNFCCC (United Nations Framework Convention on Climate Change)

  • Conference of the Parties (COP) held every 2 years

  • COP 29 held in Baku this November

• 1997: Kyoto Protocol

  • Set limits for developed countries to make cuts

  • US never ratifies, Canada pulls out

  • Emerging economies (China, India) grow rapidly but have no obligations under Kyoto

    • Their emissions start to grow during this period but when Kyoto started they did not have this so they have no obligation

New model: Paris agreement

• More politically palatable:

  • Everyone has to do "something"

  • Countries themselves decide how much: Nationally Determined Contributions (NDCs)

  • Designed to allow US President to circumvent Congress

  • (Some) Climate Finance

    • Developed countries are supposed to supply some money to developing

• Core issues today:

  • Stock-take last year: How have countries done so far? (result: not enough)

  • Phasing out of fossil fuels

  • Climate finance, including "Loss and damage" fund

    • How much money would developed countries give to developing to help them reach the climate goals + relief for climate related disasters

Domestic interests

Climate action requires that we restrict GHG-intensive activities through higher prices, bans, quotas...

In the long run, we all win from policies to mitigate climate change, but in the short-medium run

Domestic collective action problems

• The costs of effective climate action are acute and concentrated = easy for industry to organize and lobby

• The benefits of effective climate action are diffuse, they benefit everyone in the world = most (young) citizens benefit, but easy to free-ride off others' climate protests

Domestic collective action problems: two outcomes

1. Climate action is stopped/watered down due to forceful lobbying

2. The costs of climate action are born by CONSUMERS, not BUSINESSES

• → E.g. The German Energy Transition largely paid for by energy taxes on households, not businesses

Energy poverty

• When the price of GHG-intensive products rises, not all households can:

  • Pay to insulate their homes

  • Pay for an electric car

  • Install solar panels and heat pumps

• Problem: The poorest households spend the biggest income share on energy

3 common policy approaches to fight climate change

1. Carbon taxes

2. Emission trading

3. Green industrial policy

Carbon taxes

• Put a tax on carbon to "price in" the negative effect of climate change (Pigouvian tax)

• What do you do with the tax revenue?

  • Pay for energy transition

  • Pay for adaptation, loss and damage of climate change

  • Use the money for something else

• Canada and Switzerland: Rebates (Lump Sum = everyone gets the same back)

  • still creates incentives, because your behavior does not affect your rebate

  • only the worst polluters worse off in the end

  • can be progressive - poorer households get back more

  • Problem: people tend to underestimate their rebates and overestimate the costs of carbon taxes

Carbon taxes - how are Lump Sum Rebates progressive?

*People tend to prefer even more progressive —> like only poorer get anything back

Emissions trading

• Cap and trade system

  • Gov sets cap

  • Industries have to follow these caps

  • They can buy permits that allow their emissions

  • If they don’t use up all of their permits, they can sell them to other industries

  • The more emissions they cut, the less permits they have to buy

    • The more they can sell

  • The price of permits and the price of the punishment tend to be quite similar —> does not defer industries from going against the cap

  The incentives haven’t been good enough (too low price of carbon) —> industries wont want to cut 

  EU has now created a price of carbon that actually creates an incentive —> companies still might cheat (have to keep an eye on enforcement)

• The world's largest carbon market: European Emissions Trading System (ETS)

Globalized trade = carbon leakage ?

• High price of carbon => companies shift production to countries with lower carbon prices

  • Evidence of existence of carbon leakage is mixed: so far, seems limited, but we don't know what would happen at higher carbon prices



3 possible solutions to carbon leakage:

1. Global price on carbon (very, very hard to negotiate)

   1. Take away any incentive to relocate to get cheaper price

      1. Very small chance that this happens bc you always want to be the one country that doesn’t do this

2. Tariffs on foreign goods at the border to "level the playing field"

   1. Limit relocation as they will have to pay tariffs on the carbon produced good anyway

3. Give free permits/tax breaks to companies that export/compete against energy-intensive imports

   1. Argued that it is not that effective

Ex. The EU Carbon Border Adjustment Mechanism

• Initially, EU gave away free ETS permits to companies to "level the playing field" in import-competition and exports

• Problem: Lots of free permits limit incentives to decarbonize

• New solution: Instead of free permits for import competition, CBAM: tariff on products from countries that do not have equivalent carbon prices (Trying to switch from solution 3 to solution 2)

  • Companies liked the idea of the CBAM AND free permits

  • Companies did not like the idea of paying for permits when CBAM introduced

• Note: This may incentivize countries that are dependent on EU market to also put a price on carbon

Why could the EU not be able to impose CBAM and give away free permits?

WTO rules

• You CAN impose trade measures to prevent climate change - exceptions for environmental protection in GATT Article XX

• BUT those measures can't be arbitrary or discriminatory:

  • You CAN impose a CBAM|

  • You CAN put tariffs only on products from countries without carbon pricing

  • You CAN'T impose a CBAM and ALSO give your industry free permits

*Sorry, European Industry, you can't have it all

Green industrial policy: ‘Big Green Push’

• Some argue that green industries should be treated as "infant industries"

• Green transition requires large-scale investment in low-carbon technologies

• Changes to public and private infrastructure:

  • charging networks for EVs,

  • pipelines for green hydrogen

  • smart grids in energy networks

  • Train infrastructure to be less reliant on cars

*Private investors are unlikely to do this, governments are needed in order for this to be possible

• Green industrial policy has political benefits:

  • Instead of imposing costs on polluters, you give incentives and subsidies to green industries

  • Building up your green industries creates jobs

  • Green industrial policy fosters industries that will lobby in favor of climate action

Green industrial push: US inflation reduction act 2022

• Introduces Tax Incentives, Grants, Loan Guarantees

• Tax credits (-subsidies) for companies investing in clean energy, transport and manufacturing

  • Lowers cost on some things and does not increase prices

• Tax credits for consumers to make EVs, solar panels, heat pumps etc. more affordable

Does the US IRA go against WTO rules?

Yes, but it’s still in the works so no official action taken

• Many of the tax breaks are only applicable to locally produced goods (or goods produced by ‘trade partners’)

  • Eg. Consumers get a tax break for EVs produced in the US but not EU → goes against national treatment

• The EU might challenge the IRA at the WTO

State Capacity

"ability and effectiveness of a government or state in performing its functions and responsibilities, including policy-making, implementation, and service delivery, to meet the needs of its citizens" (Peters, 2018)

Limits of state capacity

• Green transitions require money and good governance:

  • Make and incentivize major investments

  • Monitor and enforce climate laws

  • Monitor the effective use of climate subsidies and climate aid

  • Build resilient infrastructure and disaster response

• Many developing countries lack the state capacity to effectively implement a green transition

Subsides and green push sound very well but state capacity limits it

 → The more developed you are the more state capacity you have

 

International Climate Finance

"financing that seeks to support mitigation and adaptation actions that will address climate change"

Why do we need international climate finance?

Limited state capacity

International Climate Finance: ex. UNFCCC

• Under UNFCCC, developed countries are supposed to provide and mobilize funds for developing countries' climate action

  • In Paris, developed countries reaffirmed commitment to mobilize $100 billion per year until 2020

  • 2022 exceeded $100 bn for first time ($118bn)

  • In Baku, they just agreed to increase that to $300 billion per year until

  • 2030. Developing countries called this "a joke," - trillions are needed

New supply challenge: raw materials

• Energy transition depends on critical raw materials used in batteries, low-carbon power generation and electricity grids

• Danger of disruptions - countries (and companies) have started to invest in lowering their dependence:

  • recycling, at-home processing, substitution

• Watch out for global fights over raw materials:

Picture: China can balance the wests dependence on these metals