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The Paris Agreement, Stringent Climate Policy, and Stranded Assets

Paper Session

Saturday, Jan. 7, 2017 1:00 PM – 3:00 PM

Swissotel Chicago, Zurich B
Hosted By: American Economic Association
  • Chair: Armon Rezai, Austrian Science Fund

Stranded Assets: The Transformation of Economic Values in the 21st Century

Graciela Chichilnisky
,
Columbia University

Abstract

he extraordinary geological transformation of our planet since 1945, which in a few decades went from the Holocene geological period to a new era of the Anthropocene, was led by 20th century economic progress and in turn has led to an equally momentous transformation of economic values in the 21st century. <br />
<br />
This article examines the transformation of economic values from the viewpoint of capitalism, a transformation that is based on changes in three (3) fundamental analytical tools that have pinned down and defined economic value so far: (1) market prices and underlying property rights on natural resources including the key global commons: energy, air, water and biodiversity, (2) the economic notion of "impatience" or discount factors that compare present vs. future values, and (3) the treatment of fundamental uncertainty in decision making including frequent and rare events or "black swans." Stranded assets are viewed from the lens of today's drastic changes in these three (3) economic notions that embody and define economic value and explain optimal economic policies in a period of revolutionary change in values.

Assessing the Potential Impact of Negative Carbon Technology on Optimal Climate Stabilization: An Analytical Framework With Multiple Embodied Technologies

Paul David
,
Stanford University
Peter Hammond
,
Stanford University and University of Warwick

Abstract

There is an obvious and worrisome disjunction between the aspirations expressed in the COP-21 Paris Agreement and the near term prospect of practical steps that could achieve them. We focus on the challenge of designing a program of actions to reallocate global investments in order to deploy an array of technologies that could achieve timely stabilization of the global climate. Departing from the familiar economic approach followed in coupled modelling of the global macroeconomy and climate system, we consider realistic technologies that must be embodied in durable physical capital goods — a salient distinguishing characteristic of the world’s energy sector. This novelty enriches the dynamics of a social-welfare optimizing transition to a production regime sufficiently decarbonized to sustain optimal long-run economic development. To recognize the threat of abrupt and catastrophic changes in the climate system, another feature of our analysis is the “carbon budget” imposed (parametrically) upon the planner — thereby fixing the permissible increase in the atmospheric concentration of CO2 arising from economic production activities during the transition. The four distinct technologies considered are those that (i) produce fossil fuels from non-renewable resource deposits, (ii) burn fossil fuels in a production process, (iii) use “alternative” renewable energy sources, and (iv) directly capture CO2 from either the ambient air or industrial exhaust gases. We refer to the latter as “negative carbon technologies” (NCTs), which must be embodied in a distinctive and novel form of capital equipment. The particular potential effect of NCTs, some of which are starting to show commercial promise, is to relax the carbon budget. If this is done optimally, its direct and indirect impacts on the allocation of resources throughout the economy would reduce the welfare cost of the transition, and could quicken subsequent development of the world economy, especially that of its poorer regions.

The Simple Arithmetic of Carbon Pricing and Stranded Assets

Frederick van der Ploeg
,
University of Oxford
Armon Rezai
,
Austrian Science Fund

Abstract

Climate policy has to combine ethical judgments with projections about future economic, technological, and climatic developments. Integrated assessment models (IAMs) aim to do so but have been criticized for being highly complex, insufficiently open access, and underestimating the threats of climate change (Stern, 2013; 2016). We present a simple framework that captures the essence of IAMs and makes their underlying assumptions transparent and which opens the discussion of the political and social obstacles to climate policy. We use a simple framework for the cost-benefit analysis of climate action to derive a simple rule for the global price tax in the presence of a backstop renewable energy source that is currently more expensive than fossil fuel. This tax is a function of current world GDP, key ethical considerations, and geophysical parameters. Using this tax rule, we also provide rules for the optimal fraction of fossil fuel reserves that should be left in the crust of the earth (cf. Carbon Tracker, 2013; McGlade and Ekins, 2015) and the optimal transition time to the carbon-free era. Our calculations require only a pencil and the back of an envelope, but yield values very close to those obtained from numerically maximizing welfare with a detailed IAM of growth, development, energy and climate change. We hope that our simple arithmetic helps policy makers and climate scientists to gain a better understanding of the ethical, economic and geo-physical drivers of optimal climate policy.

Hedging Climate Risk

Patrick Bolton
,
Columbia University

Abstract

We present a simple dynamic investment strategy that allows long-term passive investors to hedge climate risk without sacrificing financial returns. We illustrate how the tracking error can be virtually eliminated even for a low-carbon index with 50% less carbon footprint than its benchmark. By investing in such a decarbonized index, investors in effect are holding a “free option on carbon.” As long as climate change mitigation actions are pending, the low-carbon index obtains the same return as the benchmark index; but once carbon dioxide emissions are priced, or expected to be priced, the low-carbon index should start to outperform the benchmark.
JEL Classifications
  • G1 - Asset Markets and Pricing
  • Q5 - Environmental Economics