The IEA on the carbon price: CO2 has to cost much more

The International Energy Agency (IEA) has said we need a much higher carbon price, called for investment of $500n a year in clean energy, and warned that rising oil demand could threaten the world’s security.

It holds some remarkably radical views for a government-backed multinational organisation, particularly one which has been accused of being in thrall to the US.

Launching its World Energy Outlook – heavily trailed in the FT – on Tuesday, the IEA called for a revolution in the industry to tackle the threat of climate change.

Above all, it stressed the need for a significantly higher price of carbon credits than is currently effective in the European Union, or initially envisaged in the US.

As Fatih Birol, the IEA’s chief economist, put it to the FT, two numbers will shape the future of the world’s energy supplies: 450 and 147.

450 parts per million is the maximum concentration of greenhouse gases in the atmosphere compatible with giving the world a 50/50 chance of keeping the global temperature increase below 2°C: the level agreed by leading economies’ governments as the acceptable limit for climate change.

$147 is the price that oil reached at its peak in July last year: a level that the IEA believes played an important role in triggering the world recession.

Those two numbers set out the dimensions of the challenge the world faces.

We are on course for a climate change “catastrophe” if present energy demand trends continue, the IEA warns. Large economies, particularly China, India and the US, also face sharply rising oil import bills, increasing the vulnerability of their economies to future price shocks.

The solution to both of these problems is the same: to impose a price for carbon dioxide emissions, through a combination of cap-and-trade systems, taxation and regulation, that will curb demand for fossil fuels and reward the development of renewable energy and nuclear power.

The technologies already exist to deliver the IEA’s revolution, although many of them are not yet commercially viable without government subsidy or other support.

Electric cars, nuclear power and underground storage of carbon dioxide emissions would all play important roles, although by far the biggest contribution will come from energy efficiency.

The problem will be the political acceptability of setting the carbon price high enough to bring about the widespread deployment of those technologies.

The IEA believes the world will need to spend an average of an extra $500bn or so every year from now until 2030 to hit that 450 parts per million target, on top of the $1,200bn or so that is required just to keep energy supplies coming.

That is a big increase, and as Birol made clear, “a very strong signal needs to be sent to the energy sector” to make that investment happen.

By that, he said, he meant not speeches or newspaper articles, but a financial incentive: a carbon price high enough to deter investment in high-emitting energy such as traditional coal-fired plants, and to encourage enough investment in renewables such as wind and solar, nuclear power, and carbon capture and storage.

A world reshaped to hit that 450ppm target would be very different from today. By 2030, about 60 per cent of all new cars sold would have to have some form of battery power, whether hybrid or all-electric. That electricity would have to be produced with much lower emissions, and by 2030, about a third of the world’s total energy supplies would have to come from zero-carbon sources such as nuclear and renewables.

There will be many other advantages to such a world, apart from staving off the threat of the 6°C temperature rise implied by extrapolating current trends, for which the adjective catastrophic is probably rather too mild.

Oil demand will be lower, reaching just 88.5m barrels per day by 2030, little changed from today’s 85m b/d consumption, and well below the “business as usual” projection of 105m b/d. As a result, the price of oil is also expected to be lower: $90 per barrel on average in 2030 (in 2008 dollars), down from $115 in the business as usual case (although any oil price predictions should of course be taken with a very large handful of salt.)

But in spite of those benefits, persuading voters in Europe and particularly the US to accept that high a carbon price will not be easy.

The cap-and-trade system in the Kerry-Boxer energy bill now before the US Senate includes a “collar” to stop the price of carbon emissions permits going above $28 per tonne in 2012, rising to about $48 in 2020 and about $90 in 2030. So the IEA’s required price would test the limits of that system throughout. And even that bill will require a huge effort to pass.

Higher carbon prices will mean higher electricity bills, and as cap-and-trade systems work only indirectly on road fuels – through refineries emissions – may need to be supplemented with higher fuel taxes. Persuading a US public that still holds profound reservations about the science of climate change to accept those higher costs is an uphill battle.

One of the striking ironies of the IEA’s analysis is that China, often seen in the US and Europe as the greatest obstacle to tackling climate change, may be the least of the world’s problems.

The IEA has calculated that if all the measures now under consideration in China’s 12th five-year plan are enacted, the country would contribute more than a quarter of the emissions reductions needed by 2020 to put the world on course to keep greenhouse gases below 450ppm.

Those measures, including the rapid growth of nuclear and renewable energy, the strucutral shift in the economy away from manufacturing, and improvements in domestic insulation, are not primarily uintended to tackle climate change; they are aimed at strengthening China’s energy security and cutting local air pollution.

However, Mr Birol says, they would have the effect of “putting China in the forefront of fighting emissions globally.”

He adds that China’s experience of implementing energy policy, as in the drive to bring electricity to half a billion people that was accomplished over the course of a single decade, gave him confidence that those objectives would be met.

The IEA’s democratic rich-country member states have a much less impressive record of keeping their promises.

For every year the world delays, the IEA says, the cost of keeping to 450 ppm rises from its original $10,500bn by another $500bn.

It is hoping for the US and China, in particular, to commit to a climate deal in Copenhagen next month. Without that, Mr Birol says, “we are in trouble”.

Related links:

Fossil fuel use must peak by 2020, warns IEA
Ask Fatih Birol
a question about the new IEA report
Don’t cry for Opec – even in a low-carbon future
IEA warns non-Opec oil supply will peak next year

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