· Potsdam Institute for Climate Impact Research

Coal phase-out: Announcing CO2-pricing triggers divestment

Political measures to reduce CO2 are triggering opposing developments: faster exploitation of raw materials, the "green paradox" versus the loss of investors and the related decline in emissions.

Divestment versus "green paradox"

Putting the Paris climate agreement into practice will trigger opposed reactions by investors on the one hand and fossil fuel owners on the other hand. It has been feared that the anticipation of strong CO2 reduction policies might – a ‘green paradox’ – drive up these emissions: before the regulations kick in, fossil fuel owners might accelerate their resource extraction to maximize profits.

Yet at the same time, investors might stop putting their money into coal power plants as they can expect their assets to become stranded. Now for the first time a study investigates both effects that to date have been discussed only separately. On balance, divestment beats the green paradox if substantial carbon pricing is credibly announced, a team of energy economists finds. Consequently, overall CO2 emissions would be effectively reduced.

CO2 reduction by up to 20 percent

“We find that ten years before carbon pricing policies are actually introduced, investors start pulling their money out of the coal power sector,” says lead-author Nico Bauer from the Potsdam Institute for Climate Impact Research (PIK). “They shy away from investing in fossil fueled power plants as they realise 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 percent, 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. “Adding a carbon price of 20 US-dollars per ton of CO2 doubles the cost of using coal,” says 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.”

A study shows that the divestment effect predominates

Computer simulations of energy markets’ future dynamics are commonly used to investigate the economic effects of policies. “We ran our simulations with a variety of CO2 pricing levels, steadily reaching between 25 and 300 US-Dollars per ton CO2 by 2050, with a medium scenario reaching 100 US-Dollars. These taxes were introduced with a number of different delays to represent various degrees of climate policy stringency and credibility and see how fossil fuel markets react in anticipation of such climate policies,” says co-author Jérôme Hilaire from PIK and the Mercator Research Institute on Global Commons and Climate Change (MCC). He adds: “This is to account for uncertainties, but the divestment effect prevails over the green paradox effect in almost all tax cases investigated regardless of the implementation delay, and therefore decreases overall emissions..."

From the PIK Press Release

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