What is the Welfare-Optimal Discount Rate in Rapid Energy Transitions?

Let’s talk about this critical but poorly understood parameter in the expansion of clean energy.

Image by Mona Tootoonchinia from Pixabay

“Net-zero by 2050” has become quite fashionable in energy and climate circles in recent years. Even though near-term projections continue to deviate strongly from this ideal, it is worthwhile to consider the implications of such a rapid shift. This article focuses on one of the most important parameters in the energy transition: the discount rate.

The IEA net-zero by 2050 scenario (NZE) and a scenario with limited global cooperation (e.g., rich countries not financing decarbonization in developing countries).

If we want a rapid transformation, the welfare-optimal discount rate will be high because of the large emphasis on near-term change. This implies that distant decades are strongly discounted relative to the near-term future.

Within the economic system, high discount rates (or financing costs) tend to favor technologies with low capital costs because they can create more near-term impact for a given amount of investment.

An Illustrative Example

Let’s compare two fictitious technologies supplying a steady stream of clean energy at a capacity…