The “Most Important Thing We Can Do to Avoid a Climate Disaster”
Getting from “Green Premiums” to “Green Dividends”
I recently ran across a Facebook post from Bill Gates, which says: “We need to get greenhouse gas emissions down to zero. Here’s the single most important thing we need to solve.” The post links to a GatesNotes blog with the title:
“MY TOP PRIORITY The one thing I hope people take away from my climate book: Lowering the Green Premiums is the single most important thing we can do to avoid a climate disaster.”
Gates highlights the example of renewable aviation fuel, which costs $5.35 per gallon compared to $2.22 per gallon for fossil fuel. The difference, $3.13 per gallon, is the Green Premium. To put that into perspective, the European Union’s Emission Trading System (EU ETS) is currently trading carbon at $54 per ton-CO2, which is equivalent to 52¢ per gallon for jet fuel. That price would add $22 to an air ticket for a New York-to-London flight. Carbon pricing is not actually levied on trans-Atlantic flights because the U.S. would have nothing to do with the EU ETS, but even if it were, such an anemic “price signal” would be insufficient to motivate either fuel switching or a significant reduction in air travel. The Green Premium for jet fuel would add $136 to the ticket price (equivalent to a $326 per ton-CO2 carbon price) — and that doesn’t include non-CO2 climate effects of flying (contrails and NOx), which would need to be offset at a higher cost.
Overcoming the barrier of Green Premiums
The “Green Premium” concept is illuminating because it exposes the vast disparity between our marginalist climate policies and the requirements of decarbonization. The following graphic, adapted from Gates’ Facebook post, provides a conceptual visualization of the Green Premium:
I’ve added a “carbon tax” block to the picture to illustrate the problem: The carbon price from a conventional carbon tax or cap-and-trade system would be much too small to overcome the price barrier created by the Green Premium. If governments try to set carbon prices high enough to actually make a serious dent in emissions, people will riot in the streets.
To overcome this dilemma Gates calls for a “ton of innovation” to reduce the cost of zero-carbon alternatives to the point where Green Premiums are eliminated — or are at least reduced sufficiently so that carbon pricing can be effective. But his one-dimensional conceptualization of the problem masks an approach that can facilitate an immediate ramp-up in renewable energy commercialization, even with initially high Green Premiums. The above graphic shows pricing relationships, but does not give any sense of how much money is actually changing hands because it doesn’t show sales volume. The following is a more informative visualization graphic showing prices in the horizontal dimension and relative sales volume (market shares) in the vertical dimension.
Initially, while renewable technologies are in their nascent stage, their prices are high but they have minuscule market share, so their Green Premiums can be subsidized at relatively little cost. The “subsidization levy” shows how much fossil fuels would need to be taxed to finance the subsidy. A relatively modest tax could immediately neutralize the price barrier to renewables, initiating a feedback loop of production expansion and cost reduction through economies of scale and innovation to the point where renewables become cost-competitive without subsidization.
This illustrates the dynamic that has been driving the explosive growth of wind and solar photovoltaic (PV) power over the last two decades. What opened the flood gates to renewable energy wasn’t a brilliant new engineering invention or technology, but rather an inventive financing mechanism, the feed-in tariff system pioneered by Germany in the early 2000s, which provided price support to solar and PV. When the program began, the Green Premium for renewable energy was quite high — about 45¢/kWh (equivalent to a carbon price of about $450/ton-CO2 based on substitution for coal). But the subsidization was financed by a surcharge on consumer electricity bills amounting to only 0.56¢/kWh (3% of household electricity costs). The surcharge was roughly equivalent to a $5.60/ton-CO2 carbon price, but it was not structured as a carbon tax and was not part of any kind of economy-wide system of carbon accounting, trading, offsets, or price homogenization. It was basically a straightforward tax on electricity. And in contrast to typical carbon taxation policies, the revenue was not rebated to consumers or offset against other taxes; it was used to finance green energy commercialization.
Taxation can be an effective policy tool for decarbonization if the revenue is used for the specific purpose of decarbonizing the taxed industry.
The feed-in tariff was effective because the revenue was used only to finance decarbonization of electricity. The key takeaway from the above graphic, as exemplified by the solar/PV industry, is this: Taxation can be an effective policy tool for decarbonization if the revenue is used for the specific purpose of decarbonizing the taxed industry.
The tax and subsidy can take a variety of forms. The U.S. employs R&D subsidies, renewable tax credits (which are basically government-financed subsidies), and renewable portfolio standards (which, in effect, mandate industry subsidization of renewables). These policies have catalyzed rapid capacity expansion and cost reductions in wind and PV. Over the last decade, PV costs have fallen by 82% and wind prices have fallen by 46%, to the point where unsubsidized PV and wind are now the least costly utility power sources. By 2030 prices are expected to drop further by 72% for solar and 43% for wind, laying the groundwork for a zero-carbon economy.
Similar subsidization policies could accelerate expansion of industries such as green hydrogen, green steel and cement, and green aviation, which are at the stage where PV was two or three decades ago. For example, returning to Gates’ example of aviation fuel, the EU-ETS carbon price of $54 per ton-CO2 (or a 52¢ per gallon fuel tax) would only have marginal impact on aviation emissions, but if the revenue were applied to subsidize sustainable aviation fuel it could cover the current Green Premium for 14% of the current aviation fleet. By the time production capacity actually reaches that level, the price for green jet fuel will have dropped significantly, perhaps to the point where subsidization is no longer needed.
The market evolution of green jet fuel might be similar to PV, which has become cost-competitive without subsidies at only 2% market share. A relatively low fuel tax, e.g., less than $10 per ton-CO2 (or 10¢ per gallon) would probably suffice to initiate widespread commercialization of green jet fuel. The U.S., China, and Russia might be amenable to partnering with the EU on a subsidization policy to decarbonize aviation, especially if it would help develop their own green fuel industries. Also, a carbon-offsets market for jet fuel Green Premiums could leverage individual action to help accelerate decarbonization of aviation.
Carbon taxes vs subsidies
With a feed-in tariff or similar alternative policies the “price signal” comes mainly from the subsidy, not from the tax. The efficacy of such policies refutes the conventional wisdom on carbon taxes, as stated by Gates: “Put a price on carbon. … Where the revenue from this carbon price goes is not as important as the market signal sent by the price itself. …” (from Chapter 11 in his book). Using the revenue to subsidize renewable fuels could amplify the price incentive for decarbonization by more than an order of magnitude relative to the carbon price itself, entirely neutralizing the Green Premiums.
Carbon tax proposals typically envision an initially low and gradually increasing carbon price. It is initially low because the discounting calculus underlying the “social cost of carbon” diminishes the value of early action on climate change, favoring procrastination over early action. Moreover, if the tax starts out high then taxpayers will revolt. A feed-in tariff, by contrast, starts out with a very high price incentive, which can be much higher than any contemplated carbon tax, but which is financed by a comparatively modest tax. The price subsidy decreases over time as renewable technologies gain market share and become less dependent on the subsidy. This proactive, early-action regulatory approach would be much more effective at kick-starting the green economy. Also, early action — not procrastination — can better capture the positive investment potential from green energy.
Subsidies vs investments
Green Premiums are a transient obstacle that can be overcome with efficient financing policies such as feed-in tariffs. Once they attain market maturation and economies of scale, green technologies can be enormously profitable. (Renewable energy investments in the U.S. market have been yielding 200% returns.) As Gates said in his book (Chapter 11): “There are markets worth billions of dollars waiting for someone to invent low-cost, zero-carbon cement or steel, or a net-zero liquid fuel…”
But who will be getting those “billions of dollars”? Green technologies require long-term subsidization by taxpayers and consumers before commercial equity markets will put up risk capital for market expansion, but those subsidies could lead to greater wealth concentration and inequality if the financers of the subsidies don’t get equity in return for their investment. Government subsidization policies that are structured to return investment dividends would be able to leverage the enormous profit potential of green technologies to effect a rapid transition to carbon neutrality.
Australia’s Clean Energy Finance Corporation, for example, is a government-owned bank that invests in clean energy projects and delivers positive returns for taxpayers. Such investments can expand the scope of climate actions that governments can take beyond what can be done with deficit- or tax-financed subsidization.
Government action could also help to efficiently channel private investment toward sustainable technologies. Taking the airline industry as an example, a multinational investment program for sustainable aviation fuel could be structured as a government-administered, industry-wide collaboration on technology development and commercialization, with mandated cost and profit sharing across the global aviation industry.
There is no guarantee that clean-energy investments will be profitable, but their costs and risks — and any investment gains — should be distributed equitably among investors and stakeholders to ensure an economically and politically sustainable green economy. We can’t have “equity” (in the social justice sense) without “equity” (in the shareholder sense).
