Carbon conundrum

Much has happened since I wrote the last blog. The change of prime minister has been welcomed by financial markets, and Rishi Sunak has shown himself to be a sensible leader, even if there are questions about his true convictions. There are many issues that his government must address, after Liz Truss set out to make the Big Throw. Although necessary, unfortunately she did so without much political savvy.

Today I will discuss one of the most pressing issues facing the country, expertly described in a new book by leading academics Philip Booth and Carlo Stagnaro. In “Carbon Conundrum” they start with the premise that global warming is to an extent caused by industrial CO2, then they unpick the tangled web of policies being used to try to reduce emissions.

In the book, the authors point out the way “climate policy may be formed so as to become aligned with the targets of economic efficiency, and not just environmental effectiveness.”

As we face the energy crisis, with the government covering huge costs for homes and businesses over the coming months, we must understand the economic conditions that helped create it.

The authors argue that we have a set of subsidies and taxes that are “arbitrary and totally unrelated to any rational assessment of social costs.” They reveal that by reflecting “externalities” of products and energy through a mixture of taxes and subsidies, the benefits of reducing CO2, which has been a major political priority for over a decade, are vastly outweighed by the economic costs created by these policies.

It is an effective criticism: Instead, “an economically rational climate change strategy should aim to reduce carbon emissions at minimum costs. It should not consist of badly designed taxes and subsidies with the economic rents handed out to interest groups.”

These subsidies distort the market, boosting the construction of new windmills but failing to produce important carbon-free technologies such a nuclear or carbon capture, sequestration and utilisation.

“As ever, in economics, there are trade-offs,” the authors conclude. “The question that is widely discussed, therefore is the extent to which we should try to reduce carbon emissions and global warming.”

A simple carbon tax, similar to cap-and-trade, is consistent and uncomplicated. It is the “least worse” approach, the authors claim. But to get to this policy we must unravel the destructive regulations that were designed for one reason but are having unintended consequences, especially in increasing the price of electricity and heating for millions of homes.

This conundrum, as they call it, is a great opportunity to capitalise on Brexit. It is worth listening to Jacob Rees Mogg, who has argued that the UK should get rid of the EU carbon trading project ETS. As former energy secretary he has seen up close that the policy “makes all of our energy costs higher” and “does not reduce carbon emissions, as it leads to more imports which are cheaper but emit abroad rather than in the UK.”

Let me return to the “Carbon Conundrum”, which raises the interesting clue that this simple CO2 tax policy is being blocked by green interests because – though it could actually reduce emissions, with subsidising renewables “a highly inefficient way to reduce emissions” – it may in fact harm the economics of their favourite renewable energy.

“A transparent carbon tax would affect relative prices dramatically as well as affecting the total cost of energy use. If we do use the EU’s own estimate of the external costs from energy use, there is no doubt that there would be an increase in the cost of energy overall. The increase would be unequal across energy sources: it would be more modest for oil, natural gas, hydro power and biomass as compared with for coal, wind power and solar power. All else being equal, this would result in a reduction of energy demand in general and a change in demand patterns away from coal, solar and wind and towards natural gas, hydro power and biomass.”

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