How to deliver the energy transition

We all agree on the principle of cutting emissions. This is how to actually make it work

April 21, 2022
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As well as protest, we need practical answers to climate change. Photo: Girvan / Alamy Stock Photo

There is a vast gap between the goal of limiting global warming to 1.5°C, and the actual climate plans, policies and investments that governments and societies have so far committed to in order to do so. Narrowing that gap is the great imperative of our time. The 1.5°C goal requires the world to reach net-zero emissions of greenhouse gases by around 2050—an extremely challenging timescale, but an essential one if the most dangerous impacts of climate change are to be averted. The really contentious debates are no longer over whether fundamental change is necessary or possible, but how to do it at sufficient pace.

There are those who focus narrowly on boosting “climate finance,” assuming perhaps that investment in renewable energy and electric cars is basically working and the world just needs more of it. Others argue for putting economies on a war-like command footing to dramatically accelerate change. But what does experience tell us works?

The evidence comes not only from the hits and misses of public policy over the past two decades, but also happenstance—the three great (but transitory) oil price shocks of the 1970s, 1980s, and 2000s. From an energy perspective, the impacts of these unplanned (and for most people, painful) events were as important as deliberate attempts to effect change. The oil crises spurred waves of investment in energy innovation: alternative kinds of vehicles, energy efficiency, solar photovoltaics, wind turbines and—until the accidents at Three Mile Island and Chernobyl—nuclear power. They also spurred new ways of extracting oil, such as fracking. With current natural gas and oil price spikes fast becoming a fourth great energy shock, we should look at what we can learn from history.

Misjudged markets

The orthodox approach to tackling climate change concentrates on fixing two key market failures—redressing its inability to properly account for environmental consequences, and its inability to adequately reward innovation.

The established policy fix for the former is to impose emissions pricing that makes it more expensive to pollute. For the latter, it is government support for research and development (R&D), either through subsidies for businesses or direct state investment.

The past oil shocks were, albeit unintended, test runs of partial emissions pricing. They encouraged reductions in oil use and investment in alternatives through the sheer force of high prices. The oil shocks demonstrated how the price mechanism can work.

But many years of talk—and some action—on carbon pricing have not led to sufficiently rapid progress. Policymakers have been wrestling with how to transform energy systems for years and no one has yet found the right economic formula. So what actually is it in our economies that inhibits a decisive pivot away from fossil fuels to low-carbon alternatives like renewables and electric vehicles?

There are several possible answers—in addition to the orthodox ones—each with implications for how to address the climate imperative. The first is that government and business are each often hesitant to act before the other does. The oil shocks overcame this problem because they sparked anxieties about oil dependence similar to those being experienced today, spurring both governments and businesses in Europe, the United States and East Asia to throw themselves behind innovations that helped deliver alternatives to. However, without such shocks, governments find it difficult to deliberately price emissions and make fossil fuel use more expensive because of the painful impacts on businesses and consumers. And without the credible prospect of higher prices for fossil fuels, businesses can hesitate to invest in advancing alternatives to them.

The really contentious debates are no longer over whether fundamental change is necessary, but how to do it

The second is that pioneers of energy alternatives typically face high initial costs, because existing energy systems and manufacturing are tailored to the old technology. Where this is not accounted for in government policy, progress is too slow. The third is the other barriers that can stand in the way of change, such as inflexible institutions and consumer habits. For example, solar and wind power is increasingly a lower-cost alternative to that from new coal or natural gas plants. But investment in renewables is not accelerating as fast as one would expect, suggesting that other things like misaligned institutions, regulations and power grids are getting in the way.

Virtuous circles

If we want to overcome these inhibitors, we need to look at the interdependence between different parts of the system and the way decisions from one firm or customer can spill over, causing a ripple effect.

Consider petrol cars and service stations. Both of these existing technologies benefit from standardisation and substantial scale economies. Early movers to advance alternatives—electric vehicles and charging points—must overcome high switching costs, with consumer anxiety about the distance between charging points deterring the early purchase of electric vehicles, and a limited driver pool of potential customers for the early installers of charging points.

Over time, these costs should decline for everyone, as more electric cars take to the road and more charging points become available. And because of the substantial scale economies in manufacturing new technologies—making things for the mass market is often cheaper than doing so for a market niche—the sheer fact of their popularity will make them cheaper still.

Similar transitory effects arise with other fossil fuel uses and their supporting infrastructure. Again, it is early movers who will set in train the dynamic by which society shifts to something new. So policy needs to encourage alternatives by pro-actively creating markets for them, thereby supporting both early-adopting customers and businesses that pioneer the technology. This support can spur innovation and encourage new business activities to grow, along with the new skill pools and supply chains to support them. Several countries with large car markets and domestic manufacturers have provided grants for electric car purchases and new charging points, which have played a major role in scaling up these technologies and driving down their costs.

Proposals from the Biden administration for tax credits for green hydrogen (from electrolysis of water) are one example of the sort of further action needed to decarbonise those parts of the economy that cannot be electrified or use low-carbon power like renewables.

Governments must also promote more efficient use of energy and materials through information and education, as well as regulation. These measures can help overcome a lack of consumer understanding and hesitancy towards the new, to ensure investments in thermally efficient buildings, electric heating and massively increased recycling. They are also going to need to rewire electricity markets, to ensure compatibility with renewables and overall low-carbon systems.

When governments forge new markets, directly kickstarting alternatives to fossil fuels, they achieve something else, too—they bolster the credibility of their climate goals and policy promises. This gives businesses the confidence to more rapidly scale up the technology and drive down its cost, facilitating change and in many cases reducing the eventual need for politically-sensitive emissions pricing.

article body image Kristoffer Tripplaar / Alamy Stock Photo

Drivers still aren’t confident they’ll be able to find a charging point. Kristoffer Tripplaar / Alamy Stock Photo

The price of fairness

There is another important reason why governments have not taken more of the steps needed to get climate reform on track. It clearly does not help that raising the price of emissions inevitably pushes up the costs of personal transport, heating and more. Such costs typically weigh heavily in household budgets—especially those of less affluent households. The sentiments of hardship and unfairness are real and sometimes have spilled over into the streets—for example with the gilets jaunes protests in France, which followed fuel tax hikes. With energy bills once again rocketing up the political agenda, sustaining support for emissions pricing is going to be tough. Indeed, in March Nigel Farage launched another populist campaign—this time for a referendum on the government’s plans to achieve net zero by 2050.

Businesses and investors rightly see a danger that the energy transformation loses momentum and need to see signals the government remains committed. That will take extra subsidies to kickstart new technologies and much more besides. Carbon pricing is a necessary part of that mix, but there is no getting round the fact that it presents a serious fairness problem for those who take the hit of higher costs. In principle, the proceeds from emissions taxes could simply be used to fund financial support targeted at people living on lower incomes. But it can be tough to persuade voters that what is being taken with one hand really is being given back with the other—especially when there are bound to be some whose line of work, or transport or heating needs, will still see them lose out.

A more creative approach to fairness would take account of the wide variation in the costs of achieving net zero in different parts of the energy system and economy. Some sectors should be relatively easy to decarbonise—for example, much of road and rail transport and indeed energy for our homes and offices—in the long term. This is because solar photovoltaics, wind turbines, rechargeable batteries and heat pumps look set to get cheaper and become ubiquitous. Such changes can come at a very high initial cost—estimated at $2 trillion globally for the transition to cost-effective solar and wind power. But by the 2030s, these low-carbon technologies are likely to be as competitive as their polluting alternatives. In the long run, they will likely need at most moderate emissions pricing to encourage their uptake.

By contrast, it will be far harder to transform other sectors—aviation, shipping and heavy industries like steel, cement, chemicals and plastics. The difficulties arise from requirements for things which, even once ramped up to scale, still look likely to remain very costly: for example, low-carbon fuels such as green hydrogen and carbon capture and storage. These alternatives appear inherently more expensive than traditional fossil fuel use and are only likely to attract the requisite investment if governments make a credible commitment to strict emissions pricing (so burning coal, oil and natural gas becomes truly uneconomic).

It should be possible to undertake smart emissions pricing by differentiating the price between “easy” and “hard” sectors without compromising on net-zero, or indeed on overall cost effectiveness. In some ways, public policy is already drawing this distinction with differentiated deadlines—for example, rapid requirements for ditching internal combustion engines in cars and moves away from coal-fired power plants. At COP26 last year, many countries committed to turn away completely from these things within the coming decade or two. When there are affordable low-carbon alternatives in sight, like renewables and electric cars, governments should focus on directly supporting their early advance and using regulation to phase out the old technologies.

By contrast, in the “hard” sectors, hefty emissions pricing is the only way—and in some contexts it is beginning to kick in. Consider the EU emissions trading scheme for large industrial plants. For most of the last decade, the price had languished at a low level. But after 2020 reforms, it is now imposing a much stricter price of $80–90 per tonne.

Unsurprisingly, European industries are now increasingly demanding “border carbon adjustments” (tariffs, in plainer parlance) to counter lost competitiveness in sectors such as tradable materials and material-intensive manufactured goods. This is entirely understandable, and as things stand some such adjustments will be needed to stop pollution simply being outsourced to firms in laxer regulatory environments. But such border charges could also see a turn to wider protectionism which would do no one any good. It would be far better if the industrial world could be persuaded to embrace smart emissions pricing, rather than a one-size-fits-all price across the whole economy,

That would involve carefully tailoring the price on carbon to the projected long-run cost of eliminating emissions in a given sector. And because alternative energy technologies are already well advanced in many of the most politically sensitive and consumer-facing areas, the cost for individuals worried about driving, heating and using household appliances would be bearable. Tailored regimes would help to make emissions pricing fairer.

This is especially important amid the current cost of living crisis, with the real possibility that the spikes in natural gas and oil prices lead to a lurch back to coal as much as a surge forward to renewables. The urgent task for governments is to create a credible way for businesses and households to invest in a safer climate and future for us all.