Expert Commentary

The opinions of the authors expressed herein do not necessarily state or reflect those of Senator Lugar and shall not be used for advertising or product endorsement purposes.

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Energy Policy in an Uncertain World Threatened by Dangerous Climate Change

By Gary Yohe
Woodhouse/Sysco Professor of Economics, Wesleyan University

Two hundred experts from around the world met in February of 2005 at the invitation of Britain’s Prime Minister Tony Blair to scope out the dimensions of what might turn out to be “dangerous” human interference with the climate system. More than 40 of the papers initially presented at that meeting were subsequently peer reviewed, and they have been published by Cambridge University Press in a new book entitled Avoiding Dangerous Climate Change.

The meeting and the publication of its proceedings have, of course, attracted the attention of the climate “contrarians” who claim that there is no climate problem. Their view is that the body of scientific evidence that indicates that humans are changing the climate is fraught with uncertainty, at best, and motivated by a religious fervor for unbridled environmentalism at worst. They claim that there is no way for us to substantiate any such claim. In fact, a few continue to argue that we cannot be sure that human activity is warming the planet.

How should we respond to their critique? We could cite lots of literature and point to the technical details behind the blizzard of observed climate impacts. But that would play right into their “if you can’t convince them, confuse them” strategy. Much of the world’s population would look at the technical debate, decide that none of us know what we are talking about, and turn their attention to other matters. They would, in short, use confusion born of scientific uncertainty as a reason not to act.

I propose a different response. I think that the policy community in the United States and elsewhere should muster enough political leadership to look the contrarians squarely in the eye and say “You’re right! We don’t know exactly how much warming the planet experience over the next century. We are not sure precisely how local climates will change over the next 100 years. We cannot guarantee that are fears about potentially dangerous climate change are justified, but you cannot be sure that they are not!”

What do people do when they are faced with profound uncertainty of high-consequence events even if they come with low probabilities? They buy insurance – against the risk of fire, against the cost of automobile accidents, against the potential of serious health problems, and the like. If they are lucky enough to have money to invest in the stock market, they diversify their portfolios. In short, they hedge their bets.

What does this insight mean for climate policy in general and the price of fossil fuel more specifically? It means that we should acknowledge the risk that climate change could be dangerous is a fundamental reason for enacting at least a modest but persistent policy of reducing greenhouse gas emissions – using tax or permit mechanisms, for example, to reflect a risk-based measure of potential damage in the price of fossil-based energy. At what level? Published estimates of the economic cost of those damages vary widely – a reflection of the already acknowledged uncertainty. The median estimate is $2 per barrel of oil. More than 20% of the estimates lie above $9 per barrel, and the average is $5 per barrel.

To be clear, tacking a static per barrel carbon tax onto the price of oil would not do the trick over the long term. The appropriate charge for carbon should increase in real terms by 2% or 3% per year – approximately the real rate of interest in a growing economy. This systematic ratcheting is the critical component of any policy; it is the persistent and predictable increase in the effective price of carbon that would give the policy traction at all. Why? Because investment decisions that will define the private and public capital infrastructures of our economies for the next century will be made before 2025; to be economically efficient in the face of the risk of climate change and climate policy, they must be made with the expectation that carbon will be more expensive next year than it is now.

To be doubly clear, a modest intervention in 2006 that would be economically benign in the near term would not protect us from the effects of uncertain but potentially dangerous climate change impacts, per se. It would, instead, protect us from dramatic increases in the more easily understood economic costs of policy adjustments in the future. Failing to recognize these costs of policy adjustment (because we fail to recognize climate change as a threat to how we do business) would simply increase the likelihood that energy intensive projects will continue to go forward. New buildings (and renovated buildings, for that matter) would be less energy efficient than they could be. The transportation fleet would be more energy intensive than necessary. We would lock ourselves into long term investments that would dramatically increase the cost of future policies that may become necessary.

What if I had to pick a number for 2006? Given all of the impacts that are not yet part of the more traditional approaches, I do not think that the $5 per barrel is too high. I could be just as comfortable with $10 per barrel, but $2 per barrel would probably work, too. Indeed, the only imperative at this point is that a positive charge for the carbon of oil (and coal, natural gas, and other varieties of fossil fuel) be factored into investment decisions and that its gradual, year to year increase be immune be immune from political manipulation.

For further information regarding this topic, see the following sources:

Senate Foreign Relations Committee Hearing, “The Hidden Cost of Oil,” March 30, 2006.

Forthcoming chapter from Avoiding Dangerous Climate Change, “Assessing the Risk of a Collapse of the Atlantic Thermohaline Circulation,” February 2, 2005.

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