6.2 - trade in energy, OPEC and IPE of climate change

Question 1

the energy trilemma

Answer 1

• stable energy supply
• no energy poverty
• climate change mitigation

! unlike the monetary policy trilemma, this is NOT A STRICT trilemma: it is hard but not impossible to get all three

stable energy supply: energy is fundamental good for our economies and lives more than almost any other (power production, fuel most forms of transportation, heat homes, supply electricity to our homes)

• abundance of reliable, cheap energy fuels economic development
• lack of reliable, cheap energy can cause deep economic crisis

Question 2

two interrelated crises

Answer 2

• energy crisis: dependency on Russian fossil fuel
• climate crisis
  !can also look at cumulative emissions (emissions in history, not just now) -> US largest cumulative emissions
  !also take into account who was in control at the time: e.g. high emissions Indonesia were during Dutch control

Question 3

global sources of energy + trade in energy

Answer 3

gas, oil and coal provide the biggest chunk of energy today -> stable supply and green energy hard to combine

mostly non-renewable goods

huge flows imports/exports, flows are as to be expected: away from Russia and Middle East (bc they have a lot of nonrenewable resources)

Question 4

OPEC history

Answer 4

founded first half C20: 7 large western controlled oil companies: the “seven sisters”
-> now (bc mergers): Exxon, Shell, BP, Chevron

1960: 5 countries were seven sisters were operating worked together: form OPEC to make the system fairer: stabilize prices seven sisters had to pay for drilling in the countries + to ensure fair return on capital for investors

• you can see it as a trade union -> negotiating together gives more negotiation power
• Saudi Arabia, Iraq, Iran, Kuwait, Venezuela

1970s: OPEC asserts power by imposing oil embargo (causing inflationary shock western world)

1980s: institutionalized “cartel”: have mandatory production quotas for members to keep supply steady and prices high

2016: problematically low oil prices (acc to oil countries) -> formed OPEC+ to coordinate with more countries on output quotas (e.g. Russia)

Question 4

institutions governing energy policy

Answer 4

no one institution or agreement governing energy policy

main institutions

• oil exporters: OPEC - Organization of Petroleum Exporting Countries
• oil importers: IEA - International Energy Agency

also other institutions that meddle in energy policy

• UNFCCC
• dealing with specific types of energy: IRENA, IAEA (atomic energy)
• WB

Question 5

OPEC Oil Embargo 1973

Answer 5

• By 1973: OPEC’s production of oil at over 50% world share
• 1973: Yom Kippur War = alliance Arab states vs Israel (west supported Israel)
• ## Arab members of OPEC impose an oil embargo on US & Netherlands and cut production-> Result: Price of imported oil to US quadruples, double-digit inflation (bc as oil prices go up, other prices also go on)
  = cause stagflation: high unemployment and inflation

Question 6

Oil Cartel and Oil Prices

Answer 6

OPEC negotiates quotas on how much oil to extract and export to keep prices high for everyone

• e.g. oil price drop after 2008 crash: OPEC countries jointly reduce output (bc also less demand)

BUT: coordinated output cuts hard o maintain - Prisoners’ Dilemma: incentive not to cut and to keep drilling, profit from high prices

some argue that Saudi Arabia (biggest producer) has role of enforcer : tit-for-tat: if you break your quota, so will Saudi Arabia, so prices will go down

!this breaks down repeatedly, so quotas don’t really work (always)

Question 7

OPEC today

Answer 7

• 13 member countries
• still account for more than half of world’s crude oil
• shale boom in US and Canada has undermined OPEC’s influence in North America
  *US starts frecking (extracting oil from shale) so starts to produce more than Saudi-Arabia

Question 8

the IEA

Answer 8

= organization for Oil Consumers

created 1974 under OECD framework (= only developed country members, cause otherwise you’re not in OECD) = direct effect oil embargo

goal = reliable energy supply (pool, keep reserve/pool) -> avoid future oil shocks (to counteract price shocks)

measures:

• emergency stocks and collective oil emergency response
• promote energy efficiency and diversification
• research into energy markets and consulting
• Promote Clean Energy Transition (today)

IEA data and OPEC data on what needs to happen to fight climate change is very different

Question 9

climate change as prisoners’ dilemma

Answer 9

keep emitting vs cut emissions

climate change = collective action problem: everyone wants to free-ride on other’s emission cuts

countries want other countries to cut emissions and themselves keep emitting

-> both countries keep emitting = Nash equilibrium
- dominant strategy to keep emitting no matter what the other does
!even though this option is for both worse than both cutting emissions

*if one cuts than climate change is mitigated at least somewhat

Question 10

international climate negotiations

Answer 10

1992 = countries agree on UNFCCC (UN Framework Convention on Climate Change)
= framework convention which we still use to do climate change negotiations

• conference of the parties (COP) held every 2 years
• COP 29 held in Baku this November
• common but differentiated responsibility (based on eco development, ability to pay etc.)

1997 Kyoto Protocol = first agreement under this framework

• set limits for developed countries to make cut (differentiated responsibilities)
• US never ratifies, Canada pulls out
• emerging economies (China, India) grow rapidly but have no obligations under Kyoto
  -> states fail to agree on the second cuts that Kyoto had foreseen: people have run out + people don’t agree, only EU is trying

Question 11

new model: the Paris Agreement + core issues today

Answer 11

agree to keep global warming below 2 degree increase, aim for under 1.5

More politically palatable:

• Everyonehas to do “something” (not just developed countries have to cut, otherwise US would not agree)
• Countries themselves decide how much: Nationally Determined Contributions(NDCs)
  only thing that the agreement mandates is that you contribute, how big it is (how much you will cut emissions) countries can decide by themselves
• Designed to allow US President to circumvent Congress (domestic institutions!!: US congress refused to ratify Kyoto, probably would’ve refused to do so with Paris)
• mandates (Some) Climate Finance (developed countries need to pay some to developing countries)

Core issues today:

• Stock-take last year (review NDCs + judging if they have done enough): How have countries done so far? (result: not enough: NDCs not ambitious enough)
• Phasing out of fossil fuels (transition away, rather than phase them out completely)
• Climate finance, including “Loss and damage” fund

Question 12

domestic interests

Answer 12

Climate action requires that we restrict GHG-intensive activities through higher prices, bans, quotas…

In the long run, we all win from policies to mitigate climate change (bc costs cutting emissions are less bad than costs climate collapse), but in the short-medium run:

winners: among producers of green energy and green transportation

losers among producers:

• fossil fuels
• energy-intensive producers (use fossil fuels: e.g. metals, glass, paper, fertilizers, chemicals)
• producers that use Energy-Intensive Inputs (everyone that uses e.g. glass or metals also has to pay more)
• Petrol Car Producers
• Airlines (electric planes not a thing yet)
• Cattle farmers (land and water intensive (deforestation) + emission methane)
• ….

Question 13

domestic collective action problems

Answer 13

cost of effective climate action are acute and concentrated = easy for industry to organize and lobby
- e.g. American Petroleum Institute, German Automotive Association, US Chamber of Commerce
- also companies themselves lobbying: e.g. Toyota (not good at electric cars)

benefits of effective climate action are diffuse, they benefit everyone in the world = most (young) citizens benefit, but easy to free-ride off others’ climate protests
= large and diffuse interest group, hard to come together, there is lobbying, but not as much as on the other side

two outcomes that can arise from collective action problems:

• climate action is stopped/watered down due to forceful lobbying: we don’t cut emissions enough
• the cost of climate action are born by CONSUMERS not BUSINESSES (-> energy poverty)
  *e.g. German Energy Transition largely paid for by energy taxes on households, not businesses

Question 14

3 common policy approaches

Answer 14

1. carbon taxes
2. emission trading
3. green industrial policy

Question 15

3 common policy approaches
- carbon taxes

Answer 15

put a tax on carbon to “price in” the negative effect of climate change (Pigouvian tax)
- can happen at production and consumption stage, mostly happens on the consumption stage

what do you do with the tax revenue?

• pay for energy transition
• pay for adaptation, loss and damage of climate change = fund regions or household that are hard hit by climate disasters
• use the money for something else

Canada and Switzerland: Rebates (Lump Sum = everyone gets the same back)
- tax everyone same percentage, give everyone same amount of money back

• still creates incentives, because your behavior does not affect your rebate (you get same amount of money back no matter if you pay -> still incentive to cut out emissions)
• only the worst polluters worse off in the end
• can be progressive: poorer households get back more
• problem = people tend to underestimate their rebates and overestimate the costs of carbon taxes (you notice immediately if prices rise, harder to see how much rebate you got for what (you just look at the aggregate)) = they are more unpopular than they should be based on actual interests

Question 16

how are Lump Sum Rebates progressive?
- taxes

Answer 16

Household A - lower middle class

• make $30.000 a year, spend 10% - $3.000 on energy
• carbon tax increases price of energy by 10% -> additional cost: $300
• all citizens get back $500 -> Household A has $200 more in their pocket than before

Household B - upper class

• make $200.000 a year, spend 5% - $10.000 on energy
• carbon tax increases price of energy by 10% -> additional cost = $1000
• all citizens get back $500 -> Household B has $500 less than before

Question 17

energy poverty

Answer 17

= when the price of GHG-intensive products rises, not all houses can:

• pay to insulate their homes
• pay for an electric car
• install solar panels and heat pumps

problem = poorest households spend the biggest income share on energy
(in relative terms, not in absolute terms)
-> proportionally taxes on energy etc. are harder on poorer people

Question 18

3 common policy approaches
- emissions trading

Answer 18

= cap and trade
- cap = choose how much CO2 can be emitted
- trade = permits that companies can trade: they can sell if they still have CO2 “left” they can sell
every year the cap gets stricter

-> incentivizes companies to cut emissions so they can sell permits rather than buy them
BUT in practice: incentives not good enough: carbon prices too low + fines for exceeding permitted levels not high enough + firms don’t get caught

world’s largest carbon markt: European Emissions Trading System (ETS)
= EU response to Kyoto obligations

1. phase 1&2: no shortage of permits bc it was a try-out
   - 2008 crisis -> countries start hording permits bc they were relatively cheap?
2. taken two decades to pull exces permits out of the system, now it is enough to incentivize cutting emissions

Question 19

common criticism of taxes and emission trading system = carbon leakage

Answer 19

high prices of carbon in one country -> companies shift production to countries with lower carbon prices = you haven’t actually done this

• evidence of existence of carbon leakage is mixed at best = seems limited for now, but don’t know what would happen at higher carbon prices
• companies use it as threat when they lobby, but no real evidence that it has occured

3 possible solutions:

1. global price on carbon (very, very hard to negotiate)
2. tariffs on foreign goods at the border to “level the playing field” (when companies leave country and start to export to it)
3. give free permits/tax breaks to companies that export or compete against energy-intensive imports
   -> this is what the EU has done

Question 20

EU carbon border adjustment mechanism (CBAM)

Answer 20

Initially, EU gave away free ETS permits to companies to “level the playing field” in import-competition and exports

Problem: Lots of free permits limit incentives to decarbonize

New solution: Instead of free permits for import competition, CBAM: tariff on products from countries that do not have equivalent carbon prices
*for now in trial phase where there is no tariff yet, just monitoring what comes in

• Companies liked the idea of the CBAM AND free permits
• Companies did not like the idea of paying for permits when CBAM introduced

Note: This may incentivize countries that are dependent on EU market to also put a price on carbon (bc exporters have to pay tariff at border, you may as well do tax on carbon emission so that the don’t have to pay the tariff)

why no CBAM and free permits??
WTO did not allow it: you can impose trade measures to prevent climate change, but measures can’t be arbitrary or discriminatory:

• you can impose CBAM
• you can put tariffs only on products from countries without carbon pricing
• you can’t impose a CBAM and also give your industry free permits

Question 21

3 common policy approaches
“big green push”: green industrial policy

Answer 21

green industries should be treated as “infant industries”
(like big push idea ISI)

green transition requires large-scale investment in low-carbon technologies = individual investors are unlikely to invest

also requires changes to public and private infrastrucutre:

• charging networks for EVs
• pipelines for green hydrogen
• smart grids in energy networks

green industrial policy has political benefits:

• instead of imposing costs on polluters, you give incentives and subsidies to green industries
• building up green industries creates jobs
• green industrial policy fosters industries that will lobby in favor of climate action

Question 22

US Inflation Reduction Act 2022

Answer 22

underlying logic = green industry policy

instead of pricing pollution,
introduced tax incentives, grants, loans

tax credits (=subsidies) for companies investing in clean energy, transport and manufacturing

tax credits for consumers to make EV’s, solar panels, heat pumps, etc. more affordable

!!clever design: Biden put areas receiving most in Republican areas -> if Trump tries to go against it may be bad for his vote share

Question 23

WTO rules and the US inflation reduction act

Answer 23

EU accuses US of breaking WTO rules with green energy incentives

national treatment: foreign products aren’t subsidized

Many of the tax breaks are only applicable to locally produced goods (or goods produced by “trade partners)E.g.consumers get a tax break for EVs produced in the US, but not in the

!is not yet brought to the WTO bc are negotiations if they will be included in the subsidies, problem is that TTIP broke down, so would have to go through something else

Question 24

limits of statee capacity

Answer 24

state capacity = ability and effectiveness of a government or state in performing its functions and responsibilities, including policy-making, implementation, and service delivery, to meet the needs of its citizen
- more developed -> more capacity

green transition requires lot of state capacity (lot of money and good governance)

• Make and incentivize major investments
• Monitor and enforce climate laws
• Monitor the effective use of climate subsidies and climate aid
• Build resilient infrastructure and disaster respons

many developing countries lack state capacity to effectively implement a green transition (without help -> we need international climate finance)

Question 25

international climate finance

Answer 25

“financing that seeks to support mitigation and adaptation actions that will address climate change”

Under UNFCCC, developed countries are supposed to provide and mobilize funds for developing countries’ climate action

• In Paris, developed countries reaffirmed commitment to mobilize $100 billion per year until 2020
• 2022 exceeded $100 bn for first time ($118bn)
• In Baku, they just agreed to increase that to $300 billion per year until 2030. Developing countries called this “a joke,” -trillions are needed (at least 2 trillion to address transition and ongoing climate issues)

!is not only bilaterally, also through IGOs, multilatralism

Question 26

a new supply challenge: raw materials

Answer 26

potentially new brewing ? commodity? crisis

Energy transition depends on critical raw materials used in batteries, low-carbon power generation and electricity grids

Danger of disruptions –countries (and companies) have started to invest in lowering their dependence:

• recycling, at-home processing, substitution

Watch out for global fights over raw materials

small amount countries controlling large share global production (Chili, Peru, China, DRC, US)
+ they are all largely processed (so that they can be used in green energy production) in China -> can lever Western dependence on this in any type of conflict