Trade in Energy, OPEC and the IPE of Climate Change

Question 1

The energy trilemma

Answer 1

Unlike the monetary policy trilemma, this is not a strict trilemma, it’s hard but not impossible to obtain all three
- Stable energy supply
- No energy poverty
- Climate change mitigation

Question 2

Why is stable energy supply important?

Answer 2

• Energy is a good that is more fundamental to our economies and lives than almost any other, we need it to:
  – Power production
  – Fuel most forms of transportation
  – Heat our homes
  – Supply electricity to our homes
• Abundance of reliable, cheap energy fuels economic development
• Lack of reliable, cheap energy can cause deep economic crises

Question 3

Institutions governing energy policy

Answer 3

• No one institution or agreement governing energy policy
• Main institution oil exporters: Organization of Petroleum Exporting Countries (OPEC)
• Main institution oil importers: International Energy Agency (IEA)
• A lot of other related to energy
  – UNFCCC (United Nations Framework Convention on Climate Change)
  – IRENA (International Renewable Energy Agency)
  – IAEA (International Atomic Energy Agency)
  – World Bank

Question 4

OPEC history

Answer 4

• First half of 20th century: Oil production dominated by “Seven Sisters”
  – Now: Exxon, Shell, BP, Chevron
• 1960: 5 countries (Saudi Arabia, Iran, Iraq, Kuwait, Venezuela) form OPEC to “stabilize prices” and “ensure a fair return on capital for investors”
  – = trade union to negotiate with oil companies
• 1970s: OPEC asserts power, oil embargo
• From 1980s: Mandatory production quotas for members to keep supply steady and prices high
  – = OPEC becomes a “cartel”
• 2016: OPEC+ (coordination with Russia and others)

Question 5

OEPC oil embargo 1973

Answer 5

• By 1973: OPEC’s production of oil at over 50% world share
• 1973: Yom Kippur War
• Arab members of OPEC impose an oil embargo on US and Netherlands and cut production
• Result: Price of imported oil to US quadruples, double-digit inflation

Question 6

Oil cartel and oil prices

Answer 6

• OPEC negotiates to curb production through quotas, keep prices high for everyone
  – eg. oil prices drop after 2008 financial crash - OPEC countries jointly reduce output
• But: Coordinated output curs hard to maintain - prisoner’s dilemma
• Some argue that Saudi Arabia - OPEC’s biggest producer - tries to uphold discipline through tit-for-tat

Question 7

OPEC today

Answer 7

• 13 member countries
• Still accounts for more than half of world’s crude oil
• Shale boom (fracking) in US and Canada has undermined OPEC’s influence in North America

Question 8

The IEA (an organization for oil consumers)

Answer 8

• Created in 1974 under OECD framework (= only developed country members)
• Goal: Reliable energy supply, avoid future oil shocks
• Measures:
  – Emergency stocks and collective oil emergency response
  – Promote energy efficiency and diversification
  – Research into energy markets and consulting
  – Promote Clean Energy Transition

Question 9

International climate negotiations

Answer 9

• 1992: Countries agree on UNFCCC
  – Conference of the parties (COP) held every 2 years
  – COP 28 held in UAE right now
• 1997: Kyoto Protocol
  – Set limits for developed countries to make cuts
  – US never ratifies, Canada pulls out
  – Emerging economies (China, India) grow rapidly but have no obligations under Kyoto

Question 10

The Paris Agreement

Answer 10

• More politically palatable (than Kyoto Protocol)
  – Everyone has to do “something”
  – Countries themselves decide how much: Nationally Determined Contributions (NDCs)
  – Designed to allow US president to circumvent Congress
  – (Some) Climate finance
• Core issues today
  – Stock-take: How have countries done so far?
  – Phasing out of fossil fuels
  – “Loss and damage” fund

Question 11

Domestic interests in climate action

Answer 11

Climate action requires that we restrict GHG-intensive activities through higher prices, bans, quota, in the long run, we all win from policies to mitigate climate change but in the short-medium run:
- Winners among producers
– Producers of green energy
– Producers of green transportation
- Losers among producers
– Fossil fuel producers
– Energy-intensive producers
– Producers that use energy-intensive inputs
– Petrol car producers
– Airlines
– Cattle farmers

Question 12

Domestic collective action problems of climate action

Answer 12

• The costs of effective climate action are acute and concentrated = easy for industry to organize and lobby
• The 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

Question 13

Two outcomes that can arise from collective action problems of climate action

Answer 13

• Climate action is stopped / watered down due to forceful lobbying
• The costs of climate action are born by consumers not businesses
  – eg. The German Energy Transition largely paid for by energy taxes on households, not businesses

Question 14

Energy poverty

Answer 14

• When the price of GHG-intensive products rises, not all households can
  – Pay to insulate their homes
  – Pay for an electric car
  – Install solar panels and heat pumps
• Problem: The poorest households spend the biggest share on energy

Question 15

3 common policy approaches to climate action

Answer 15

• Carbon taxes
• Emission trading
• Green industrial policy

Question 16

Carbon taxes

Answer 16

• Put a tax on carbon to “price in” the negative effect of climate change
• What do you do with the tax revenue?
  – Pay for energy transition
  – Pay for adaptation, loss, and damage of climate change
  – Use the money for something else
• Canada and Switzerland, rebates
  – Still creates incentives, because your behavior does not affect your rebate
  – 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 tax

Question 17

What is the world’s largest carbon market?

Answer 17

European Emissions Trading System (ETS)

Question 18

How can globalized trading lead to carbon leakage, what are some possible solutions?

Answer 18

• High price of carbon -> companies shift production to countries with lower carbon prices
  – Evidence of existence of carbon leakage is mixed: so far seems limited, but we don’t know what would happen at higher carbon prices
• 3 possible solutions to carbon leakage
  – Global prices on carbon (very, very hard to negotiate)
  – Tariffs on foreign goods at the border to “level the playing field”
  – Give free permits / tax breaks to companies that export / compete against energy-intensive imports

Question 19

The EU carbon border adjustment mechanism

Answer 19

• Initially, EU gave away free ETS permits to companies to level the playing field in import-competition and exports
• Problem: lots of free permits limits 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
  – Companies liked the idea of the CBAM and free permits
  – Companies did not like the idea of paying for permits when CBAM introduced
• This may incentivize countries that are dependent on EU market to also put a price on carbon

Question 20

Green industrial policy

Answer 20

• Some argue that green industries should be treated as “infant industries”
• Green transition requires large-scale investment in low-carbon technologies
• Changes to public and private infrastructure
  – 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 your green industries creates jobs
  – Green industrial policy fosters industries that will lobby in favor of climate action

Question 21

US inflation reduction act 2022 (climate action)

Answer 21

• Introduces tax incentives, grants, loan guarantees
• Tax credits (=subsidies) for companies investing in clean energy, transport and manufacturing
• Tax credits for consumers to make EVs, solar panels, heat pumps, etc. more accessible

Question 22

US inflation reduction act and WTO rules (climate action)

Answer 22

• Many of the tax breaks are only applicable to locally produced goods (or goods produced by trade partners)
  – eg. consumers get a tax break for EVs produced in US, but not in the EU
  – Breaks national treatment
• The EU might challenge the IRA at the WTO
• EU loosening “state aid” rules to provide its own green subsidies in race to become green leaders

Question 23

Definition of state capacity

Answer 23

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 citizens

Question 24

Limits of state capacity for climate action

Answer 24

• Green transitions require 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 response
• Many developing countries lack the state capacity to effectively implement a green transition

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, developing countries reaffirmed commitment to mobilize $100 billion per year until 2020

Question 26

Supply challenge (raw materials) for climate action

Answer 26

• 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, substitutions