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Policy Strategy Social Impact Economics Mar 2, 2011

Buy Coal?

Purchasing the dirty fossil fuel could help fight climate change

Based on the research of

Bård Harstad

Coal is the poster child of carbon-emitting fossil fuels, a distinction that is easy to understand for anyone who has seen a power plant belching black soot from its smokestacks. But Bård Harstad wants to clear the air about coal. He thinks the dirty-burning fuel could be key to combatting climate change.

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Harstad, an asso­ciate pro­fes­sor of man­age­r­i­al eco­nom­ics and deci­sion sci­ences at the Kel­logg School of Man­age­ment, has been cast­ing an economist’s eye on the suc­cess­es and short­com­ings of multi­na­tion­al cli­mate change treaties. Some of his pre­vi­ous work has sug­gest­ed that short-term cli­mate treaties were harm­ing efforts to curb glob­al car­bon emis­sions more than no treaties at all. Adding to his cat­a­log on cli­mate change leg­is­la­tion, Harstad now has anoth­er coun­ter­in­tu­itive pro­pos­al. Buy coal, he says. Lots of it.

The fatal flaw in most multi­na­tion­al cli­mate agree­ments lies in the role of non­par­tic­i­pat­ing coun­tries, Harstad notes. In the short his­to­ry of major cli­mate change ini­tia­tives, coun­tries that agree to help reduce car­bon emis­sions begin by tack­ling demand. Emis­sion caps, car­bon tax­es, and alter­na­tive forms of ener­gy are all pur­sued in an effort to low­er the amount of car­bon enter­ing our atmos­phere by mak­ing it finan­cial­ly appe­tiz­ing to decrease the amount of fuel we con­sume. The trou­ble is, Harstad says, those efforts soon become coun­ter­pro­duc­tive, thanks to the coun­tries that do not sign on.

If the coali­tion reduces its demand for fos­sil fuel, the world price declines and non­par­tic­i­pat­ing coun­tries find it opti­mal to pur­chase more oil or fos­sil fuels,” he explains.

Fix­ing the Leak
The Inter­na­tion­al Pan­el on Cli­mate Change has dubbed this phe­nom­e­non car­bon leak­age,” and it proves unavoid­able in attempts to address cli­mate issues from what econ­o­mists like Harstad call the demand” side of the prob­lem. Not only do fos­sil fuels get cheap­er, result­ing in increased con­sump­tion by non­par­tic­i­pat­ing coun­tries, but the pro­hib­i­tive reg­u­la­tions enact­ed to curb demand in coali­tion coun­tries can push indus­tries to more accom­mo­dat­ing nations where car­bon emis­sions are not regulated.

Up to now, most of the lit­er­a­ture and polit­i­cal strate­gies have focused on demand. And a lot of prob­lems arise if you focus on the demand side,” Harstad says. What I show [in my research] is that those prob­lems dis­ap­pear when you focus on the sup­ply side, includ­ing the sup­ply of oth­er countries.”

In Harstad’s sup­ply-side mod­el for a glob­al cli­mate treaty, coali­tion coun­tries would essen­tial­ly cre­ate a mar­ket for coal and oil deposits. To do this, they would first buy up the mar­gin­al sources of fos­sil fuels, i.e., deposits that are very cost­ly to exploit. Once they owned the rights to these coal mines or nat­ur­al gas deposits or oil fields, they would sim­ply decline to devel­op them. They could also sell or lease the rights to pro­duce fuel from them under the con­di­tion that any coun­try buy­ing the rights would be sub­ject to the para­me­ters of the treaty.

Even­tu­al­ly, non­par­tic­i­pat­ing coun­tries would have devel­oped all of their fos­sil fuel deposits and coali­tion coun­tries would own the rest of the mar­gin­al deposits. By reduc­ing the sup­ply of fos­sil fuels avail­able on the mar­ket, the coali­tion coun­tries could then ensure that non­par­tic­i­pat­ing coun­tries would not have the fos­sil fuel resources to dras­ti­cal­ly increase their own car­bon emissions.

By employ­ing sup­ply-side poli­cies only with­out lim­it­ing demand, the coali­tion would cre­ate a mar­ket in which the fos­sil fuel con­sump­tion price” would be equal­ized across all coun­tries. At this point the mar­ket would clear, Harstad says, as no two coun­tries could make trans­ac­tions of fos­sil fuels that would lend unqual­i­fied ben­e­fit to both. In oth­er words, some­one would have to pay. And in the absence of cheap, read­i­ly avail­able sources of fuel, car­bon leak­age would no longer derail glob­al car­bon emis­sion reduc­tion efforts.

Under these con­di­tions, the first-best out­come is reached and, regard­less of full par­tic­i­pa­tion or not, Harstad writes, the coali­tion imple­ments its ide­al pol­i­cy sim­ply by reduc­ing its sup­ply of fuel. There is no need to reg­u­late trade or con­sump­tion and there is thus no con­sump­tion leak­age. The fos­sil fuel price is equal­ized across coun­tries, which induces opti­mal invest­ments in technology.” 

The key is that, by lim­it­ing sup­ply, coali­tion coun­tries could in effect set the price at a point that would encour­age ener­gy con­ser­va­tion and make invest­ments in alter­na­tive fuels more alluring.“Whether the right to exploit fos­sil fuel deposits is for sale or rent,” he says, the out­come is efficient.”

Mon­ey Can’t Be Every­thing
This may seem at first like wish­ful think­ing at first. It makes no finan­cial sense to pay for some­thing only to ensure that it is not used. But to address glob­al warm­ing, the world needs to be moti­vat­ed by more than finan­cial con­sid­er­a­tions. And Harstad’s sup­ply-side log­ic is not as improb­a­ble as it might seem. In fact, both the Unit­ed Nations and the World Bank are already address­ing one facet of cli­mate change through the sup­ply-side par­a­digm. In this case, the mar­ket is the world’s trop­i­cal timber.

But to address glob­al warm­ing, the world needs to be moti­vat­ed by more than finan­cial considerations. 

In the past few decades, con­sumers and gov­ern­ments in devel­oped coun­tries have become aware of the rapid defor­esta­tion of some of the world’s most boun­ti­ful and bio­di­verse ecosys­tems. As envi­ron­men­tal aware­ness rose, the price for trop­i­cal tim­ber dropped, thanks to reduced demand caused by both con­sumer reluc­tance and gov­ern­ment-imposed boy­cotts. How­ev­er, oth­er coun­tries that had been unable to afford tim­ber then increased their con­sump­tion. This tim­ber leak­age” became a huge threat to efforts to save trop­i­cal rainforests.

Defor­esta­tion is a major cause of cli­mate change, accord­ing to the Unit­ed Nations. It esti­mates that trop­i­cal defor­esta­tion and the result­ing land use changes account for near­ly 20 per­cent of the world’s car­bon emis­sions. Much like fos­sil fuel deposits, demand-side approach­es to the prob­lem were not work­ing, so the UN devel­oped a pro­gram called Reduc­ing Emis­sions from Defor­esta­tion and for­est Degra­da­tion, or REDD

The plan, says the UN, is to cre­ate a finan­cial val­ue for the car­bon stored in forests.” What that trans­lates into is pay­ing devel­op­ing coun­tries to pre­serve their rain­forests, to leave a mar­ketable resource untouched. Cur­rent­ly, Nor­way, Den­mark, and Spain are financ­ing forests in south­ern hemi­sphere coun­tries like Bolivia, Viet­nam, and the Demo­c­ra­t­ic Repub­lic of the Congo.

Harstad believes a sim­i­lar mar­ket for car­bon deposits could be suc­cess­ful. As he points out, he is not try­ing to invent a whole new way of doing busi­ness. In real­i­ty, a mar­ket for exploit­ing fos­sil fuel deposits already exists, since coun­tries fre­quent­ly sell, auc­tion, license or out­source the right to extract their own oil and oth­er min­er­als to inter­na­tion­al com­pa­nies, as well as to major coun­tries like India and China.”

Admit­ted­ly, there are com­pli­ca­tions. For exam­ple, non­par­tic­i­pat­ing coun­tries might be inclined to search for new deposits of fuels to get around the pro­hib­i­tive costs of exist­ing sup­plies or to sell them to the cli­mate coali­tion, which intends to con­serve them. (The lat­ter moti­va­tion for explo­ration is con­sid­ered an eco­nom­ic inef­fi­cien­cy — the coun­tries would be search­ing for deposits for the wrong rea­son.) And some schol­ars point to the green para­dox,” which pre­dicts a short-term rise in car­bon emis­sions as coun­tries scram­ble to use it now if it will get hard­er to do so in the future,” Harstad says.

Besides, per­haps par­tic­i­pa­tion is no longer such a big prob­lem. In Decem­ber 2010, 194 coun­tries signed the Can­cun Agree­ment that came out of the UN’s 16th Con­fer­ence of the Par­ties of the Unit­ed Nations Frame­work Con­ven­tion on Cli­mate Change. In 1997 only 37 coun­tries signed the Kyoto Pro­to­col. Sure­ly con­cerns about non­par­tic­i­pa­tion should be alleviated.

But Harstad is quick to point out, the Can­cun Agree­ment is non­bind­ing and will rely essen­tial­ly on good­will and vol­un­tary coop­er­a­tion. And that brings it all back to par­tic­i­pa­tion. Undoubt­ed­ly, many coun­tries will not chip in” at the lev­el of oth­ers. There will also be hag­gling over specifics of cap and trade sys­tems or car­bon tax­es or what­ev­er demand-side approach the coali­tion takes to reduce car­bon emissions.

The beau­ty of Harstad’s sup­ply-side mod­el is that pos­i­tive out­comes could still be achieved even if the world’s lead­ers are not all on the same page. Coun­tries may be unwill­ing to sign on to multi­na­tion­al cli­mate agree­ments or drag their feet at tak­ing the steps need­ed to reduce their car­bon emis­sions, but when it comes to join­ing a mar­ket for the fos­sil fuels cur­rent­ly need­ed to pow­er our world, they can­not sim­ply sit on the sidelines.


Relat­ed read­ing on Kel­logg Insight

Tim­ing Is Every­thing: The dura­tion of cli­mate agree­ments influ­ences their success

And the Poor Get Poor­er: The eco­nom­ics of high­er glob­al temperatures

Featured Faculty

Bård Harstad

Faculty member in the Department of Managerial Economics & Decision Sciences until 2013

About the Writer

Adam Hinterthuer is a freelance science writer based in Madison, Wisconsin.

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