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USJI Voice Vol.21

Choosing Energy: Market mechanism required to stimulate innovation that will reduce abatement costs of climate change

February 06,2017
Nobuhiro Horii
Associate Professor, Kyushu University

In recent years, coal has been firmly established as a poor energy choice. In May 2016, the Smith School of Enterprise and the Environment, University of Oxford (UK), published a report highlighting a global tendency to strengthen environmental regulations that tackle climate change. Consequently, gas-fueled and renewable power sources are improving their competitiveness and are rendering coal power as “stranded assets”. The report warns as conclusion that investments in coal power, Japanese power companies plan to build newly will become unrecoverable bad debts.

The report indicates that the “stranded assets” of Japanese power companies will grow to $61.62 billion if coal-fueled power were to be forbidden in 15 years due to stricter regulations and investors need to be aware of this risk Japanese power companies are taking. Additionally, severe criticism of coal is evident in international aid policies in the past few years. European and U.S. aid agencies in particular, have avoided funding projects for construction of new coal-fueled power plants.

However, is the decision to not utilize coal and lock it away correct? Except for the U.S. domestic market, which has succeeded in the commercial production of shale gas, coal remains the cheapest fossil fuel. Technological measures against conventional air pollutants (SO2, NOx, and PMs) are already widespread, and the cost competitiveness of coal is strong enough to bear the cost of introducing these technologies. However, technology to cope with climate change is still in the development stage, and poses the largest barrier for coal use.

Energy Demand Outlook under the Paris Agreement

What impact will strengthening regulations to mitigate of climate change have on coal use? The World Energy Outlook 2016, prepared by the International Energy Agency (IEA), presents the New Policies Scenario that reflects the greenhouse gas reduction targets committed by countries through the Paris Agreement, called the “Intended Nationally Determined Contributions (INDC)”. According to the New Policies Scenario, energy consumption in 2040 would have increased by approximately 30% compared to the 2014, as 51% increase is foreseen in non-OECD developing countries although energy consumption is expected to decrease by 4% in OECD member countries. This will depend on their stages of economic development.

A study of different energy sources indicates that fossil fuels, which accounted for 81% in 2014, are expected to decline to 74% by 2040. Meanwhile, renewable energy sources, such as photovoltaic and wind power are expected to grow significantly from 13% in 2014 to 20% in 2040 as primary energy sources, and from 22% to 36% in power generation. In addition, gas consumption is expected to increase to 49%, the highest among fossil fuels.

However, coal consumption is also expected to increase by 5%. Despite a decline in power generation from 41% in 2014 to 28% in 2040, coal will continue to be the largest power source. Coal consumption is expected to decline in China, the world’s largest coal consumer, and the U.S., EU, Japan, and Korea, but is expected to grow substantially in India, other ASEAN countries, and Africa. The consumption of these countries will increase faster than the reduction in consumption of the current major coal-consuming countries. The important point is that the level of coal-utilization technology of these developing countries is low; implying that technology transfers from the current major coal-consuming countries will have significant influence as climate change countermeasures.

The New Policies Scenario points out that even if the countries participating in the Paris Agreement achieved their respective INDC, the world’s CO2 emissions in 2040 will increase by almost 20%. In order to achieve the goal of maintaining the rise in temperature in 2100 to less than two degrees Celsius above than pre-industrial levels, CO2 emissions have to be reduced further by half. Although the Paris Agreement is a landmark achievement, there is still a long way towards the ideal goal. The IEA also presented the 450 Scenario, which shows one of the paths towards the “less than two degrees Celsius rise” target. According to the 450 Scenario, power generation from renewable energy sources, such as wind and photovoltaic power, must increase by over 60% compared to the New Policies Scenario. Likewise, gas use must be reduced by 40% and coal use must be cut drastically by almost 80%.

Many Problems Urgently Require Priority Attention in Developing Countries

Should the world be making efforts to move towards the realization of the 450 Scenario at this point in time by further strengthening regulations? The author believes that this should not be done. The reasons are as follows.

A major reason for the acceptance of the Paris Agreement was that it did not adopt a top-down allotment of emission reductions by deciding an overall global target. Instead, it adopted a method whereby each country voluntarily established their respective targets and committed to efforts towards realizing their targets. The gap between the CO2 emissions predicted by the New Policy Scenario and 450 Scenario can be described as the gap between the real-world solutions that each country can accept, considering limitations posed by factors such as economic growth and investment capacity. There is significant concern regarding the excess favoritism towards renewable energy, as seen in the 450 Scenario, and limitations on the use of gas and coal, both of which will be promoted by political initiatives and not by market mechanism; and will cause the cost of climate change countermeasures to rise sharply.

In particular, in the case of coal, which has not been favored by policy, the power generation cost predictions for 2040 in the New Policy Scenario indicate that coal power will be higher-cost than gas and even wind and photovoltaic (mega solar) power in the U.S. and EU, as a result of strengthened regulations. However, in China, coal and other sources of energy will generally be at similar cost levels, and in India coal will continue to be the cheapest power source. Developing countries, which prioritize on economic growth, are understandably intent on saving the cost of energy as much as possible and spend the saved money on infrastructure, technology, and social security benefits.

Sub-Saharan Africa is a region with areas that require low cost and stable sources of energy. Presently, these areas are home to 620 million people, approximately half the population, who do not have access to electricity. It is forecasted that in 2040, Sub-Saharan Africa will continue to account for 75%.of the global population without any access to electricity.
Ironically, Sub-Saharan Africa possesses rich resources as it hosts 30% of the world’s proven reserves of oil and gas, but is unable to utilize produced oil and gas for its own use and exports most of it. This is because it does not have the economic ability to bear the cost of power generation if oil and gas are used domestically. As a result, excluding economically developed South Africa and some countries that possess resources for hydro power generation, there are very few large-scale power plants as they require large stable demand source from the industrial sector and several household users who can afford the tariff. By using coal, which is overwhelmingly cheap, the hurdle for electrification in Sub-Saharan Africa can be lowered and low electricity tariff generated by coal power itself can promote industrialization and economic development.

Although climate change issue on a global-scale is important, we must not forget other urgent problems that must be solved in developing countries. Furthermore, many of these problems can be resolved only if developing countries achieve economic growth. The Conference of Parties to the UN Framework Convention on Climate Change (COP) meets once a year and the media loves to report on it with much fanfare. However, many problems faced by developing countries receive little attention, as they are probably unexciting. The problems that should be tackled as a matter of high priority and the interests of the media and public often do not coincide.

Achieving the Ideal Efficiently through Innovation

The ideal objective projected by the 450 Scenario should be pursued to address the adverse effects of climate change. However, we should take advantage of the fact that several decades are available until the deadline of the goal. This period promises the possibility of new innovations and revolutionary countermeasures. It is important to build a system that promotes innovation broadly without excluding any options. To close the gap between the ideal and reality, it will be essential to increase efficiency by reducing the cost of countermeasures through innovation. Accordingly, the tendency to exclude coal as an energy choice, despite its high economic efficiency and availability of mature technology to address conventional air pollution, must be reconsidered. Innovation to lower coal’s high CO2 emissions can be expected to emerge from unanticipated sources. The limitation on coal use by policy will hinder such technological development.

Of course, this does not mean all efforts to abate climate change can be dismissed. The U.S. must not adopt the new Trump administration’s policy to cancel the Paris Agreement. Rather, the U.S. must also commit to realizing the target under the Paris Agreement, which can be achieved realistically by introducing feasible countermeasures, and therefore can be effective in promoting innovation.

As a specific measure, the carbon tax, for example, internalizes the environmental cost in the price, clarifies the real merits and demerits of coal use, and reflects the balance between low price and high environmental abatement cost. For companies, unpredictability should be horrible in determining the investment for innovation. Companies cannot invest in innovation when fear that coal use may be abruptly prohibited prevails, and their investments may become “stranded assets.” However, once the target for emissions reduction is identified and the cost is indicated in the form of a tax rate, companies can make decisions for investment based on the cost and benefit. The existing state of affairs is such that investment in innovation is being significantly impeded by the unreasonably high risks accompanying coal use, prompted by political reasons. For example, while $800 billion in subsidies have been invested in renewable energy over the past ten years, the investment in Carbon Capture and Storage (CCS) has been no more than $20 billion. This disparity should be corrected and equal footing must be given to aid for innovation.

Japan should move forward with cooperation to build coal-use systems that have low environmental impact, and share its currently developed advanced technology with new coal consuming countries. In addition, although renewable energy is being adopted in developed countries, base-load fossil fuel power continues to be necessary to a certain degree to provide a stable supply of electricity during the intermittency of renewable energy. Thus, it is important that Japan devotes effort to the development of the most advanced coal-use technology including CCS, and the adoption of such technology domestically.



The USJI Voice is a policy-related opinion paper produced by researchers at USJI-affiliated universities. The USJI Voice is written for experts in areas connected to U.S.-Japan relations. Please share with us your opinions and suggestions related to your areas of interest.

The USJI does not take specific political positions. All views and conclusions expressed in the USJI Voice are those of the authors in their private capacity and do not represent or reflect the views of the USJI as a whole.

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