Announcing CO2-pricing triggers divestment

Researchers have shown that there will be an opposite reaction between investors and fossil fuel owners as and when the Paris climate agreement is put into practice.

Scientists have believed that the anticipation of strong CO2 reduction policies might – a ‘green paradox’ – drive up these emissions: before the regulations kick in, fossil fuel owners might accelerate their resource extraction to maximize profits. Yet at the same time, investors might stop putting their money into coal power plants as they can expect their assets to become stranded.

A new study has investigated both effects that to date have been discussed only separately. On balance, divestment beats the green paradox if substantial carbon pricing is credibly announced, a team of energy economists finds. Consequently, overall CO2 emissions would be effectively reduced.

“Strong future climate policies can reduce emissions even before they come into effect if they are credibly announced,” says lead-author Nico Bauer from the Potsdam Institute for Climate Impact Research (PIK).

While the Paris agreement is weak in short-term policy ambition, with close to 200 countries committing themselves to limit temperature increase to well below 2 degrees Celsius compared to pre-industrial levels, it will require strong climate policies in the future to reduce emissions over the longer term.

Computer simulations of energy markets’ future dynamics are commonly used to investigate the economic effects of policies.

“We ran our simulations with a variety of CO2 pricing levels, steadily reaching between 25 and 300 US-Dollars per ton CO2 by 2050, with a medium scenario reaching 100 US-Dollars. These taxes were introduced with a number of different delays to represent various degrees of climate policy stringency and credibility and see how fossil fuel markets react in anticipation of such climate policies,” says co-author Jérôme Hilaire from PIK and the Mercator Research Institute on Global Commons and Climate Change (MCC).

If different CO2 pricing regulations at different price levels were to be introduced in different countries, the authors find that while some emissions-intensive production facilities move from places of high regulation to those with low standards, this effect is limited.