Hans-Werner Sinn

Nationalökonomie & Finanzwissenschaft

Ifo Viewpoint

Ifo Viewpoint No. 106: The Green Paradox

Munich, 16 June 2009

The foremost goal of European environmental policy is to curb energy consumption. Governments are busily promoting alternative energy, improved building insulation and more efficient cars. These programs cost billions – and probably achieve the exact opposite of what the environmental policymakers intend: the global extraction of coal, gas and oil shoots up instead of sinking.

The explanation is simple: the fact that the green policies herald a gradual tightening of policy over the coming decades exerts a stronger downward pressure on future prices than on current ones, decreasing thus the rate of capital appreciation of the oil and gas fields. The owners of these fields regard this development with concern and react by increasing extraction volumes in order to stash their wealth in the security of a Swiss bank account, where higher yields beacon.

That is the green paradox: environmental policy slated to become greener over time acts as an announced expropriation that provokes owners to react by accelerating the rate of extraction of their fossil fuel stocks, thus accelerating climate change.

Environmental policy must at long last turn its attention from fossil fuel demand to its supply. Instead of mulling over for the thousandth time which technical fixes could be applied to reduce carbon dioxide emissions, we should turn to the core question of how to induce the resource owners to leave more carbon underground, as that is the sole practicable way to solve the climate problem.

It may sound trivial, but it is always ignored in public debate: other than the useful but limited afforestation efforts, there are only two ways to curb the accumulation of carbon dioxide in the atmosphere and, with it, slow down global warming. We must either temporarily refrain from extracting carbon from the ground, or stuff it back into the ground after harvesting its energy. All the technical and political initiatives to curb the greenhouse effect must subordinate themselves to this fundamental truth.

Bringing carbon dioxide back underground is easier said than done. One third of the primary energy in the original fuel is consumed by scrubbing CO2 from the exhaust and subsequently compressing it into a liquid. On top of that, the amount of storage volume required is gigantic, as each carbon atom is joined by two oxygen atoms upon combustion—and they all need to be stored. Thus, in the case of anthracite coal more than five times as much volume is required as the original coal occupied underground, while in the case of crude oil the proportion is more than three-fold.

According to estimates by the IPCC (Intergovernmental Panel on Climate Change), the Earth’s depleted coal mines and oil and gas deposits will offer room for barely one tenth of the CO2 that would be generated by all the recoverable carbon resources. For that reason, if we are to curb climate change, carbon extraction rates must be slowed down.

Those convinced that with the brave new technologies proudly displayed in many newspapers’ special sections we can avert climate change should specify how they would move resource owners to extract less fossil fuel. And that is precisely the sticking point. Politics so far exhibits not the slightest glimmer of thinking in this direction. From the Environmental Agency through the Greens to the relevant EU commission there is not a thing on the matter.

Even science itself overlooks the issue. Mathematical models that attempt to depict the long-term fossil fuel extraction path do not concern themselves with the climate. Climate-theoretical models, in turn, do not concern themselves with the extraction of such resources. Only now have scientists started to analyze both aspects jointly.

The politicians’ dogged silence regarding how we can slow down the rate of fossil fuel extraction smacks of shirking. Gesture politics go a long way towards soothing green-tinged souls (and firming up business for the environment industries), but whether they actually achieve anything appears to be of no interest.

And indeed nothing is being achieved that helps our climate. The massive efforts of the Europeans have not been able to reduce the aggregate emission of carbon dioxide. In fact, they have not even caused a tiny dip in the rising emissions curve.

The beneficiary of Europe’s policy is not the climate, but the rest of the world. As environmental policies exert increasing downward pressure on the world market price for fossil fuels, the resource owners feel compelled to extract their stocks faster than they would otherwise. This has been music in the ears of Americans, Chinese and all the other environmental sinners, who have profited from the resulting lower energy prices and raised their consumption by even more than Europeans have reduced theirs.

On the face of it, we could pin our hopes on a different effect: that the green policies will eventually push the price of fossil fuels in the world market below the extraction costs, making extraction unprofitable. This hope is baseless, however, because, like old Rembrandts, resource prices are not driven by cost but by scarcity, and they have always hovered far above the extraction costs.

That is even now the case, in the midst of the dramatic fall in prices triggered by the current economic crisis. With oil prices slightly above 60 dollars per barrel, extraction costs in the Arabian Gulf, including exploration, amount to around one to one-and-a-half dollars, and even the extraction of the Canadian tar sands costs, including exploration, no more than 15 dollars.

Fossil fuel prices will steadily increase over time as the resources become scarcer and extraction costs higher. Presumably, however, there will never come a point when extraction costs overtake product prices—or even come near them. An environmental policy based upon pushing prices below production costs would need a very big hammer indeed. Marginal measures as those currently in force are, and will be, plainly insufficient for that purpose. And this is fortunately so, as the argument for permanently sealing off part of the resources still in situ to the detriment of generations far in the future finds neither economic nor ethical justification.

To be effective, environmental policy has only two options: Either it makes it unattractive for resource owners to convert their fossil fuel wealth into financial investments, for instance by subjecting the corresponding interest income to a withholding tax, or it creates a seamless consumer cartel through the establishment of a global emissions trading system. The emissions trading system would effectively put a cap on worldwide fossil fuel consumption, thereby achieving the desired slowdown in extraction rates. Furthermore, part of the proceeds would be diverted from the resource owners’ pockets to the national treasuries of the countries selling emissions certificates. The pleasing would meet the useful.

Anything else is mere bragging.

Hans-Werner Sinn
Professor for Economics and Public Finance
President of the Ifo Institute

Published as "Kurzarbeit auf der Bohrinsel“, Handelsblatt, No. 101, 28 May 2009, p. 47, additionally printed in Financial Times, no. 37.090, 27 August 2009, p. 7.