Pearls and Irritations

Leading up to this month’s major climate change conference in Paris, there has been a welcome increase worldwide in the commitment to address climate change generally and, in particular, to restrict global warming to two degrees Celsius. Although they are still insufficient to meet the two degree target, the initial national commitments to be taken to the conference are, perhaps, more ambitious than might have been expected a couple of years ago.

One of the side effects of this increased ambition has been a growing focus on the role of coal in increasing carbon emissions. In particular, there has been a developing sentiment in favour of banning investment in new and expanded coalmines in Australia. The “keep it in the ground” campaign started mainly as a green activist movement, although supported by respected media outlets such as The Guardian. Yet the campaign appeared to be more ideological and emotional than one that would attract the support of rational policy analysts. More recently, however, the campaign has been endorsed in an open letter to world leaders by 60 eminent Australians, including two highly regarded economists, Bernie Fraser, a former Secretary of the Treasury and Governor of the Reserve Bank, and Professor John Quiggin of the University of Queensland.

In this article, I address the following issues:

• The main findings of the recently published World Energy Outlook by the International Energy Agency (IEA), including the projected use of coal in generating electricity out to 2040 and how this would change if the world was on a two degree pathway
• In this context, whether prohibiting new coal mines would be an efficient or effective means of reducing carbon emissions globally so as to meet climate change objectives.

IEA’s World Energy Outlook, 2015[1] 

In its latest projection of global energy use, the IEA has reduced its previous estimates of the role that coal is likely to play in future electricity generation.[2] Its main scenario is based on an assumption that the world will take action along the lines of the national commitments for the Paris summit. It has been suggested that this would put the world on a pathway to stabilising the global temperature increase at around 2.7 degrees Celsius. While this outcome would fail to meet the two-degree target by a significant margin, this outcome remains perhaps the most reasonable assumption at this stage.

In analysing pathways to meeting emissions targets, it needs to be appreciated at the outset that we are not dealing with a slow growing market. The IEA estimates that global demand for electricity will increase by 70 per cent between 2013 and 2040.

The IEA’s main scenario takes account of the Paris commitments to counter climate change. While negotiations at the summit may produce a slightly more ambitious result in terms of pledges, on the other side of the coin it is likely that over time some countries will fall short of meeting their commitments. On that basis, it seems likely that this scenario is based on assumptions that are realistic and may be closest to the eventual outcome.

Under this scenario, fossil fuels would still supply over half of the world’s electricity in 2040, with the main fuel type shares being:

• Coal – 30%
• Gas – 23%
• Nuclear – 12%
• Hydro – 16%
• Wind and Solar PV – <10%

While coal’s global share of the power generation market would fall substantially under this scenario from 41 per cent in 2013, its use in absolute terms would increase by nearly 25 per cent in a much larger market. ‘Conventional’ fuels capable of providing continuous power (coal, gas, nuclear and hydro) would account for over 80 per cent of supply. Under this scenario, the two technologies much favoured by some green groups, wind and solar PV, together would account for less than ten per cent of global power supply in 2040.

The IEA also produced a more optimistic scenario of fuel shares in electricity generation in 2040 should the world follow a pathway consistent with achieving the two-degree target. This would result in the following fuel shares in power generation in 2040:

• Coal – 12%
• Gas – 16%
• Nuclear – 18%
• Hydro – 20%
• Wind and Solar PV – >30%

Depending on which scenario you believe, therefore, coal is still likely to play a considerab;e role in power generation in 2040. Much of the coal combustion is projected to occur in Asia, particularly in India. Of course, much depends on technological changes and their relative costs, which are extremely difficult to predict. If there were a breakthrough in the commercial applicability of carbon capture and storage (CCS), for example, coal could claim a much greater share of future carbon budgets. The same argument applies to renewables, where the development of practical long-term storage solutions is perhaps potentially greater than a CCS breakthrough. Also, the potential of small modular nuclear reactors appears promising, with considerable development work occurring in both the US and China.

An important conclusion from the IEA’s analysis is that even under the optimistic outcome of the nations of the world agreeing to take actions to limit global warming to two degrees, coal could still play a significant role in power generation in 2040. If the outcome falls short of this, as seems likely, coal’s future role will be commensurately greater.

Would banning new coal mines provide an efficient policy approach?

The proposal to ban investment in new and expanded coalmines signifies that substantial public costs, or negative externalities, are associated with the use of coal. There is little doubt that the combustion of coal to produce electricity has made the greatest contribution to increasing carbon concentrations in the atmosphere. Therefore, the most prominent miscreant in bringing about climate change is clear and, except for a few deniers and “sceptics”, overwhelmingly accepted by policy makers globally. Unless the resulting emissions can be captured and stored, there is a substantial negative externality associated with the combustion of coal.

In light of this clear conclusion, the question addressed in this section is how the issue should be addressed in policy terms so as to bring about the most efficient outcome. One widely canvassed approach in recent times is to ban investment in new coalmines and in expansions of existing mines.

Fundamentally, this is a resource allocation issue and is, therefore, more a question for economists than scientists or engineers. Most economists would agree that the most efficient way to deal with negative externalities is to impose a tax on the externality and then allow the market to determine the optimal allocation of resources. For example, if coal-fired power generation threatens the environment in terms of climate change, the most efficient way to deal with this is to tax the resulting emissions of carbon dioxide. Applied over all forms of power generation by means of a carbon tax or an equivalent emissions trading system (ETS), this application of a cost on carbon would help to ensure that carbon emissions from power generation were reduced by means of a strong market signal to investors in the electricity generation market. A carbon tax or ETS would provide a disincentive to invest in coal and other fossil fuel power generation plant and an incentive to invest in low or zero emissions technologies.

Banning new coalmines would reflect an arbitrary approach to reducing emissions. On what basis should various fuels be permitted or banned? Why is coal to be singled out but other fuels with significant emissions such as oil and gas are not? There is also a problem in that many of the interest groups that want to prohibit coal mining would also like to ban other fuels as well. Not only are some environmentalists ideologically opposed to all fossil fuels, including gas, but they also object to competitive zero emissions power generation technologies such as nuclear power and hydro-electricity. Banning coalmines may well be the thin end of the wedge. Some groups would also like to ban uranium mining and the construction of new dams. Then, of course, on the right of the political spectrum, there are groups who are vigorously opposed to wind farms on the grounds of their visual pollution. Once the size of the physical footprint of solar thermal generation is understood and the massive land resource required, some groups would probably be opposed to that technology as well. What would we then be left with?

Restricting the supply of coal by banning new mines would be contradictory to the more efficient approach to climate change of taxing carbon emissions and thereby allowing the market to determine what technologies are adopted to generate electricity. It would give a clear advantage to existing mines, which may be near the end of their economic lives and are often less efficient than new mines. It would also benefit other fossil fuels with a significant carbon footprint, such as oil and gas. The strong market signal arising from the ban would also inhibit, perhaps totally, any incentive to work on more greenhouse friendly ways to utilise the earth’s vast reserves of coal through technologies such as CCS.

Were it to be widely adopted, such a policy would also eventually raise the price of coal in developing countries, such as India, where a large proportion of the nation’s population is struggling to emerge from poverty and where currently there are very many households that have no electricity supply. In my view, it ill behoves people in countries like Australia, where their high standards of living have been built, in part, on the foundation of a secure, relatively cheap, coal-based electricity supply, to attempt to force people striving to emerge from poverty in other countries to renounce coal and pay much more for an interrupted electricity supply via renewables. For this reason, among others, nations need to think long and hard before denying natural resources to other countries that may not be so fortunate in terms of their resource endowments.

Would banning new coal mines provide an effective policy approach?

Abstracting from efficiency considerations, if the Australian government prohibited the development of new coal mines, would this be an effective approach to reducing the global use of coal for power generation?

It is difficult to see how this could be an effective policy in the absence of an agreement between all of the major coal-producing countries to restrict supply. Such an agreement would be very unlikely. There are abundant resources of coal worldwide and, hence, many alternative sources of supply to Australian mines. As may be seen from the tables below, many of the countries with abundant coal reserves are less wealthy than Australia and are most unlikely to agree to prohibit investment in their coal industries.

While the Australian coal industry is a very efficient producer, it does not dominate the global market and could not be said to possess any significant market power. Data produced by the US Energy Information Administration, for example, suggest that while Australia’s coal endowments are extensive, they amount to less than nine per cent of global reserves.[3] In 2013, Australia ranked fifth in overall coal production (metallurgical and thermal coal), accounting for less than six per cent of the global total.[4]

Exhibit 1: Major Thermal Coal Producing Countries (2013)

Source: World Coal Association, ‘Coal Statistics’, < http://www.worldcoal.org/resources/coal-statistics/>

In terms of the world’s largest producers of thermal (steaming) coal used for power generation, however, Australia is not ranked in the top five (Exhibit 1). In 2013, China’s production of thermal coal was over 12 times as great as Australia’s. The production of thermal coal in the USA and India was also far higher than in Australia, while Indonesia’s thermal coal production was over twice as great. Importantly, India now has a policy objective of being self-sufficient in coal by the early 2020s. This will require massive new investment in coal production.

Until recently, Australia was ranked first in terms of coal exports. Of Australia’s total coal exports of 336 Mt in 2013, 182 Mt were thermal coal. But in recent years, Indonesia has recorded a very rapid growth in exports (overwhelmingly in thermal coal) and has overtaken Australia. Coal exports from Indonesia more than doubled between 2008 and 2013, compared with a 33 per cent increase from Australia (Exhibit 2).

Exhibit 2: Major Coal Exporting Countries by Volume

Source: World Coal Association, ‘Coal Statistics’, < http://www.worldcoal.org/resources/coal-statistics/>

Both Indonesia and Mongolia have the capacity to increase their exports substantially. Russia, South Africa and Kazakhstan are also potential rivals. In none of these countries, as far as I am aware, is there any significant questioning of the legitimacy or acceptability of the coal industry or any support for prohibiting new investment in the industry. Indeed, investment in these industries is generally keenly sought. Also, these countries generally have less rigorous approvals processes for new projects, less of an emphasis on environmental protection and lower labour costs than Australia.

In terms of effectiveness, therefore, the question is what environmental benefit would accrue from banning new coal mines in Australia and what would be the costs? It is difficult to see any possible benefits in terms of reducing global emissions, because, as the Prime Minister has pointed out, the investment in new coalmines displaced from Australia would merely take place in other countries. As demonstrated above, Australia lacks any monopoly or even oligopoly power in this market. If Australia took a position based on ideology and emotion, it would be very unlikely to have any impact on the demand for coal globally, but at the same time would provide an opportunity for other countries to step in and capture some of the market previously supplied by Australia. It would be a classic case of carbon leakage, where, in return for no tangible benefit, Australian investment and jobs migrated to other countries. People who depended for their livelihoods on the coal industry would be sacrificed without any offsetting tangible benefit in terms of climate change.

Conclusions

It appears that the governments of the world are likely to step up to the plate and commit to taking substantial action to counter climate change at the Paris summit commencing at the end of November 2015. This is most welcome. Under most plausible scenarios of emissions reductions, however, the forecasts by the IEA suggest that the combustion of coal will continue to generate a significant proportion of the world’s electricity supply until at least 2040.

Proposals to ban investment in new coalmines or expansions, either unilaterally or globally, would be neither an efficient or effective approach to addressing climate change.

First, it would not be an efficient approach because it would be arbitrary and selective and would fly in the face of the more efficient policy of taxing the negative externalities produced by burning coal and other fossil fuels more generally. It would, therefore, provide disproportionately favourable treatment to other fossil fuels such as oil and natural gas. In addition, it would provide a boost to other low emissions base load technologies such as nuclear and hydro, which may also be in the black books of some of the groups that want to ban coal.

Secondly, it would not be an effective approach. Australia has less than 10 per cent of the world’s coal reserves and is not in the top five countries that export thermal coal. Other countries would be happy to step in to fill the gap in coal exports left by Australia. This would be a classic case of carbon leakage. Investment and jobs would be exported from Australia with no tangible benefit in terms of climate change.

There are equity issues here as well, both in terms of people in other countries currently living in poverty who seek access to the cheapest electricity and also those Australians whose livelihoods depend on the coal industry. The people who advocate banning new coal mines would generally not suffer any tangible adverse consequences if their proposal were adopted.

Finally, in the absence of commercial clean technologies such as CCS, those who believe that substantial action needs to be taken to counter climate change will accept and even welcome the longer-term decline of the coal industry. Global action to counter climate change suggests that coal is a declining asset that, in the medium to long term, may well become stranded. Yet the dismal scientist in us also recognises that Australia’s endowments of coal represent a significant asset on our national balance sheet. The industry has given rise to well remunerated employment opportunities as well as very substantial royalty income to the benefit of the Australian community as a whole. In a declining market for coal, therefore, rather than banning new investment in the industry, the rational approach for Australia would be to seek to ensure that as much as possible of the declining future demand for coal is supplied from Australian mines. This is not inconsistent with a policy stance that encompasses strong action to address climate change and achieve the two degree target.

Jon Stanford is a Director of Insight Economics and previously worked in a senior role in the Department of the Prime Minister and Cabinet. He has acted as an expert witness in a number of court cases involving proposals to develop new coal mines.

[1] In reporting this summary of the recent IEA report, I am much indebted to Keith Orchison’s analysis in his This is Power blog and his articles in the Business Spectator.

[2] International Energy Agency, World Energy Outlook 2015, http://www.iea.org/publications/freepublications/publication/WEB_WorldEnergyOutlook2015ExecutiveSummaryEnglishFinal.pdf

[3] US Energy Information Administration, ‘International Energy Statistics’, <http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=1&pid=7&aid=6>

[4] World Coal Association, http://www.worldcoal.org/resources/coal-statistics/

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