11th Oct 2019 | 23:28
INEVITABLE POLICY RESPONSE: SYSTEM MODELS AND METRICS
In my previous article (link: forecasting the next steps in the climate crisis) I examined the differences between the policy forecasts and approaches delivered by the International Energy Agency and the Inevitable Policy Response (IPR). It was the latter of which where I briefly touched upon the modelling which the IPR covers in its framework, namely the energy and land-use models within the economic system. This article analyses the elements through which the IPR designs its three economic system models (macro, energy and land-use systems), before outlining the benefits and limitations that the methods and results produce. Certain parts of this analysis will lead to the value stream models and asset level financial implications. The diagram underneath should create a clear visual representation of how the systems and models are constructed.
Firstly, all three systems factor in production activity, emissions and abatement costs (the ‘cost borne
by firms when they are required to remove and/or reduce undesirable nuisances or negative byproducts
created during production'1 – this is generally measured against the decrease in emissions).
This in itself leads to a more applicable analysis for firms since they have greater clarity as to how their
costs change according to their fall in emissions, to examine the trade-off between reduced emissions
and profit margins. One extension that I ought to suggest to this measurement, is that in addition to
quantifying the costs of transition (the abatement costs), an element of quantifying the benefits of
the short and long term would encourage firms to view the positives from switching and establish
more of a growth mindset. Firms would challenge themselves to a greater extent if they were seeking
to enhance the benefits and positive externalities of their activities, rather than if they just sought to
negate the costs. Reviewing the rise in revenues before taking costs into account enables firms to
factor in any ‘Just Transition concerns, such as food price rises and small producer rights'2, as opposed
to adding all the costs first and feeling a burden grow on maintaining profit margins.
Expanding on this further, one of the main costs that the IPR economic system emphasises in its system is carbon prices, and subsequently carbon price competitiveness. This can best be described as ‘a cost applied to carbon pollution to encourage polluters to reduce the amount of greenhouse gases they emit into the atmosphere’3. Both a tax and a quota (cap-and-trade) approach can be taken to accomplish this. Carbon pricing is a major initiative taken by countries around the globe to reduce emissions, particularly from a business and investment perspective thanks to its flexibility. The IPR has taken an intelligent decision to include carbon pricing its measurements across not only the different models but also across the three systems, as the growing use of carbon pricing jurisdiction is taking asset values and market shares by quite the storm. However, if the IPR is to take current and forecast trends in carbon pricing into account, then it ought to also consider the ineffectiveness that the policy has caused in certain sectors and scenarios. The difficulty in determining a price or quantity towards which firms have to comply means that some industries take action whilst others do not feel a large enough burden to curb their emissions. On occasions, implementation of pricing has been reactionary to external pressures rather than proactive and forceful in driving concrete change. As alternative policies such as ‘feed-in tariffs and technology quotas’4 grow in popularity, the IPR models will need to be updated and refined on a consistent basis. This will ensure it continues to provide a framework that continues to look forward but stays on track with policy and technology developments that drive firms to climate targets. After all, these are the promises and values that the IPR pride themselves on.
Having discussed aspects of the first two system models, this leads us to the final one, which reflects the financial implications of climate policies on investor and business assets. The main issue that has to be taken into account within this system is the volatility of the prices that impact asset values. Large fluctuations in oil prices, numerous other commodities and market capitalisation (from time to time) can distort the level of risk and return for investors, depending on the magnitude of the fluctuations. However, it is imperative the IPR introduces a wide variety of relevant and interlinked asset classes to examine, from equities to debt, and infrastructure to commodities. The comprehensive nature of the IPR, provided it is balanced out with future changes and trends in policies and technology, will solidify its intended status as the reliable policy forecast that corporations, regulators and investors can rely upon for guidance and progression.
An in-depth and well-documented topic, carbon pricing could only be discussed in so much detail in this article. An entire piece dedicated to the reasoning and rationale behind the strategy, alongside the results it has displayed, would provide a vivid overview for readers as to why carbon pricing is dubbed as ‘the single most effective way for countries to reduce their emissions’5. An upcoming article will critique this statement using evidence and logical economic reasoning.
1Kenton, W. (2018) Abatement Cost, Available at: https://www.investopedia.com/terms/a/abatementcost.asp (Accessed: 8th October 2019).
2UNPRI (2019) The Inevitable Policy Response Preparing financial markets for climate-related policy/regulatory risks , Available at: https://www.unpri.org/download?ac=7084 (Accessed: 8th October 2019).
3LSE Grantham Research Institute on Climate Change and the Environment (2018) What is a carbon price and why do we need one?, Available at: http://www.lse.ac.uk/GranthamInstitute/faqs/what-isa- carbon-price-and-why-do-we-need-one/ (Accessed: 8th October 2019).
4Patt, A. (2019) An alternative to carbon taxes, Available at: https://phys.org/news/2019-01- alternative-carbon-taxes.html (Accessed: 8th October 2019).
5LSE Grantham Research Institute on Climate Change and the Environment (2018) What is a carbon price and why do we need one?, Available at: http://www.lse.ac.uk/GranthamInstitute/faqs/what-isa- carbon-price-and-why-do-we-need-one/ (Accessed: 8th October 2019).
Problems cannot be solved at the same level of thinking at which they are created. I seek to publish content that dives into environmental, social and governance problems, and provide an insight into them through a unique lens and a deeper level, highlighting common misconceptions and assumptions.