Inaction vs. Action: The Cost of Choosing “Cheap”

Quite a number of articles I have written on this blog discussed the portfolio theory, which essentially debunks the myth that choosing traditional forms of energy are more economical.  As I have been saying, our penchant for choosing the energy source based on current market prices or what we term as the least cost method for energy planning, may, in fact, be more costly in the long run.

However, what I have written focused on the cost of building the power plants and energy generation. There is one aspect that makes traditional sources of energy more costly for everyone: the impact on the environment.

Perhaps, it is still unclear to many what the relationship between climate change and the use or non-use of traditional sources of energy. To put things in better perspective, we should illustrate why we must choose renewable energy with the following numbers:

According to the report ‘Energy Darwinism: Why a Low Carbon Future Doesn’t Have to Cost the Earth’, published by Citi, the power sector contributes roughly two-thirds of the total greenhouse gas emissions. On the other hand, other sectors such as land use, agriculture, and forestry, as well as other industrial processes combined only contribute a third of the overall greenhouse gas emissions.

To make matters worse, 90 percent of the greenhouse emissions of the energy sector are carbon dioxide emissions or CO2 since most greenhouse emissions are C02.  However, 65 percent of CO2 emissions from the sector are from fossil fuels and other industrial processes.

Given the above figures, surely, we can no longer say that the fossil fuel powered plants are the cheaper options.

Fortunately, the report of the third largest bank in the US also includes an analysis of the cost implications of continuing with the world’s current heavy reliance on fossil fuel versus the cost of changing the energy mix to include more renewable energy.

What Citi did in its report is to analyze two scenarios: the cost of inaction and action. Under the inaction scenario, the world will continue its energy consumption patterns that are heavily reliant on fossil fuels. Under this assumption, there would be a slight pick-up in renewable energy investment, but the penetration rate of RE will stay at 6% by 2040 and fossil fuels will compose of two-thirds of the power mix. This scenario also assumes zero investments in energy efficiency, which will result in a compound annual growth rate (CAGR) of 2.4% of electricity generation from 2015 to 2040.

On the other hand, the Action scenario assumes that the energy mix favors renewable energy as solar and wind will contribute 22% of the energy mix while fossil fuels are reduced to 28%. The penetration rate of RE also increases to 34% from a mere 6% in 2012.

Is there a difference in costs of the Action and Inaction scenarios? The report says yes, one scenario costs more than the other. Contrary to popular belief, though, the cost of taking the Action scenario is cheaper than the Inaction scenario: the business as usual energy mix is at $192 trillion while the low carbon option will only cost $190.2 trillion from 2015 to 2040.  Citi notes that the falling costs of renewable energy coupled with less dependence on fuel usage account for the cheaper costs of the Action scenario. The report stressed that “Yes, we have to invest more in the early years, but we potentially save later, not to mention the liabilities of climate change that we potentially avoid.”

 

action-vs-inaction

Cost of Action vs Inaction. Source: Citi Research

What would it cost the world if we choose the Inaction route?

 

A report written by Lord Stern with the title “The Economics of Climate Change” in 2006 warned us of the possible overall costs of failing to act on the risks of climate change. The report, widely known as the Stern Review, concluded that losses from effects of climate change would be five percent of the world’s gross domestic product (GDP) per year between ‘now and forever.’ It could even be as high as 11% when we include other effects on the environment and health, which, unfortunately, are hard to quantify.

There are also other research papers that tackled the potential losses in GDP due to damages from climate change. The Citi research noted that a temperature increase of 2.5°C could result in loss of 0.9 to 2.5 % of the world’s GDP.  A loss of 0.7% to 2.5 % of the GDP is roughly % $44 trillion, the report said.

Aside from losses because of climate change, there are also losses in GDP due to heavy reliance on traditional sources of energy.  In a study, Professor Shimon Awerbuch noted that the oil price spikes in the years 2000 to 2004 cost the European Union €700 billion. The prominent advocate of portfolio theory in energy planning further noted that the world would avoid losses of $95 to $176 billion for at least an addition of 10 percent renewable energy in the mix.

The findings of these reports may vary in their calculations, but it is clear that it’s time to do away with thinking only of short-term prices in energy planning. What we should do is plan our energy needs with the future in mind since our penchant for looking at the current and short term costs are and will cost us more. And unfortunately, the costs are not purely monetary

We favored what we thought was cheap. Sadly, what we thought would save us money is making us pay more. The Citi report summed the situation best “A simple reason why atmospheric concentrations of greenhouse gases has grown is that they have been put there as a result of our using historically the cheapest, easiest, or most readily available solutions to a requirement, such as energy. To look at it another way, adopting a lower carbon path is (at least superficially) more expensive, otherwise all things being equal we would logically have gone for a cleaner option.”

References:

Energy Darwinism: Why a Low Carbon Future Doesn’t Have to Cost the Earth by Citi

The Role of Renewables in Enhancing Energy Diversity and Security: Portfolio Approaches by Shimon Awerbuch

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