Category: Economics for Business: Ch 22

A two-week international climate change summit opened in Cancún, Mexico, on 29 November. But will the talks make any progress in tackling global warming? Will mechanisms be put in place to ensure that the previously agreed ceiling of 2°C warming is met?

After the largely unsuccessfuly talks in Copenhagen a year ago, hopes are not high. But a likely rise in global temperatures of considerably more than 2°C could have disasterous global consequences. Indeed, new evidence suggests that even a ceiling of 2°C may be too high and that, as temperatures rise towards that level, domino effects will start that may become virtually unstoppable. As Andrew Sims in the Guardian article notes:

This is the problem. Once the planet warms to the point where environmental changes that further add to warming feed off each other, it becomes almost meaningless to specify just how much warmer the planet may get. You’ve toppled the first domino and it becomes virtually impossible to stop the following chain of events. Honestly, nobody really knows exactly where that will end, but they do know it will end very, very badly.

The following podcasts and articles look at the importance of reaching international agreement but the difficulties of doing so.

Podcasts and webcasts

Post-Copenhagen, a Cancun compromise? Reuters (30/11/10)
Climate change ‘Dragons’ Den’: What are the options? BBC News, Roger Harrabin (29/11/10)
Cancun climate change summit seeks new emissions deal BBC News, David Shukman (3/12/10)
Can nudge theory change our habits? BBC News, Claudia Hammond (29/11/10)

Articles

Cancún climate change conference 2010 Guardian, (portal)
Q&A: Cancún COP16 climate talks Guardian, Shiona Tregaskis (8/10/10)
72 months and counting … Guardian, Andrew Simms (1/12/10)
Cancún climate talks: In search of the holy grail of climate change policy Guardian, Michael Jacobs (29/11/10)
Cancún and the new economics of climate change Guardian, Kevin Gallagher and Frank Ackerman (30/11/10)
Facing the consequences The Economist (25/11/10)
UN climate talks low on expectation BBC News, Richard Black (29/11/10)
Expect little from Cancun talks The Star (Malaysia), Martin Khor (29/11/10)
Don’t let us down: UN climate change talks in Cancun Independent, Jonathan Owen and Matt Chorley (28/11/10)
Cancun and Climate: Government Won’t Act, But Business Will Time Magazine: The Curious Capitalist, Zachary Karabell (28/11/10)
At Global Climate Change Talks, an Answer Grows Right Outside Huffington Post, Luis Ubiñas (29/11/10)
Cancun climate change talks: ‘last chance’ in the snakepit The Telegraph, Geoffrey Lean (29/11/10)
Climate Change Talks Must Deliver After Record Weather Year Scoop (New Zealand), Oxfam (29/11/10)
World climate talks kick off in Cancun DW-World, Amanda Price and Axel Rowohlt (29/11/10)
On international equity weights and national decision making on climate change Vox, David Anthoff and Richard S J Tol (29/11/10)
Climate treaties all bluster, no bite The Age, Dan Cass (10/12/10)

Conference website

UNFCCC COP16/CMP6: Mexico 2010 Official site

Questions

  1. What would count as a ‘successful’ outcome of the climate change talks? Why might politicians interpret this differently from economists?
  2. What can governments do to internalise the externalities of greenhouse gas emissions?
  3. What insights can game theory provide into the difficulties of reaching binding climate change agreements?
  4. What are likely to be the most effective mechanisms for getting people to adapt their behaviour?
  5. Can nudge theory be used to change our habits towards the environment?
  6. Explain the use of equity weights in judging the effects of climate change. Are they a practical way forward in devising environmental policy?

You might think that small environmentally-friendly companies would be moving into the green energy market: that setting up a wind farm, for example, would be a perfect business opportunity for a small company. In fact, the big companies are taking over this market. As the Der Spiegel article below states:

Europe’s wind energy sector is currently experiencing a major transformation. New massive offshore wind parks are soon expected to crop up off Europe’s coastline. Big companies like Siemens and General Electrics are increasing their stakes in a market worth billions. But experts warn that a new energy oligopoly may soon emerge.

So what is it about the wind energy market that makes it suitable for an oligopoly to develop? The two articles explore this question.

Winds of Change Der Spiegel, Nils-Viktor Sorge (1/11/10)
GE and Siemens Outpacing Wind Pioneers, Becoming Clean Energy’s “New Oligopoly” Fast Company, David Zax (2/11/10)

Questions

  1. What market failures are there in the wind energy market?
  2. What barriers to entry are there in the wind energy market?
  3. What economies of scale are there in this market?
  4. How are changes in this market affecting the minimum efficient scale of companies?
  5. Would there be room in the market for enough competitors to prevent collusion?
  6. How might the authorities prevent (a) open and (b) tacit collusion in the wind energy market?
  7. Do small wind energy companies have any market advantages?

Governments and businesses across the world have been trying to become more environmentally friendly, as everyone becomes more concerned with climate change and emissions. In the UK, incentives had been put in place to encourage large-scale organisations to reduce their consumption of gas and electricity. The Carbon Reduction Commitment Scheme began in April 2010, with companies and public-sector orgainisations required to record their energy consumption. Then in April 2011 it was planned that those consuming over 6000 MWh of electricity per year (about £500,000 worth) would be required to purchase ‘allowances’ of £12 for each tonne of carbon dioxide that is emitted by their use of fuel: electricity, gas, coal and other fuels. This would require the organisations working out their ‘carbon footprint’, using guidance from the Department of Energy and Climate Change. In the case of coal and gas, the emissions would be largely from burning the fuel. In the case of electricity it would be largely from generating it.

The government had intended to use the revenue received from the sale of allowances to pay subsidies to those firms which were the most successful in cutting their emissions.

By raising money from the largest emitters via a levy and giving it back as a ‘refund’ to those who cut their usage the most, the government would not have been able to raise any revenue, but it did tackle the core of the problem – reducing emissions. However, following the Spending Review, this scheme will now actually generate revenue for the government. Paragraph 2.108 on page 62 of the Spending Review states the following:

The CRC Energy Efficiency scheme will be simplified to reduce the burden on businesses,
with the first allowance sales for 2011-12 emissions now taking place in 2012 rather than 2011. Revenues from allowance sales totalling £1 billion a year by 2014-15 will be used to support the public finances, including spending on the environment, rather than recycled to participants. Further decisions on allowance sales are a matter for the Budget process.

Over 5000 firms and other organisations will now find that their hard work in cutting usage and being more environmentally friendly will give them much less reward, as the revenue raised from the levy will remain in the Treasury. All that firms will now gain from cutting emissions is a reduction their levy bill. The extra £1bn or more raised each year from the scheme will undoubtedly be beneficial for tackling the budget deficit, but it will no longer provide subsidies to firms which reduce their emissions. Furthermore, PriceWaterhouseCooper estimates that it will cost businesses with an average gas and electricity bill of £1 million an extra £76,000 in the first year and this may increase to an additional cost of £114,000 per year by 2015.

It’s hardly surprising that businesses are angry, especially when this withdrawal of subsidy, which some have dubbed a ‘stealth tax’, was not mentioned in the Chancellor’s speech, but was left to the small print of the Spending Review announcement. The following articles look at this highly controversial plan.

Articles
Spending Review: Large firms ‘face green stealth tax’ BBC News (21/910/10)
Business lose out via £1bn-a-year green ‘stealth tax’ Management Today, Emma Haslett (21/10/10)
Fury over £1bn green stealth tax in spending review Telegraph, Rowena Mason (20/10/10)
Is ‘stealth’ tax a threat to UK economy going green? BBC News, Roger Harrabin (20/10/10)
Green spending review – it could have been a whole lot worse Business Green, James Murray (20/10/10)
Coalition hits big business with stealth carbon tax Business Green, James Murray (20/10/10)
UK government hits big businesses with stealth carbon tax Reuters, James Murray (20/10/10)
UK’s carbon tax bombshell takes business by surprise Reuters, Will Nichols and James Murray (21/10/10)
CRC allowances sting in UK Spending Review The Engineer, M&C Energy Group (22/10/10)

The CRC scheme
CRC Energy Efficiency Scheme Department of Energy and Climate Change

Questions

  1. How does a tax affect the supply curve and what would be the impact on the equilibrium price and quantity?
  2. To what extent might this “stealth tax” (i.e. withdrawal of subsidy) adversely affect (a) businesses in the UK; (b) the economy more generally?
  3. Why will firms have to re-look at their cash flow, costs and revenue following this change? How might this affect business strategy?
  4. By taxing firms using more gas and electricity, what problem is the government trying to solve? (Think about market failure.)

What is the future of the Royal Mail? One thing for certain is that it needs an injection of money, which has led the government to consider either privatisation of the Royal Mail or selling it. Over the past years, we have seen continued strikes by the postal service in response to proposed changes in working practices. Mr. Cable commented that:

‘Royal Mail is facing a combination of potentially lethal challenges – falling mail volumes, low investment, not enough efficiency and a dire pension position.’

However, there are concerns that the privatisation or sale of the Royal Mail could lead to higher prices, job losses and further pension problems. The transfer of the Royal Mail to the highest bidder could shift the pension deficit, currently standing at £13.3 billion, to the taxpayer, potentially costing each taxpayer £400. The choice for the public is stark: either lose the right to send a letter anywhere in the UK for the same price or take on postal workers’ pensions.

Expecting massive opposition from the Communication Workers Union (CWU), Ministers are looking to pursue an arrangement similar to that of John Lewis, whereby staff are given shares in the company. This will give the staff an incentive to perform well to improve the performance of the company and hence increase their future dividend. Read the following articles and then try answering the questions that follow.

Royal Mail is to be privatised, government confirms BBC News (10/9/10)
Royal Mail sell-off is confirmed BBC News, Hugh Pym (10/9/10)
Royal Mail privatisation backed Press Association (10/7/10)
Royal Mail sale could cost £400 per home as taxpayers set to fund £13.3 billion pension deficit Mail Online, James Chapman (10/9/10)
Royal Mail pension plan challenged by regulator BBC News, Ian Pollock (30/7/10)
Ministers consider offering 20 per cent of shares in Royal Mail to staff Telegraph, Christopher Hope (10/9/10)
Cable to privatise ‘inefficient’ Royal Mail Independent, Cahal Milmo and Alistair Dawber (11/9/10)
Royal Mail revolution needed, say bankers Telegraph, Louise Armitstead (10/9/10)

Questions

  1. What are the problems that the Royal Mail is facing? Why have they occurred?
  2. What are the arguments for and against privatisation of the Royal Mail?
  3. How might privatisation lead to job losses and higher prices?
  4. What type of business arrangement does John Lewis have? Explain why this may improve overall performance of the company?
  5. If the pension deficit is passed on to the government, why will it cost the taxpayer? Is such an arrangement (a) efficient (b) equitable? Explain your answer.

$8 billion – this is the likely cost of the BP oil leak, which spilled 206 million gallons of oil into the Gulf of Mexico. Whilst the oil leak has been stopped for some time, there were ongoing concerns that the leak would re-appear due to the underwater pressure. The cost of stopping the leak has been substantial, but BP will face further costs, as the company begins to pay out compensation.

$20 billion is the compensation that residents of the Gulf of Mexico will receive. Further to this, BP has said that it will invest more money in promoting the tourism industry there, which has suffered from the oil spill. However, what about the fishing industry? Although compensation will be paid for the losses incurred, will this continue in the long term? The oil may cause a loss in productivity in certain populations of sea-life. How will this impact us? If certain fish became scarcer, then their price will rise accordingly, whether you purchase the fish at a shop or have it as a meal in a restaurant. To make matters worse, the hurricane season has arrived in the affected areas, which will make the clean-up effort even harder.

As BP’s share price has fallen, individuals have suffered from lower dividends. Jupiter Income Trust had almost 10% of their portfolio invested in BP, which largely explains the 9 per cent drop in their payout.

Articles

BP oil well ‘poses no further risk’, says Allen BBC News (5/9/10)
BP oil spill fallout hits Jupiter dividend Mail Online, Richard Dyson (4/9/10)
Gulf Oil leak: biggest ever, but how bad? BBC News, Richard Black (3/8/10)
BP oil spill didn’t hit tourism too hard Jabber Lounge, Gloria Rand (5/9/10)
BP oil victims face strings on $20 billion oil fund Telegraph, Rowena Mason (20/8/10)

BP share price data
BP historical share prices Yahoo Finance
BP share price chart Interactive Investor

Questions

  1. Which industries have been affected by the oil leak? Don’t think too close to home – look at the wider picture.
  2. Is the oil spill an example of a negative externality? Can it be illustrated on a diagram and, if so, how?
  3. What has happened to BP’s share price since the beginning of the oil spill? Put this on to a graph to trace the trend. Try to explain the changes in the share price using a demand and supply diagram.
  4. How would BP have calculated the compensation to be paid to residents of the Gulf of Mexico? Would cost–benefit analysis have been involved?