The Economics of Coal Phaseouts Sugandha Srivastav and Michael Zaehringer 22 Sept 2023 INET Oxford Working Paper No. 2023-17 The Economics of Coal Phaseouts By Sugandha Srivastav* and Michael Zaehringer * sugandha.srivastav@smithschool.ox.ac.uk Abstract Fossil fuels are the world’s greatest source of greenhouse gas emissions and must be curtailed to achieve temperature targets. Technology-specific mitigation policies such as coal phaseouts may be required for reasons including limited success with carbon pricing, administrative ease, high salience, and ability to tackle a range of environmental and social externalities. Coal investors and communities that rely on mining may resist policies that increase costs such as direct taxation. Instead, compensation for early closure may be a more politically feasible route, especially given concerns around achieving a just transition. Compensation decided via a negotiated approach suffers from asymmetric information. Competitive auctions can help discover efficient compensation payments and order of closure. However, successful auctions require considering: 1. additionality and interaction with existing climate policies, 2. dynamic incentives, and 3. system-wide effects and security of supply. In the absence of being able to implement an auction, strengthened incentives for scrappage and repurposing of assets could be options. Policy Insights 1. Compensation for early closure may be a politically feasible alternative to “polluter-pays” policies such as direct coal taxation, carbon pricing, and cap-and-trade schemes to restrict tonnage of coal. 2. Competitive auctions can deliver efficient compensation payments for early coal closure relative to negotiation-based approaches which suffer from asymmetric information. 3. Supply-side policies such as retiring emissions allowances in line with the coal phaseout can help mitigate carbon leakage risk. 4. Careful consideration around dynamic incentives, local market structure, and system stability is needed to ensure that the design of the auction fosters competition and delivers efficiency. 5. Policy alternatives such as strengthened incentives for scrappage and repurposing of coal assets may be suited to contexts where auctions are deemed infeasible due to high levels of market concentration. Keywords Coal phaseouts, auctions, asymmetric information, compensation, climate policy, net zero, Germany 1 Introduction A net zero future cannot have unabated coal. Fossil fuels are the world’s greatest source of greenhouse gas emissions. There is already enough fossil fuel energy in the system that if these assets were operated until the end of their economic lifetimes, the world would breach the 2degree temperature target set by the Paris Agreement (Tong et al. 2019). Numerous countries around the world have now acknowledged this and have coal phaseout targets in place (Fig 1). Figure 1: Coal phaseouts A common approach to addressing climate change is to put a price on CO2. A carbon price is “technology-neutral” since it does not tell firms how to cut down on emissions (firms are free to replace fossil fuels with renewable energy, increase energy efficiency or stop a certain activity altogether). A carbon price can theoretically be effective in phasing out coal if the price signal is stable and high. However, in practice, this is rarely the case (Rafaty et al. 2020). A coal phaseout is a “technology-specific” measure because it focuses on a specific source of emissions. While economists typically prefer technology-neutral policies because they can find least cost abatement, there might be several reasons why a technology-specific approach is favorable (Fig. 2): • • • • If there is no measurement infrastructure to track CO2, a feasible alternative is to target a close proxy such as coal combustion, which is easier to measure. Coal combustion has negative societal impacts beyond CO2. It is linked to numerous pollutants such as SO2, NO2, O3, particulate matter, and heavy metals (European Commission 2009). It increases child mortality (Barrows et al 2019) and has quantifiable negative impacts on water and land (Cardoso 2015). While a piecemeal approach to calculating and pricing each externality could be followed, it could also be reasoned that the expected net negative societal impact is large enough to rationalise a regulated phaseout, as has been done for other harmful substances. Since coal phaseouts relate to discrete and high