The cost-efficiency carbon pricing puzzle

Christian Gollier ()
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Christian Gollier: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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Abstract: Any global temperature target must be translated into an intertemporal carbon budget and its associated cost-efficient carbon price schedule. Under the Hotelling's rule without uncertainty, the growth rate of this price should be equal to the interest rate. It is therefore a puzzle that many cost-efficiency IAM models yield carbon prices that increase at an average real growth rate above 7% per year, a very large return for traders of carbon assets. I explore whether uncertainties surrounding the development of green technologies could solve this puzzle. I show that future marginal abatement costs and aggregate consumption are positively correlated. This justifies doing less for climate change than in the safe case, implying a smaller initial carbon price, and an expected growth rate of carbon price that is larger than the interest rate. In the benchmark calibration of my model, I obtain an equilibrium interest rate around 1% and an expected growth rate of carbon price around 3.5%, yielding an optimal carbon price above 200 USD/tCO within the next few years. I also show that the rigid carbon budget approach to cost-efficiency carbon pricing implies a large uncertainty surrounding the future carbon prices that support this constraint. I show that green investors should be compensated for this risk by a large risk premium embedded in the growth rate of expected carbon prices, rather than by a collar on carbon prices as often recommended.

Keywords: Carbon budget; Risk-adjusted Hotelling’s rule; Climate finance; Climate beta (search for similar items in EconPapers)
Date: 2024-11
Note: View the original document on HAL open archive server: https://hal.science/hal-04938709v1
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Citations: View citations in EconPapers (1)

Published in Journal of Environmental Economics and Management, 2024, 128, pp.103062. ⟨10.1016/j.jeem.2024.103062⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04938709

DOI: 10.1016/j.jeem.2024.103062

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