Essays on information and climate change: conclusion and

summary
By Ian Temperton
1
Thermodynamics is the science of transformations
2
and the
science of systems.
We are concerned here with a number of systems: that which
has been created by human-kind on Earth which provides us
(most of us) with a substantially greater length and quality
of existence than we would have had otherwise; the energy
system which powers the development and maintenance of
that human system on Earth; the nancial system of money
and information ows which powers the development of
that physical energy system; and the wider planetary system
in which we exist (of which our biosphere, atmosphere and
oceans are the major part).
We are also concerned with a number of transformations
of those systems. Our existence on Earth is the result of a
number of accidents in geological time which have lead to
the Earths systems being amenable to human development
and habitation within this particular inter-glacial period. While
operating in the full knowledge that meteorite impacts, long-
period oscillations around the sun, volcanic activity or the
eventual expiry of the sun will one day lead to the extinction
of the human race on Earth, we are concerned with preserving
our current state of civilisation and its generally positive
trajectory for as long as possible. This being our deeply felt
ethical obligation to the generations which come after us
(actually it is probably a genetic predisposition). It is also true
to say that the events which will otherwise destroy us currently
seem likely to happen only on a timescale which is orders of
magnitude greater than known human civilisation and hence
substantially beyond our ability to comprehend.
The only known prospect of the Earths wider systems being
transformed in a way which threatens the human-dominated
system and the abrupt end to the current benign state of
that system is the result of the almost instantaneous (in
geological time) release of substantial quantities of gases
with enhanced warming characteristics into the atmosphere.
We fear a transformation of the Earths system which is
consistent with those which have happened previously
in geological time, where a dramatic and abrupt change
in the composition of its atmosphere has caused major
changes to its sea level, glaciations levels, temperature, and
weather patterns. We fear the destruction of the Greenland
and Antarctic Ice shelves; we fear sea level rise; we fear
the deglaciation of the Himalayas; and major changes in
our weather systems. Such transformations, when they
have occurred in periods where life existed on Earth, have
created mass extinctions and hence massive changes in the
biological systems of the planet.
We fear these transformations, not necessarily for their own
sake, but for the impact they have on the human systems
in which we have invested so much historical resource and
on which we crucially depend. Our human system, while
apparently dominant on the planet, is both critically wedded
to the wider planetary systems and in a constant battle for
survival against them
3
.
Amongst the many ironies of climate change is the fact
that the transformation we fear is the result of the most
productive transformation in human history, which was,
itself, the product of a great transformation of the planets
system by its interaction with biological life.
We owe much to the organisms of prehistoric times
which contributed to the transformation of the Earths
References:
1. Ian Temperton is Head of Advisory at Climate Change Capital. From late 2009 to early 2011, he was a Visiting Business Fellow at the Smith
School of Enterprise and the Environment at the University of Oxford. This is one of a collection of essays that are the result of his research
during that time. I would like to thank everyone at the Smith School and Oxford (especially Cameron Hepburn) and those who have read early
versions and provided comments. These include Rupert Edwards, Malcolm Keay, Rick Jefferys, Walt Patterson, Ben Caldecott and Robert Ritz.
All errors and omissions remain entirely mine.
2. This is a quotation taken from Enrico Fermi the Nobel Prize winning physicist, but I think it is also a general statement. See (Fermi, 1936).
3. See (Lovelock, 2006) and (Lynas, The God Species: How the Planet can Survice the Age of Humans, 2011) and while I have focussed in these
essays on the transformation since the industrial revolution see (Ruddiman, 2005) for some fascinating work on the fact that we have been at it
since we were cavemen.
Page 1
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References:
4. I appreciate that mines were not a mile deep (in fact even now I dont believe there are any actually mile deep mines) and that entropy wasnt
discovered until late in the nineteenth century. Allow me the occasional bit of artistic licence, if you will.
system into one habitable by human civilisation through the
extraction and sequestration of carbon in the Earth in the
form of hydrocarbons such as coal, oil and gas. This pre-
historic transformation, in part, provided us with the benign
atmospheric situation which we inhabit today.
The ability of the human race to impose itself so dominantly
on the planet in the last 250 years or so has involved the
reversal of that pre-historic transformation. The creation of the
great order and capacity for useful work within the human-
dominated system of the planet has enhanced human life and
caused an exponential growth in almost every measure of
human existence (including and especially population).
The second law of thermodynamics tells us that disorder
must always increase (and hence capacity for useful work
decrease), and hence as we have increased the order and
capacity for useful work in the human systems of the Earth
we have increased the disorder and reduced the capacity for
useful work of the rest of the systems in the universe. With
the whole universe as our sink for disorder then this should
not be a concern. However, it is not. The consequence of the
release of greenhouse gases into the atmosphere is that our
planet becomes a more thermally closed system, and hence it
can only expel sufcient heat to the wider universe to balance
the suns incident energy by being at a higher temperature.
One consequence of our current transformation is that we are
closing ourselves off, thermally, from the wider universe and in
the process retaining greater disorder in the planets systems
as we increase the order and capacity for useful work of the
human-dominated systems of the planet.
Our challenge now is to transform the energy system on
which the human dominated systems of the planet rely
into one which is no longer dependent on the use of stored
hydrocarbons and hence which does not increase the state of
disorder in the wider planetary systems. We have, if you like,
the thermodynamic denition of sustainable development,
and that is development of the human systems of planet Earth
without the creation of disorder in the wider planetary systems.
How come the transformation of our human system has been
so dependent on hydrocarbons? Some would say that this
is obvious, and is a simple consequence of the cheap and
abundant nature of hydrocarbons as an energy source. This
may be true, but I do not believe it is as obvious as it seems.
Hydrocarbons are abundant, and in some parts of the world
cheap to extract, but no-one should under-estimate the
scale of the investment which has been required over the
last 250 years to access that energy. The entrepreneurial
endeavour, capital deployment and political turmoil which
have surrounded the development of our hydrocarbon
energy system have been immense. In no way did
investments in coal mining in eighteenth century England
look the sure thing that they may now appear in hindsight
for instance.
Surely the sun and wind and other renewable resources
were equally apparent to our forebears and so was it really
a simple matter of cost which saw hydrocarbons win out? I
do not believe so. There is one renewable energy resource
which required large amounts of capital and the taking
of major risks in order to exploit, but which was pretty
much exploited to the full in all practical instances and
that is hydropower. Hydroelectric power is an example of
a renewable energy resource which was harnessed at least
contemporaneously with much hydrocarbon development.
So was it cost? And why were so much more obvious
sources of energy such as sun and wind ignored? Standing
back, and removing our historical prejudices for a moment,
it seems very strange to imagine a eighteenth or nineteenth
century entrepreneur walking in the hills of England on a
sunny day with the wind buffeting him as he walked and
him thinking to himself: I know what, I will dig a mile
underground and see if I can nd a store of low-entropy
energy
4
.
Of course, hydroelectric power is not the only example
of humans looking to harness renewable resources. Long
distance transport (in the form of sea travel) was dominated
by the wind until only 150 years ago, and wind and water
mills ground corn for centuries. So it must just have been
that hydrocarbons turned out to be a lot cheaper. Right?
Wrong. I frankly dont know whether hydrocarbon energy
is, has ever, or will ever really be cheaper than clean forms of
energy. However, I am completely certain of one thing and
that is that hydrocarbons deliver us that energy in a much
lower state of entropy than that in which we can harness
most clean energy resources. Hydroelectric dams are the
renewable energy exception because they have inherent
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References:
5. Anyone who does actually believe this is has either never met anyone from these three categories of individual, or has been one a little too
long.
6. This makes for an interesting reection on many of the ethical issues in climate change, but that is for another time.
storage capacity and hence the ability to move energy in time,
and therefore it is no accident that they were developed at
scale at least contemporaneously with hydrocarbons.
The transformation that has occurred in the worlds energy
systems from 1750 or so onwards is not one of the discovery
of new energy sources. It is the discovery of low-entropy
sources.
So the transformation we need to make in our energy system
is not about energy at all, it is about entropy. It is about
no longer increasing the entropy of the planets systems
through the release of stored energy in the Earth, but instead
harnessing the suns incident energy in all its disparate forms
and delivering it in space and time for the use and convenience
of humankind.
The reliance we need to wean humankind off is not as often
quoted, the reliance on cheap polluting energy, but it is the
reliance on low-entropy sources of energy, and the ease with
which they allow useful work to be done at the place and time
of our convenience. This means the transformation we need
to create in our energy system is the ability to instantaneously
reduce the entropy of that system at any given place and time
such that it can provide the same level of useful work as the
current hydrocarbon energy system does.
Throughout this nal essay I will highlight areas where I believe
that the current mantra of the environmental movement is
self-defeating. The rst, of course, is that we do not have an
energy crisis, we have an entropy crisis. Unless we understand
this, we will never understand how we got to the system
we have today and we will also never understand how we
create the transformation which we wish to see in our energy
systems. It is the entropy problem which is hard to solve and
the reliance on low-entropy energy sources which is so hard to
break, not the energy itself.
Second is that our choice of energy system to date has been
completely logical and based on the low-entropy state of
hydrocarbon fuels and the additional convenience that we
can generate from such fuels. It is the replacement of this
low-entropy system which is the most daunting task. The
hydrocarbon economy, I am afraid, is not maintained by a
conspiracy of hydrocarbon company executives, western
politicians and middle-eastern autocrats
5
. It is maintained by its
inherently low entropy state: pure and simple.
This leads to the third failing of the environmental
movement and that is that they have a habit of saying
that we have all the technologies we need to migrate to a
low-carbon energy system. We do. But that simply isnt the
point. What we do not have is all the technologies that we
need to transform our energy systems to a low-carbon one
while maintaining its current low state of entropy and hence
its ability to deliver useful work in space and time. I do
believe however that we now have the potential to create
such technologies, from the knowledge we have available to
us today
6
.
The mechanism for the reduction of the entropy of the
energy system is the use of information. Information, which
we know to be equivalent to entropy in a thermodynamic
and information theory sense, is the crucial component
of the low-carbon energy system. It is not sun and wind
which will replace oil, coal and gas, it is information. Only
information has the capacity to transform the high-entropy
captured incident energy of the low-carbon system and turn
it into useful work in space and time.
Storage and interconnection are crucial new components of
the energy system, as they allow us to act on information.
Both of these new components of the energy system, you
will note, consume energy, and hence my fourth gripe
in almost as many paragraphs. Thermodynamically, the
reduction of entropy in a dened system requires energy
to be expended. Given that today we get our energy in a
low-entropy state for free then it is clear that a low-carbon
energy system of the future will use more energy, not less,
even if we ignore all the increased demands we expect
on the energy system. Hence while I agree that energy
efciency investments are important, environmentalists
need to stop saying that the answer is using less energy.
Thermodynamically this simply isnt true. Using more energy
is the answer to our low-carbon energy dreams.
So it is indeed true that if we transform our energy system
to include clean energy and energy efciency investments,
we will create a system which creates less disorder in the
wider planetary systems, but we will also create chaos in the
human energy system and the reduction in the convenience
provided to humankind by the energy system will not be
tolerated by the wider populous.
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Information therefore has a role crucial in both the energy
system itself and in the nancial system that directs capital
to the investments required in that energy system. The low-
carbon and low-entropy energy system of the future will be
vastly more capital intensive than the energy system we have
today. This means that the systems of climate change nance
must cause the efcient deployment of vastly more capital
than has been deployed in todays hydrocarbon-based system.
This is evident from all we see in the market, but it is also close
to a thermodynamic fact given that we have been getting our
energy in a low-entropy state for free (or more correctly at the
expense of the planet and hence of future generations). The
scale of this capital deployment and the fact that we have an
entirely new challenge of developing a low-entropy energy
system in the absence of hydrocarbons are perhaps the two
things about climate change which are the most daunting,
given the time we potentially have to solve them.
Let us deal rst however with the role of information in the
low-carbon and low-entropy system of the future. Information
systems in many applications allow for the increase in the
utilisation of systems through their intelligent and efcient use
and hence the delivery of greater utility from the same capital
investment. Outside the energy sphere one can think about
the utilisation of communications infrastructure and within
the energy system one can think about the shared use of grid
and other infrastructure. Information therefore is crucial in
reducing the required amount of physical energy capture, use,
transmission and storage investments which are required in the
low-carbon and low-entropy energy system. It is also crucial in
optimising that system on a minute by minute basis.
Because information can therefore lead to a less capital
intensive system, it appears that as well as being equivalent
to entropy, information is also equivalent to capital in the
energy system, in that there is some trade-off between further
capital investment in the low-carbon energy system, and the
enhanced use of information.
The low-carbon and low-entropy energy system of the future
will need to manage vast quantities of information on the
available energy resources of the system (is the sun shining
on the solar panels, can we turn the nuclear power station
on quickly, is the wind blowing etc?), the energy needs
of the human uses of the energy system (bath time in an
hour, granny is cold this winter, I need the car tomorrow
afternoon etc), and of the energy stored and available for
use. This requires a massive increase in the bandwidth of
information in the energy system, and it will require that
information to be digested and processed in a way which
allocates the available energy resources to the needs and
preferences of the users of the system.
If we assume that this system will be a form of market then
this information will be brought together by that market (or
collection of markets) and that allocation of resources will be
substantially arbitrated between the myriad of agents in that
market by price. In information theory terms we will need a
high bandwidth market which will therefore be of inherently
higher entropy because ex-ante there will be a very wide
range of uncertain outcomes, and it is absolutely essential
to the stability of the overall system that it is capable of
receiving low probability, but then high information content,
messages.
Markets then reduce the entropy of the system at the
point of settlement. In information theory while the
communication channel may be one of high entropy, and
hence the receiver is in a state of high uncertainty before the
message arrives, the entropy of the receiver is reduced by
the receipt of the message. Similarly the low-carbon energy
system has high entropy and has a state of high uncertainty
before the market clears, but the market clearing allocates
the resources appropriately and reduces the entropy of the
system for the users of energy.
Information is therefore what turns a high-entropy system
of energy capture and use, into a system of low entropy for
the users of the energy system as they are delivered their
required utility from the energy system in space and time.
A consequence of the high- entropy information system is
that the allocations will be made by a price which must be
inherently more volatile and have a greater range than we
are used to. Again this is close to a thermodynamic fact.
Page 5
If we are to replace our free low-entropy energy sources
with high-entropy sources, then the information system which
bridges the gap between those high-entropy sources and the
desires of users must be able to absorb a much wider range
of information and must have much greater ability to allocate
resources based on a wider range of uncertain price.
There is an increasing trend in energy market design to create
certainty of price. This is in some respects well meaning as
we will see in the rest of this essay, but it is also completely
misguided, if misapplied. As we have shown, the energy
system of the future will need to have a system of allocation
of resources which has much more volatile and widely ranging
prices at least in the short-term or we simply will not be able
to have the informational ability to reduce the entropy of the
energy system to a useful state for its users.
Numerous of the remaining gripes about the environmental
movement and the energy market intelligentsia will be about
their apparent desire to destroy both information and the
ability of economic agents to communicate with each other.
If there is a recurring sin of the environmental movement it is
certainly the desire to destroy information and its associated
communication.
This trend for the introduction of certainty into energy markets
is the rst of these. If regulatory systems are established which
prevent the transmission of sufcient information between
agents in the low-carbon energy system via price or other
mechanisms then it will simply be impossible to create a system
which reduces the entropy of the energy system to a state
equivalent to that we have inherently in the hydrocarbon-
based system.
Increasing short term energy price volatility is an essential part
of saving the planet.
The reason for this trend in the development of price certain
mechanisms, as noted above, is well meaning (if somewhat
misguided and infuriating), and it derives from a rudimentary
understanding of the next issue in the use of information
in the low-carbon energy system and that is in the direction
of capital to low-carbon investments. Policy-makers have
recognised that ex-ante price uncertainty, that essential feature
of a low-carbon, low-entropy energy system, can create an
incentive to delay investment, or put another way, increase the
opportunity cost of investment above the level of the NPV of
the investment.
This is completely true and is further exaggerated in the case
of low-carbon investments such as clean energy and energy
efciency as they have a high degree of capital intensity and
a high ratio of average to marginal cost. The investment
decisions that agents make are therefore highly irreversible
(another concept borrowed from thermodynamics, you may
notice) and hence the prospect of new information in the
future in the form, for instance, of price volatility, causes
there to be a substantial opportunity cost associated with
investment today compared to delay.
The simple fact is that most energy capture and usage
(reduced usage) investments in a low-carbon energy system
have very little use for information in the future and hence
it is completely true that future uncertainty at the point of
investment simply puts the cost of investment up above the
cost of the real NPV of the investment and hence causes the
investment to be more costly than it otherwise would be.
This premium to NPV which is due to the value in delay can
be seen as a cost of information. In other words it is the cost
of being able to observe an agent making an investment
decision in the presence of uncertainty in the future. You
dont get to observe the NPV of the investment but you do
get to observe the circumstances under which the agent will
invest.
The premium paid above the NPV of the investment is
created by the value of waiting to see future uncertainty
resolved and hence the value of receiving future information
before the investment decision is made. Hence when we
pay this premium we can see it as the price we have to pay
to create action today in the presence of uncertainty, or the
value to us of observing investment today compared to the
investment agent observing information in the future.
Hence it is not that price certainty is inherently good, but it
is true that in the presence of price certainty, price certainty
is good.
To unpack this. Price certainty is good for two reasons.
Firstly, if the investment itself cannot react to the future price
signals then the information contained in those price signals
is clearly useless to it (for instance a wind farm is going to
produce energy when the wind blows whatever the price
is in the market). Secondly, the reason for price uncertainty
to exist in the incentive mechanism for investment in low-
carbon energy is to account for the fact that those setting
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the parameters of the mechanism might not know what the
price actually is. In this case price discovery is a good thing,
but we have done enough thermodynamics now to know
that nothing is ever free, and so the observed price discovery
will come at a certain cost. Information has a cost and that
cost is the premium over NPV created by the inherent price
uncertainty at the point of investment.
Hence it is possible only to observe the price at which an
investment is made; it is not possible to observe the NPV of an
investment. The simple paradox is that in order to observe an
act of uncertain value today, a premium must be paid above
the real cost of that investment, and that premium itself is
created (at least in part) by the fact that we have to create a
system with price uncertainty in order to observe uncertain
prices.
Taking the rst form of price certainty rst. If the investment
being made has no use for the information in the market
over its asset life, which is the case for most capture and use
investments in the low carbon energy system, then there is
little point in exposing them to that price uncertainty at the
point of investment. To do so simply creates deadweight cost
in the system, as investment agents wait, or require to be
remunerated with the opportunity cost of waiting in order
to invest, due to future information on which it cannot act
anyway.
Hence there is little point in exposing a wind farm, solar farm,
or home insulation investment to our ever more volatile short-
term energy price because they have no capacity to act on the
information they will receive. Such investments are the creators
of disorder in the energy system. They create information but
they cannot use it.
Hence the price certainty people have a point in this regard
as there is no point in exposing investments made today
to future price uncertainty to which they cannot react, but
which will cause an information cost to be reected in the
initial investment cost (the deadweight cost). This is what we
referred to as asset matching in our rst essay. However
such investments must be allowed to communicate their
information into the energy system to the fullest extent,
as someone else has to use that information to reduce the
entropy of that system such that the energy captured or used
can be done so usefully.
In the presence of certainty about the price of investments,
therefore, those who advocate price certainty win, with
the qualication that they are right that the investment
in question should not be required to be the receivers
of information, but they must not be prevented from
transmitting their information into the wider energy system.
If you like, the difference between many low-carbon energy
investments like say a solar farm, and a hydrocarbon based
one, say a coal-red power station, is that the former can
only transmit information, it cannot usefully receive it. A
coal-red power station can both transmit and receive
information in the market (more correctly it can react to
receiving information). This difference in their capacity to
participate in the information ows of the energy system is
a function of the starting state of entropy of their energy
sources (the sun being high, and the coal being low). Again
we have an information equivalence of entropy, inherent in
the design of our energy system.
We are not certain, however, of the cost of investment
of the majority of the investments which are to be made
in order to transform our energy system. Hence it is less
obvious that price certainty is a good thing in the second
regard which is observing the true cost of investment in low-
carbon energy systems.
If we are uncertain as to the NPV of an investment then
we can set a certain price at that certain NPV and hence
stimulate investment at the lowest deadweight cost to
society, because we will not be paying for future uncertainty
or suffering delay in investment due to that uncertainty.
However in a world where we are not certain as to the true
investment cost then we must establish a system that has
inherent price uncertainty in order to discover the price at
which people will invest. We will, as a consequence of this,
suffer information costs, because that price discovery is not
going to be free.
This is another fundamental failing of the environmental
movement and that is its inherent aversion to anyone
making a prot, or heaven-forbid, a super-prot.
Well it is a simple fact of the need to stimulate investment
in things which have uncertain costs that it will require the
value of the investment to be above the NPV, because the
information decit which is inherent in doing something
new and hence of uncertain cost means that we have to
Page 7
pay for the information resolution. Another example of the
environmental policy community destroying its very life-blood,
information, is the constant attack on any environmental
investment which appears to be making prot above its
NPV. This prot embodies the very information which the
environmental movement needs in order to manage the
transition to the low-carbon economy.
Having said this, it is responsible policy-making to limit the
level of uncertainty and hence information cost (super-prot)
in order to properly manage the limited resources we have to
deal with the transformation of the energy system. Hence we
should look hard at the degree of uncertainty we put into the
systems which we design in order to discover the information
as to the cost of making economic agents invest.
This basically involves managing the ex-ante entropy of the
information channel used to discover the price of investment,
and there is an inherent trade-off between designing a system
which can capture all low-probability outcomes and one which
minimises the costs of obtaining that information.
As an aside, but an important aside, for the most part in
these essays I have been describing genuinely unknown
costs of investment, rather than information asymmetries
between investors and policy-makers. There is a whole
issue of information asymmetry in policy-making, of course,
but industry and the investment community have proven
themselves to be pretty poor at predicting the real cost of
wind, solar, nuclear and various other forms of low-carbon
investment over very recent times and so I see the information
decit we face as being inherent rather than the product of
different levels of information between different actors in the
market.
So, for instance, if you are a UK policy-maker then you can
be pretty certain that in order to achieve a high level of
production of renewable energy in your energy system you are
going to have to harness offshore wind power at scale. The
cost of offshore wind power is uncertain, but there are some
data points of relatively limited statistical relevance, but they
exist all the same and (today) are at the level of around 3m /
MW of investment cost. Costs have been 1.5m / MW in the
not too distant past and there are people in the market saying
costs could more than halve again, and there are those who
say they could need to be 4m / MW to make some of the
deeper water applications sufciently attractive.
Given this (not particularly good) information and knowing
that the higher the ex-ante entropy of the incentive
system then the greater the cost of observed information
(in the form of investment decisions) at all levels then
as a UK policy-maker you probably would not devise an
incentive scheme that had the potential for the value of
an offshore wind farm to be zero to 10m / MW. If the
system embodied uncertainty in this range then the cost
of observing investment and hence the cost of information
would be very high, and, of course, the observed cost would
be quite far from the true NPV value, and hence there would
be a high cost associated with a relatively low quality of
information.
If you x it at 3m / MW however, given the relatively recent
uncertainty in price then you stand a high chance of being
wrong, and hence seeing no investment or stimulating a
large amount of investment without the opportunity to
observe any indication of the obviously truly lower cost.
Hopefully these essays have well and truly buried the idea
of a single global carbon price as a stimulant for large-scale
investment in low-carbon energy generation, but just in case
we can play the argument through this example of offshore
wind in the UK.
We have shown that for investment in entities incapable of
the receipt of information then price signals which change
over the life of the asset simply create deadweight cost.
Hence a carbon price which is formed on an annual (or even
more frequent) basis provides information which is only
creating deadweight in the investment in offshore wind in
the UK.
Furthermore, a global carbon price has to have the ex-ante
entropy required to capture the cost of observing investment
in every form of low-carbon investment in every country
and in every carbon-saving technology throughout the
world. Hence it has an inherent uncertainty, due to the
high potential information content, which would cause
investments in UK offshore wind to suffer an unnecessarily
high cost of information given that we simply know that in
the UK we have to harness the offshore wind resource and
that it has recently cost around 3m / MW (give or take a bit
this is around a 250 / tonne CO2e carbon price by the way
for those who think I am mixing my units).
Page 8
This clearly makes no sense.
Instead, in such circumstances, it is better to implement a
system which attempts to discover investment cost, but then
does not expose the investments in question to price volatility
over their lifetime.
The question then becomes: how can policy-makers discover
investment cost?
We are in the fortunate position with most low-carbon
investments, that they are inherently capital intensive and
hence most of the cost is incurred at the point of investment.
This increases the potential for ex-post regret on the part of
the investor but it also means that policy for investment cost
discovery can be focussed on costs today, while retaining
exibility for the future.
The approaches taken to investment cost price discovery to
date have been two-fold. Either people have continued down
the misguided route of relying on quantity-based instruments
with high inherent volatility and hence high information costs
and they have observed only the highest possible margin
investments taking place; or they have adopted what a British
person would call the suck it and see approach.
So we know the rst approach has failed. The second however
has a varied history. In the case of the feed-in tariff regimes of
Europe, for instance, governments have tended to set a price
which is xed over the life of the asset (hence getting the
asset matching bit right) and then waited to see what would
happen. As the price is xed, then one of two things happen,
of course, either people invest or they dont. Now fortunately
non-nancial issues like local democracys effect on the
planning consent rate and the availability of grid connections
have meant that in the cases where investments have occurred
the quantity has been constrained and hence the binary
outcome has not been too harmful.
However there are well-documented examples where setting
price and seeing what happens has lead to an excess of
quantity over what policy-makers had intended (the situation
in the Spanish solar market being the best known example in
the investment community
7
).
This is basically because, while systems that set price have
many advantages in terms of asset matching and the
reduction of informational deadweight cost, there is no
mechanism in a price-based incentive for taking the market
through some sort of clearing and settlement process.
This means that unlike a quantity-based market (such as a
cap-and-trade or carbon pricing system) where the market
mechanism brings the whole market together regularly to
determine a clearing price, a price-based system can let
quantity grow unconstrained, with little information ow to
the policy-maker (or anyone else). This means that in such
price-based systems, quantity can get out of control.
In many, but not all, cases the combination of a price-based
system, with a suck it and see approach, constrained
inadvertently by other factors such as grid and planning,
has lead to policy-makers being able to reduce or increase
the prices for future investments in line with the observed
success or otherwise of the current tariff level. The truth
however, is that this has been ad-hoc and certainly not part
of a concerted strategy on the part of policy-makers to
embody their observed information in future policy-making.
It is also true that a successful xed price incentive system
simply tells the policy-maker that they can probably make
the price a bit lower next time, but it does not tell them by
how much.
There are other approaches to the same problem, and some
governments have created implicit or explicit quantity criteria
along-side their price-based systems. The implicit ones being
often based around a time limit which, when factors such
as planning, grid and the availability of resources are taken
into account, denes a quantity limit. The UKs Renewable
Obligation system had the potential to set a nancial limit
on the combination of price and quantity, but it was, in
effect, converted into a feed-in tariff relatively early in its
life
8
.
What policy-makers have generally failed to do is to be
explicit about their strategy for information management
within their incentive arrangements. Policies should be set to
expose the required range of information at an acceptable
cost, and should then have the inherent exibility to react to
that information in setting the next set of incentives.
References:
7. In 2008 the Spanish energy market saw some 2,000MW or more of investments in solar PV power stations based on a price-certain tariff
which was only ever intended to stimulate 300-400MW of investment. Given the high cost of PV systems at that time, the 2008 Spanish solar
investments are likely to rank amongst the highest.
8. In 2003 I suggested that the UKs Renewable Obligation should be modied to give price variability over a certain short period of investment
(a vintage) and then this would be systematically converted into a certain price for assets of that vintage, while the rules for the next
vintage could be set on the basis of the information received. Instead they basically turned the RO into a feed-in tariff without asset-matching
for the investments, and with regular pricing reviews, or about the worst of all worlds in other words. See (Temperton, 2003).
Page 9
For large-scale investments therefore the market is in reality
dened by the interaction between policy-makers and
the agents of investment. There is a periodic exchange of
information which it is the policy-makers job to manage the
cost of, but to be clear, it will have a cost which will show up
as super-prot for well-managed investments. In this exchange,
it is the policy-maker who makes the rst move in setting a
price, or a price range, dened by what is likely to be relatively
poor quality information (not to mention biased given where
most of it will come from). The job of the policy-maker is to
make an intelligent observation of the effects of this shot in
the dark and to harvest better quality information on which
to make a more considered (but never perfect) judgement as
to the parameters for investment incentives in the next phase.
Any intelligent policy-maker is likely to build inherent risk
management into such a system in order to limit or credibly
observe the quantity of investment taking place under the
price-based system.
The most important design consideration in this interaction is
the creation and productive use of information with respect
to investment decisions, and to ensure that the investments
which are created can transmit their information into the
energy market in such a way that allows for the reduction of
entropy of the overall energy system. The interaction between
the agents of investment and policy-makers should be aimed
at reducing the entropy of that interaction over time through
the exchange of ever higher quality information.
One of the key aspects of this interaction is that the set of
exchanges is initiated by policy-makers making a wild stab in
the dark in the pursuit of an overall climate change objective.
This is the inherent nature of markets, and is a key factor
which is ignored by those who believe that we can analyse our
way to a solution to the climate change problem.
Markets tend not to tell you what to do. They tell you if what
you are doing or what you have done is good or not. The
economic ecosystem rewards certain species of economic
activity and causes other to become extinct. If you like, the
back-drop of the markets in which we operate is causing our
endeavours to be constantly observed and those that t well in
the current eco-system tend to succeed and those that do not,
do not. No inventor, innovator, entrepreneur or the like, ever
really does a rational analysis of the right thing to do before
they do it: they simply believe in the right course of action and,
the good ones, react to, and adapt to, the interactions they
have with the wider economic ecosystem. However, despite
all the money spent on analysing markets in the world, the
rst act, is always a wild stab in the dark, based primarily on
belief.
Hence if we are to transform our nancial system such that
it creates the signals which direct capital to investments in
the low-carbon and low-entropy energy system which we
need for the future, we also need to create a system which
observes and rewards activities which contribute to the
development of that new energy system.
Such a system will be rich in information and will create
mutually reinforcing communication between the actors
in the market (both governments and private economic
agents). Such a system will also help create the global
collective action which is clearly required in order to deal
with the global collective action problem that is climate
change.
We have seen how the information exchange between
policy-makers and investors on large, capital intensive
projects can be created through the management of
information, observation and intelligent change in policy
over time to reect valuable information where it can viably
be used. We have also seen however that in this interaction
no market really forms price; that is left to the interactions
of the policy-makers and the investment agents, and as such
the ex-ante entropy is low and the potential information
content of the communication channel is similarly low.
Inherently in this exchange we have decided to make the
compromise of a somewhat awkward system of market
settlement and observation based on quantity in a trade-off
for the reduced costs of information that comes with asset-
matching and low ex-ante uncertainty for investors. We do
this based on the information the policy-maker has as to its
physical investment options and its (imperfect) knowledge of
current investment costs.
While this is the right trade-off for specic cases, nothing in
the above paragraph allows for observation outside of the
narrow communication channel of that policy interaction
and nothing allows for wider communication and economic
interaction with those outside a specic country or
technology.
Page 10
This is where quantity-based systems such as cap-and-trade
systems are essential. All the things which make such systems
inherently bad at stimulating large-scale, capital-intensive
investments in low-carbon energy production make them
an essential part of the overall eco-system of climate change
nance.
Quantity-based systems, such as cap-and-trade, involve a wide
range of countries and sectors and hence have the potential
to include a wide range of national and industrial solutions
to mitigating carbon emissions. Their scope makes them
inherently uncertain as to price ex-ante and their settlement
on a (say) annual basis, does not match the lifetime of any
large-scale investment project. However, in bringing together
all the parties in the system and enforcing settlement at a point
in time such systems cause the creation of information on
the progress of the transformation of the energy system, and
hence reduce the entropy for all observers.
Such schemes are the accounting systems of the low-carbon
economy. It is only through the provision of an economic
incentive to produce high-quality and accurate information
that we will even begin to understand the real quantity and
sources of emissions in the world economy. This is the essential
information basis from which we can start to target solutions
and it quite simply does not exist today. It will be created by
the development of schemes which pay people to create that
information through the creation of economic benet simply in
the delivery of accurate information at the time of settlement
9
.
This is why in the majority of credits in such schemes are
given away to those who pollute in the rst instance. This
creates a cost to the consumer and a benet to the majority of
those who pollute in the short-term, but in exchange for that
economic rent, we receive information as to the emissions of
the polluter involved.
In the case of cap-and-trade systems in developed countries
such as the EU ETS the development of this information
basis has been paid for substantially by the consumer via the
mechanism described above. In the case of the developing
world, if we are to create the information basis which we
so desperately need, then it is likely to be the case that the
developed world consumer or taxpayer will also pay for the
establishment of that information set (as they do in part
through the CDM at the moment).
This brings us again to some truths which the environmental
sector simply has to get used to. We have no idea how
much people really pollute and we wont unless we pay
them for the information, and the best way to achieve
this is through carbon trading systems. This will mean that
those who currently pollute the atmosphere and create
climate change will initially prot from the development of
the very schemes which we implement to attempt to avert
dangerous climate change. This is a simple consequence
of such polluters holding the most valuable commodity
we need in that ght against climate change and that
is information. To get that information we are going to
have to pay them. Monitoring, reporting and verication
(the famous MRV beloved of climate negotiators) is a
consequence of participation in global carbon trading
schemes, not a pre-requisite for joining. If it is a prerequisite
we will simply never establish a scheme with sufciently rich
information content.
Carbon trading is the accounting systems of the planet and
yes, there will be scandals, as there have been in accounting
systems for as long as they have existed, and which there
certainly have been in the development of carbon trading
schemes in the developed countries in the world who have
implemented them to date.
This doesnt matter
10
. It would matter if we were reliant on
global carbon trading to stimulate investment in large-scale,
capital-intensive clean energy infrastructure, because then
the volatility which would be created by the scandals and
mis-information would cause delay and unnecessary excess
return in such investments. However, as we have seen, we
are not reliant on carbon trading for those investments and
we should not be.
Once we unshackle carbon pricing from the unrealistic
expectation of providing a single global (or even regional
or national for that matter) investment signal to all clean
energy investment then it is able to do its real tasks so much
more effectively.
Firstly, we want to use carbon trading to lay down the
information basis of emissions in the world, and as such we
want it to be as broad a system as possible, encompassing
as many countries and industries as practical
11
and settling
References:
9. This we could call the pay the polluter principle rather than the polluter pays principle. Think it will catch on?
10. OK, it matters, in the specic case, but not at a macro level. No-one suggests that we all stop doing audits of companies because that might
lead to accounting scandals in the future.
11. Transaction costs (real transaction costs not information costs) probably limit the realistic coverage.
Page 11
on a regular basis. Hence we want as wide a communication
channel as possible and the highest possible state of ex-ante
entropy in the system, which is a level of uncertainty which is
resolved to all observers at settlement of the market. It doesnt
matter if we initially grandfather polluters rights to pollute,
as we are not expecting this to be any major incentive for
them to invest in non-polluting technologies, and we know
that information costs money, and so if we dont pay them
somehow we simply wont get the information. It also doesnt
matter if the price of credits turns out to be low for the same
reasons. In fact, we probably want the price of credits to be
low because there is no point in paying more than we have to,
to those who pollute, for information. This therefore means
that we dont really mind what the cap is to begin with, we
just care that there is one. We are also more concerned that
countries and industries participate than that investments are
created and hence the starting point for participation in any
scheme can be determined solely by the need to manage
parties ex-post regret at entering into such a scheme. Hence
we should focus on getting the deal which brings the most
participation, as quickly as possible.
Secondly, carbon trading provides for some limited ex-post
reward for those who do invest in low carbon investments.
This helps create an economic environment which rewards
low-carbon actions ex-post in a way that the general economic
system tends to reward good ideas. This will send something
of a signal to economic agents that the economic environment
is being tilted towards rewarding those who take low-carbon
actions. Ex-ante, of course, the uncertainty in the level of
carbon pricing will create delay for both polluting and non-
polluting investments, as option value is determined by
volatility not NPV, and volatility is no respecter of the direction
of the impact on NPV.
We should not, however, belittle the impact of ex-post reward
in a world where the major actions on climate change will
need to begin as wild stabs into the informational darkness.
Thirdly, carbon trading has a major role to play in the
facilitation of collective action. Such schemes allow for
the regular exchange of information between economic
agents through trading and between economic agents and
governments through both trading and the regular settlement
process. That information allows the mutual observation of
action and the costs of action with respect to climate change
mitigation in different countries and difference sectors. In order
to achieve a phase transition in the global energy system we
need all parties in the energy system to experience mutually
reinforcing economic exchanges with each other which
will build up to a transformation of the energy economy
globally.
So we can see that where specic national actions are
logical and reasonably well dened then that information
exchange is best managed based on a price-based system
between policy-makers and investment agents.
However, this means countries and industries taking
individual actions in the absence of knowledge of what
others are doing, which is unlikely to lead to continued
action as it does not pay to be too much of a leader when
the problem is global in nature. Hence we need the constant
reassurance and reward that comes with a regularly settled
system of trading, not focussed on stimulating investment,
but through which we observe and experience what others
are doing and hence hopefully receive mutually reinforcing
information which encourages continued and robust
individual action.
This is what makes the US position on cap-and-trade
schemes a bit bafing. Subject to a bit of pork-barrelling
which is just part of the rough and tumble of politics, the US
appears to get the whole individual action thing. However,
they seem to be completely against being part of a scheme
which would provide them with all the information they
need on what others are doing and what is happening
across their own economy. Particularly given that many
of the wild stabs into the informational darkness come
from the state level, it seems bizarre that the US wouldnt
want to implement an over-arching information system
and hence create the eco-system to which such individual
actions should adapt, and with it create the national and
international information basis for understanding the
continued logic and effect of individual action. Surely real
commercial trades with the Chinese would provide much
better quality information than a bunch of reports ltered
through a UN bureaucracy.
You can take a horse to water.. but anyway.
A transition to the low-carbon, low-entropy economy looks
like a system of individual actions, moderated by ever higher
quality information, within an international economic eco-
system of carbon trading that provides mutually reinforcing
information on the action of others and that holds all
concerned regularly to account.
Page 12
This is all very well, but nowhere so far have we addressed who
actually pays for all this transformation of the energy system,
particularly as we have realised that it is a thermodynamic fact
that a low-carbon, low-entropy energy system will be more
expensive than the hydrocarbon one which we have today.
Paying for the transformation has become an ever more
contentious issue in the global climate change debate. At
the time of the Kyoto Protocol there was a relatively clear
principle that it was a rich country issue to solve the climate
change problem and it was clearly unethical to expect the
poor to pay. In the complex international debate on climate
politics, two things have become abundantly clear about the
poor of the world. The rst is that a lot of them wont be poor
by the time we need to do a lot of the climate mitigation in
their countries or more importantly by the time they start to
benet from the sacrices of todays generation in solving the
problem. Secondly, there are simply rather a lot of them. Hence
it seems relatively unlikely that, whatever the historical moral
imperatives, the rich of the world are going pay for a low-
carbon, low-entropy energy system for 9 billion people by the
middle of this century.
The good news is we dont have to. Believe it or not, the good
news is that this is a collective action problem.
What matters to the developing economies of the world is
their competitive position and hence if everyone moves to a
low-carbon, low-entropy energy system then, one could argue,
that nothing has changed very much. Hence in the same way
that such countries are going to manage to maintain or adapt
their competitiveness while having greater degrees of human
rights, more workers rights, less child labour, the greater
empowerment of women, and all the other things that we
seem to have while we still struggle on in the West, they will
also be able to maintain and adapt in a world where they have
a low-carbon and low-entropy energy system.
Getting there requires three things.
Firstly, it is clear that the only people who are going to pay for
it in the developed world are the developed world and so we
may as well just get on with it.
Secondly there needs to be the information technology
capable of creating a low-entropy energy system from a low-
carbon energy system. As noted previously, I am not sure that
clean energy is any more expensive than dirty energy, but
it is clear to me that the low-entropy state of hydrocarbons
explains their dominance in the worlds energy system today.
Creating the information systems required to manage a low-
entropy energy system during the transition of the western
economies might well create a situation where information
systems are available which make it a close to straight ght
between clean and dirty energy sources for the developing
world and in that case they have everything to gain from
taking the clean option. Essentially if our development of
information systems is such that they are indeed a major
substitute for capital then we even the playing eld for the
rest of the world
12
.
This makes the debate on wind power intermittency in the
UK for instance very interesting. Many people will tell you
that the system in the UK simply cannot deal with a third
of its power coming from wind. There are two counter-
arguments. The rst is that it simply has to, so get on with
it. The second is that when it does we will have cracked the
secret code of the low-carbon, low-entropy energy economy
and other people in the world might nd that useful. Hence
my view is that wind power intermittency on a large island
in north-west Europe, while a challenge, is an immense
opportunity.
Thirdly, we need to create the information basis for
emissions in the world. This means a global system(s) of
carbon trading which creates accountability, ex-post reward
and mutually reinforcing economic interactions on the part
of actors all over the world in the energy market.
My contention is that the developed world as traditionally
dened cannot and simply will not pay for the development
of a low-carbon and low-entropy energy system for 9 billion
people. This I am afraid is another one of those slightly other
worldly beliefs of the environmental movement, which they
would do well to forget because it makes the task at hand
simply unachievable.
However, I similarly contend that we can and should in our
own self-interest pay for the three things described above.
Clearly, we have to transform our own energy system. In
doing so we will develop the information systems required
to replace hydrocarbons with information (for that is what
we are doing). And, in order to bring the rest of the world
References:
12. I appreciate that I am implying that such information systems cannot be developed in the developing world faster than they can in the
developed. Take this as just a part of the narrative. There is indeed a high chance that supposedly developing world technologists will get
there rst.
Page 13
with us we need to ll the informational void which currently
exits and as described above, we will need to pay people
to bring them into that information system. Information is
expensive, but I believe that the developed world can afford
to pay for the development of that emissions information and
accountability system as part of the general economic eco-
systems of the nancing of the low-carbon and low-entropy
economy.
So if the US position on cap-and-trade is bafing, the EU one
is simply bizarre. The purpose of a quantity-based trading
system, as we have seen, is clearly not to stimulate highly
capital intensive investment, and clearly is to lay down an
ever greater information and communication system for the
low-carbon economy. The EU is currently engaged in a policy
to restrict the importation of international credits and attempt
to force up the carbon price. This shows a complete lack of
understanding of the purpose of the instrument, restricts the
very communication channel to the rest of the world that
is so crucial to mobilising collective action, and runs the risk
of signicant and unnecessary deadweight costs in the EU
economy.
The three actions we have described here in effect embody
leadership, information technology development, and
economic information development through markets.
What is interesting is that the last two actions are analogous
and could only have become possible in recent times. One
is the development of the information systems which can
instantaneously maintain a low state of entropy of an energy
system satisfying human wants and needs in space and time
but based on high-entropy forms of energy capture. The other
is the economic system which causes our state of entropy with
respect to the knowledge of emissions of greenhouse gases
(and hence entropy) into our planetary systems to be reduced
on a periodic basis through trading and eventual settlement.
Hence we are in the business of developing two analogous
information systems of a type and complexity which could not
have been contemplated until recent times, simply because the
underlying information technologies which will be required for
both did not exist. It is only over perhaps the last decade or so
that we could have realistically contemplated either.
As we look to risk manage the existence of humans on Earth
this latter observation raises some interesting issues. Many of
us who operate in the climate change arena feel, probably
rightly, that action on mitigating emissions is far too slow
and we fear that what we observe in the planets systems
today does not even begin to tell us the damage that we
have already wrought in those systems. However, it is true
that the explosion of technological development and the
imposition of human order on the planet which began only
those 250 years ago with the beginnings of the harnessing
of low-entropy hydrocarbon energy, has lead to a point
today where only now can we begin to contemplate the
technological and economic information systems required to
wean ourselves off the very hydrocarbons to which we owe
so much of the current state of our existence.
Are we then in a self-defeating race to maintain the entropy
level of our existence?
The question is, is it possible for an advanced species
such as the human race to develop the technological and
economic ability to sustain itself on a planet like Earth? Can
we become sufciently advanced in those technological
and economic systems such that we can preserve and
enhance human dominated order on the planet before we
have expelled too much disorder into the wider planetary
systems? Or will we fail? Will we overrun the budget
accidentally left for us in pre-historic times? In so doing we
would expel so much disorder into the planets non-human
systems that we will not have the capacity to maintain and
enhance the current level of human existence against the
forces which the planets systems unleash upon us.
Without hydrocarbons we would not have been able to
create the order in human existence and the capacity for
greater human enrichment that we have, but we only have
a certain budget for increasing the entropy of the planets
other systems before all the resources at human disposal
will not be able to maintain our version of order against the
associated disorder which it created.
We have seen that in the absence of high quality
information the rst act is always a stab in the dark, and
in the case of climate change we know that there is a high
probability that observable effects lag cause by quite some
time, and hence when we receive denitive information it
may already be too late. There is no archaeological evidence
that advanced species have imposed themselves on the
planet before in the history of Earth, and we have not yet
communicated with or experienced other planets with such
advanced species, and hence we have little experience to
learn from. Our attempts therefore to maintain order in
our systems on our planet are a rst-of-a-kind effort, with
all the informational issues which come with that. It may
Page 14
be that our few hundred years of extreme colonisation of the
planet do little more than leave a legacy from which the next
advanced species to evolve, in say a billion years, can learn as
they attempt to dominate the planet in a similar way.
If we are to learn fast enough to maintain order against
the powers of the planet, then it is for the environmental
movement, in all its forms, to seek to increase the power
of the information in the worlds energy systems, even if
that means confronting some difcult facts including that
information is costly, and often transmitted in the form of a
protable decision.
It is information which will allow us to transform our energy
systems to deliver low-carbon and low-entropy energy for our
use and convenience. This will require a transformation in our
nancial system to reward, account and communicate in ways
which direct capital to investments in that low-carbon and low-
entropy system.
It is also then information which, in place of low-entropy
hydrocarbons, will allow us to maintain and expand the
transformation of the Earth which we are in the process of
executing, without creating forces in the planets other systems
which we cannot resist.
For a while longer, at least.
CCC Head Ofce
Climate Change Capital
3 More London Riverside
London SE1 2AQ
United Kingdom
T: +44 (0) 20 7939 5000
F: +44 (0) 20 7939 5030
www.climatechangecapital.com
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