The Invisible Green Hand

8/9/2019 The Invisible Green Hand

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The Invisible Green Hand:

How Individual Decisions and MarketsCan Reduce Greenhouse Gas Emissions

Martha Amram, Ph.D.

and Nalin Kulatilaka, Ph.D.

April 2008


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Th Iviil Gr Had:

How Individual Decisions and Markets Can Reduce

Greenhouse Gas Emissions

APRIL 2008

Martha Amram, Ph.D.and Nalin Kulatilaka, Ph.D.


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AbouT THe MILken InsTITuTe

The Milken Institute is an independent economic think tank whose mission is to improve the lives and economicconditions o diverse populations in the United States and around the world by helping business and public policyleaders identiy and implement innovative ideas or creating broad-based prosperity. We put research to work with thegoal o revitalizing regions and nding new ways to generate capital or people with original ideas.

By creating ways to spread the benets o human, nancial, and social capital to as many people as possiblethe democratization o capitalwe hope to contribute to prosperity and reedom in all corners o the globe.

AbouT sAVe

SAVE (Strategic Action Volunteer Eort) brings together teams o volunteers adept at deploying state-o-the-artnancial technologies and capital market solutions to tackle complex economic and public policy challenges. Its energyservices initiative is working to accelerate the adoption o clean, energy-ecient technologies through innovativebusiness models.

2008 Milken Institute


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Mil ItittTh Iviil Gr Had

1. Introduction .....................................................................................................................1

2. Buying Time with Climate Change Policy ..........................................................................3

3. Cheap Solutions, Broken Markets .....................................................................................9

4. The Central Role of Private Investment Decisions ............................................................13

5. New and Reconnected Markets to Support Private Decisions .........................................17

6. Experiencing Climate Change Locally .............................................................................25

7. A New Geometry for Climate Change Policy ...................................................................29

8. Conclusions ....................................................................................................................35

About the Authors ..............................................................................................................36

Tal f Ctt


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1. Introduction

Every day, each one o us makes a host o purchase and consumption decisions. Embedded in every purchase

is some amount o greenhouse gasand so our many small, individual actions add up to global climate

change.1 This paper outlines a strategy or reversing the course o climate change in exactly the same way,

using the strength o our market economy to produce results quickly and cheaply.

Our market-based approach is not just about the type o solution we avor; it brings an entirely new

perspective to the problem. From global accords to legislative agendas, the current thinking sees a proposed

solution to climate change as something to be imposed on a large, reewheeling, and global economy, as i

it were a simple entity ready to receive constraints or the common good. But some companies, industries,

and countries have large incentives to deeat the proposed solutions, so, not surprisingly, legislation and

global accords stall. Meanwhile, at the micro level, progress is made through local policies and initiatives,

and these shape many private investment decisions. In this paper we ocus on this nexus, the local actionsand small decisions that also aect climate change. We may achieve national legislation or a global accord

in the uture, but the local level also presents a rich opportunity or infuencing the course o events.

The purpose o this paper is to shit the debate on climate change. For policy analysts, we provide a new

argument: that local policies are a tangible and eective solution, as they can be more tailored to local

conditions and markets. For businesses, we provide a road map to protable business opportunities that are

the result o new markets, or the knitting together o older, ragmented markets. And or concerned citizens,

our analysis shows that grassroots lobbying eorts can produce signicant change. Our ramework shows

citizens what they should ask o local leaders. A national policy or international accord will only help to

accelerate the changes and incentives described here, deepening the prot opportunities and shiting the

tipping point or many private decisions.

A second goal o this paper is to remove a layer o abstraction that oten exists in climate change policy. We

aim to connect the big ideas to micro decisions and local realities. It is at this level o detail that climate

change solutions must workthey must be the best choice or private decision-makers. While local actions

may be shaped or tipped by public policy or regulatory constraints, it is ultimately the many small decisions

made by individuals that will drive emissions out o our purchases and consumption.

By putting markets at the center o our analysis, and by dening climate change solutions in response to market

strengths and gaps, we hope to demonstrate the scale, speed, and cost-eectiveness o market-based solutions.

The invisible hand can lead to a sharp reduction in emissions, shiting the path o climate change itsel. With

a little prodding and the help o both national and local policies, the invisible hand can go green.

We will begin by stating the problem, relying on a clear policy ramework known as stabilization wedges (rst

proposed by two Princeton University proessors, Stephen Pacala and Robert Socolow2). Their ramework

1 For a vivid description o the impact o our daily actions, see Alex Shourmato, An Eco-System o Ones Own,Vanity Fair, May 2007.

2 Stephen Pacala and Robert Socolow, Stabilization Wedges: Solving the Climate Problem or the Next 50 Yearswith Current Technologies, Science, Vol. 305, no. 5686 (December 2004), pp. 968972.


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links climate science and policy actions, and has two salient conclusions: First, there is no single technology

that will solve our emissions problem; it will take a portolio o solutions. Second, while complex and onerous,

the climate policies currently being debated are only the rst step. These policies will serve only to slow

down emissions growth so that we might strive or more aggressive emissions reductions in the uture. They

will not be enough to halt or reverse climate change.

In Part 3 o this paper, we turn to low-cost solutions or greenhouse gas (GHG) emissions. Seemingly cheap

and immediately available technologies are available, so why arent they widely used? The answer is broken

markets. What looks cheap on paper is hard (and more expensive) to implement in the real world. To

illustrate, we take a close look at the lowly household water heater and examine the drivers and barriers or

early replacement with an energy-ecient model.

Our central argument is that the private investment decision is the key driver o GHG emissions by humans.

At a day-to-day level, emissions are largely set by behavior, which in turn is constrained by the existing

capital stock. Because capital stock is so long-lived, the private investment decision is a moment o great

consequence or determining urther emissions levels. Public inrastructure shapes private investment

decisions, but we argue that public institutions typically respond ater the act; they have a poor track record

o acting beore catastrophe strikes. This leaves us relying heavily on markets to tip private investment

decisions toward clean technologies.

In Part 5 we provide multiple examples o new and reconnected markets that can tip private decisions

and accelerate the adoption o clean technologies. In contrast to many climate policy papers, we are not

presenting technology solutionswe are providing solutions to market problems.

The discussion to this point has considered the problem rom a macro or national level. But climate change is

experienced locally, so Part 6 will explore the role o local conditions. Regional weather patterns or individual

catastrophes are sometimes interpreted as evidence o climate change and can galvanize communities

and individuals into action. Extreme weather can destroy inrastructure, leading to higher local taxes and

depleting the asset base. Local conditionsinrastructure, wealth, regulations, and morewill determine

the costs o adapting to a changing climate in a given area. Because we experience climate change at the

community level, local policies and market dynamics become more important, as they are ways to tailor

solutions to the conditions immediately at hand.

We return to the macro policy level in Part 7, which contains a visual summary o our thinking. While

the Pacala and Socolow ramework or climate change policy comprises seven wedges, a market-based

policy looks like a mosaicthe aggregation o many private decisions. Looking urther into the uture andpreparing the groundwork or the second stage o a market-based climate policy, we outline the objectives

or an intense, ambitious R&D eort that would develop the key technologies to be deployed.


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2. Buying Time with Climate Change Policy

In 2007 the United Nations issued a series o reports that revealed new scientic data, updated climate

change models, and presented strategies or mitigation. The reports warned that the world must reverse the

growth o greenhouse gas (GHG) emissions in the next ew years (by 2012 or 2015) to prevent serious climate

disruptions.3 One o the clearest and most accessible ormulations o how we might quickly reverse global

emissions trends was put orth by Pacala and Socolow (2004). Figure 1 is a stylization o their scheme.

Figure 1: The Emissions Reduction Challenge

0

2

4

6

8

10

12

14

16

1900 1950 2000 2050

Year

AnnualCarbonEmissions

(gigatonsof CO)

Current Trend

Toward Doubling

of Emissions

Toward

Stabilization

of Emissions

Great Depression

Present Levels

Source: Carbon data rom Carbon Dioxide Inormation Analysis Center, Oak Ridge National Laboratory,U.S. Department o Energy

Figure 1 traces actual emissions between 1900 and 2005, and then shows alternate projections to 2055. The

sharply increasing trajectory in the second hal o the twentieth century illustrates the size o the challenge

we ace; reversing the long-term trend will be a huge endeavor. Emissions in 2005 were approximately 7

gigatons o carbon per year (7GtC/year). Pacala and Socolow noted that i we continue along this trend line,

the amount o carbon in the atmosphere in 2055 would be double the amount we have today and triple the

atmospheric concentrations o the pre-industrial era (beore 1780 or so). On the other hand, we can halt

emissions growth at current levels. The area inside the two scenarios sums up the climate change challenge.

Is there a way to avoid the top path? Which technologies could soak up the anticipated emissions that lie

between the top path and the fat path?

3 U.N. Chie Seeks More Leadership on Climate Change,New York Times, November 18, 2007.


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Figure 2: The Wedge/Technology Solution

7 wedges (7 technologies)

are needed to stabilize

emissions

1 wedge = 1 gigaton of

CO2 emissions in 2050

Stabilization of Emissions GrowthTODAY 2050

Extrapolation of Historical

Emissions Growth

Figure 2 shows the ramework or the solution. The stabilization triangle has been divided into sevenwedges. Each wedge starts out as a thin sliver in the year 2005, but grows over time, eventually eliminating

emissions o 1 gigaton o carbon dioxide (GtC) per year by 2055. Emissions in 2055 are expected to be 7

GtC larger per year than 2005 levels, so seven wedges are needed to achieve emissions stabilization. In their

paper, Pacala and Socolow suggested teen immediately available technologies that could serve as wedges,

including solar energy, biouels, nuclear power, carbon sequestration, energy eciency in buildings, and

so on. Their point was that we need not wait to achieve emissions stabilization. Acting today can arrest

emissions growth, setting us on the fat path and buying time to nd new ways to create steeper emissions

reductions ater 2055.

As the authors detail, the technologies are currently available, but they must be deployed at historically

unprecedented levels to achieve the emissions reduction o a wedge. For example, natural gas produces

about hal the carbon emissions o coal per unit o energy, so one wedge might be the switch rom coal to

gas. But to achieve a reduction o 1 GtC by 2055, the use o natural gas must grow to our times its current

level. Photovoltaics (solar cells or producing electricity) might serve as another wedge, but similarly, the

photovoltaics capacity installed and running in 2055 would have to be 700 times larger than todays capacity

(equivalent to a 14 percent annual growth rate) to achieve a 1GtC emissions reduction by 2055. Because

they are ocused on technology, Pacala and Socolow do not detail how these massive changes would be

catalyzed or how deployment rates would be sustained or the next ty years. Their action plan is missing


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the incentives needed to begin and sustain this massive capital stock transormation. (An obvious rst step

is to look or the lowest-cost solutions, which we will examine in the next section.)

It is useul to compare the emissions stabilization strategy proposed by Pacala and Socolow to other policies

currently enacted or proposed. While Pacala and Socolow base their analysis on a two-step solution, localand national polices are more aggressive one-step programs. These are shown in Figure 3.

Figure 3: Massive Capital Stock Transormation Under Any Climate Change Policy

0

2

4

6

8

10

12

14

16

1900 1950 2000 2050

Year

ExtrapolationTwice current level

StabilizationCurrent level

RPS1990s level

Cap & trade1970s level

Complete reversal1780s level

Annual

CarbonEmissions

(gigatonsof CO)

Historical Emissions

Present Levels

The rst reduction plan shown in the gure is the Renewable Portolio Standards (RPS), programs enacted

by twenty-six states that are generally aimed at reducing emissions to 1990s levels. The cap-and-tradelegislation considered by Congress is more aggressive, with a goal o reducing emissions to 1970s levels.

As todays emission rate is 70 percent higher than the rate in 1970s, these legislative proposals contain a

signicant reversal o the capital stock choices made since then and a historically unprecedented decoupling

o emissions growth and economic growth. And, as a nal note, because carbon takes decades to leave the

atmosphere once it is emitted, it will require a severe reduction in emissions to achieve a reduction o carbon

in the atmosphere.4

The policy proposals illustrated in Figure 3 contain ambitious goals, but at least in the early stages, these

goals are being met. Their early success conrms Pacala and Socolows initial contention: we already have

the technologies today that can stabilize emissions. What is missing rom this picture is how to sustain and

expand these early wins in a growing economy.

4 A useul summary o climate status is: Summary or Policymakers o the Synthesis Report o the IPCC FourthAssessment Report, IPCC, November 15, 2007 (www.ipcc.ch/pd/assessment-report/ar4/syr/ar4_syr_spm.pd).


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6

Reducing Emissions: Now or Later? And Who Will Take the Lead?

No one knows exactly how climate change will unold and what its eects will be, and emissions reduction is

costly. Suppose breakthrough technologies that can cheaply and easily remove carbon rom our atmosphereare just around the corner. Why invest in emissions reduction today? One answer was provided by the Stern

Review, a British report issued in early 2007 that translated rising temperatures and changes in climate

patterns to economic losses.5 The report examined many potential outcomes, but one mid-range scenario in

particular provides a useul summary: unless action is taken today, the size o the economy in 2050 will be

signicantly smaller, a shrinkage that negatively impacts the standard o living and worsens the poverty rate.

(Predicted outcomes range rom a 3 percent loss o GDP to a 20 percent reduction in capital consumption.)

To avoid this catastrophe, the Stern Review argues that it is worthwhile to give up 1 percent o GDP today.

When presented as a crisp trade-o, the choice seems clear, and the report argues or immediate action.

But climate change is a very uncertain process, and this uncertainty rerames the question: do we want to

sacrice todays GDP to insure against uture economic losses? Perhaps waiting to invest is a better choice,

particularly when any reduction in GDP has a high immediate human cost. Insights into these trade-os

can be gained rom considering a model on the value o waiting in the ace o environmental uncertainty

presented by Robert Pindyck o MIT.6 Pindyck notes that there are two types o uncertainty: economic (the

cost o various uels and output prices) and environmental. Economic uncertainty is reversibleprices go

up and downwhile environmental uncertainty may not be so. Others, such as Gregg Easterbook, have

argued that environmental damage (acid rain, the hole on the ozone layer, and so on) has been reversed

through concerted action in the past, with aster results and a lower cost than was expected.7 Thus waiting

to solve climate change may be less costly than we surmise. Pindycks model shows, however, that even a

small amount o environmental irreversibility greatly diminishes the value o waiting. Certainly the news

headlines suggest increasing concern by scientists that the point o irreversible damage is near.8

5The Stern Review on the Economics o Climate Change, Oce o the Treasury, British government(http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cm).

6 Robert S. Pindyck, Uncertainty in Environmental Economics (December 2006): NBER Working Paper No.W12752. Available at SSRN: http://ssrn.com/abstract=949761.

7 Gregg Easterbook, Some Convenient Truths,Atlantic Monthly, September 2006.

8 U.N. Chie Seeks More Leadership on Climate Change,New York Times, November 18, 2007, and In Greenland,Ice and Instability,New York Times, January 8, 2008. See also Summary or Policymakers o the Synthesis Reporto the IPCC Fourth Assessment Report, IPCC (www.ipcc.ch/pd/assessment-report/ar4/syr/ar4_syr_spm.pd).


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The Stern Reviews numbers and Pindycks model argue or immediate action. Meanwhile, newspaper

headlines make the link between local weather, adverse outcomes, and climate changesuggesting that

we have no time to wait.9 But what immediate actions should we take? And who should lead the way? Any

social insurance policy will have uneven and immediate costs on current citizens. How can a representative

institution link these tangible costs to vague and elusive benets? In a successul scenario, the costs are

borne and disaster is averted, leaving many citizens eeling overtaxed. But in most scenarios, the costs are

borne and damage is incurred anywayleaving citizens believing that their government ailed to prepare

or disaster.

The issue o social insurance, as with the stabilization ramework o Pacala and Socolow, raises questions

about the actors. Later in the paper, we will provide examples o government actions that have been too

little, too late when conronted with uncertain disaster orecasts. Leadership comes not only rom tough

macro trade-os, but also rom micro-level policies that strengthen markets and tip private decisions to

clean outcomes, making individual consumers the key actors.

9 A random sampling rom theNew York Times: Inch by Inch, Great Lakes Shrink, and Cargo Carriers Face Losses,October 22, 2007; Precipitation Across U.S. Intensies Over 50 Years, December 5, 2007; World Food SupplyIs Shrinking, U.N. Agency Warns, December 18, 2007; U.N. Chie Seeks More Leadership on Climate Change,November 18, 2007; and In Greenland, Ice and Instability, January 8, 2008. See also the U.N. report cited in note 8.


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3. Cheap Solutions, Broken Markets

Technologists, who provide a list o possible technologies that could stabilize emissions, are oten ollowed

by business analysts, who rank the available technologies by cost. Over the years there have been a number

o detailed studies that provide a clear sorting o emissions-reducing technologies.10 Table 1 summarizes

ndings rom a recent study by McKinsey & Co., a global consulting rm.

Table 1: Technology Solutions Ranked by Cost

Cost per ton

of CO2

abatedPositive return

on investmentBelow $25 per ton $25 to $50 per ton

Total Reduction

(gigatons of CO2

per year)1.3 0.8 1.0

SelectedTechnologies

Building insulation Nuclear Industrial motor systems

Lighting systems Livestock Carbon capture

and sequestration

Air conditioning Forestation Coal plant retrots

Water heating Enhanced oil recovery Waste

Fuel eciencyWind

(low cost penetration)Biodiesel

Technologies that reduce emissions are listed in three columns in the table. The items in the rst group, on

the let, have lietime benets that exceed their cost, providing a positive return on investment. Cumulatively,

these technologies could reduce annual CO2

emissions by 1.3 gigatons. Technologies in the middle group

cost less than $25 per ton o CO2

abated, and the third group, in the right column, costs less than $50 per

ton abated. The total savings possible rom employing all o these technologies is 3.1 gigatons per year. Many

o these technologies, such as building insulation or increased water heater eciency, are available right

now. Others, such as coal plant retrots or biodiesel, are expected to reach a cost-eective scale by 2030.

Results similar to those shown in the table have been ound by others as well; some technologies such as

insulation and ecient water heating continually pop up as good personal investments that happen to be

good or the environment as well. So the obvious question is: i these technologies are so cheap that they

actually make us money, why arent they widely adopted, to the point o negative marginal returns?

The answer to this question has been called the eciency gapthe dierence between the clear, avorable

economics o many energy-eciency technologies and their low rate o deployment. The eciency gap has

been noted in energy policy literature since the energy crisis o the mid-1970s.11

10 An early study is Alan Manne and Richard Richels, Buying Greenhouse Insurance (MIT Press, 1992). See alsoClimate Map 2030 by Vattenall, January 2007 (http://www.vattenall.com/climatemap/) and Reducing U.S.Greenhouse Gas Emissions: How Much at What Cost?, McKinsey & Co., November 2007 (http://mckinsey.com/clientservice/ccsi/).

11 Alan Manne and Richard Richels, Buying Greenhouse Insurance (MIT Press, 1992).


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In a recent article, Marilyn Brown succinctly laid out the reasons or the eciency gap, including

misalignment o incentives (the principal-agent problem); weak price signals; insucient inormation; lack

o capital; distortions through legislative or scal policies; unpriced costs; unpriced benets; and the relative

unimportance o carbon reduction compared to other investment or purchase attributes.12

Adam Jae and Robert Stavins examined the rational eatures o investment or consumer adoption behavior

that could lead to the appearance o an energy-eciency gap. 13 For example, they noted that technologies

come in bundles o attributes, and oten a prominent eature is unattractive. Many people, or example,

understand that compact fuorescent bulbs save energy, but still wont buy them because they dont like the

color o light the bulbs produce. In a similar vein, a recent article proled the green choices o a ski resort.

Each year the green team presented ideas that lowered both costs and energy use to the resort owner, only

to see them squeezed out o the budget by less green projects with higher returns.14 Finally, Jae and Stavins

note that new technologies ace long adoption cycles, so a critical observer might see an energy-eciency

gap, but the reality is a normal rate o adoptionone that remains incomplete or many years.

To ully understand the notion o the energy-eciency gap, consider the lowly residential water heater. Every

house has one, and on average they consume about 15 percent o the homeowners energy budget. 15 The

EPA estimates that 60 percent o water heaters are replaced on an emergency basis. 16 The rustration o a

homeowner temporarily without hot water no doubt puts energy eciency last on the list o buying actors.

In the middle o the night, or on short notice, the homeowner calls the installer to replace the water heater.

But the installers incentives have little to do with energy eciency. His perormance is being measured on

speed, the reliability o his product, and his service demeanor. Meanwhile, many parties are trying to tip

the homeowners decision: the utility oers a rebate or energy eciency; the U.S. government oers a tax

credit; and a host o nonprot advocacy groups provide detailed inormation on ecient water heaters. Yet,in the panic o having no hot water, none o these actors matter greatly. Speed trumps other concerns.

The water heater decision brings up another problem. There is so little dierentiation between standard gas

and electric water heaters that, in 2004, the EPA declined to rate them or inclusion in their Energy Star

program. Since 2004 a number o new technologies have been developed and marketed, but they have a

combined market share o less than 1 percent. This urther conuses the marketplace, as the installers must

act as pioneering adopters or their customersa very risky business proposition!

12 Marilyn Brown, Market Failures and Barriers as a Basis or Clean Energy Policies, Energy Policy 29,pp. 1197 1207).

13 Adam Jae and Robert Stavins. 1994. The Energy Eciency Gap: What Does It Mean? Energy Policy 22 (10):804810. A. Jae, R. Newell and R. Stavins, Energy-Ecient Technologies and Climate Change Policies: Issuesand Evidence, Resources or the Future (r.org), 1999.

14 Little Green Lies, BusinessWeek, October 20, 2007, 4552.

15 http://www.energystar.gov/index.cm?c=new_specs.water_heaters.

16 EPA water heater drat 2 update.


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Now lets look at the 40 percent o homes that do not replace their water heaters on an emergency basis.

Table 1 shows two o the actors infuencing a replacement decisionthe outdoor water temperature and

the cost o natural gasand the optimal replacement decision or three dierent locations. The results in

the middle column show the number o occupants needed to warrant an early replacement. For example,

in Palo Alto, Caliornia, where natural gas prices are high, early replacement is warranted in all homes. But

in Brookline, Massachusetts, where gas prices are lower, early replacement is warranted only in homes with

high hot water use.

Table 2: The Water Heater Early Replacement Decision in Three Locations

Cold watertemperature

(F)

Price ofnatual gas

($ per therm)

Replace ifnumber ofresidentsexceeds

Cost of water( per 10gallons)

Replace ifnumber ofresidentsexceeds

Brookline, MA 48 $1.30 5 13.7 6

Sunnyvale, CA 56 $1.47 3 2.7 5

Palo Alto, CA 62 $2.07 0 6.5 0

Note: Assumes constant natural gas prices; early replacement is warranted when a price rise o more than 3 percent per year is orecast.Source: GreenNow USA

The two right-hand columns o Table 2 illustrate the perversity o some energy-water links. First, examine

the column showing the water costs to the homeowner. The costs are the highest in Brookline, where a per-

gallon assessment was added to water bills to pay or a new sewage treatment plant in Boston Harbor. Palo

Alto has the second-highest water rates, due to the presence o a wastewater treatment plant. Sunnyvale

gets the majority o its water rom a local acquier. In all three locations, there are substantial savings to

be gained by using less hot water in showers. This can be done by shortening shower time or replacing the

shower head with an ultra-low fow unit (one that uses 1.25 gallons per minute instead o the fow rate o

most shower heads, which is 2.5 gallons per minute). Ironically, once hot water use is reduced by a new

shower head, there is less value in replacing a standard hot water heater with an energy-ecient one. This

is shown by an increase in the number o occupants needed in each home to warrant early replacement in

Brookline and Sunnyvale.

The simple water heater market is a good illustration o the energy-eciency gap. Decisions are made or

noneciency reasons, and there is an interaction between technologies (water heater vs. shower head) thatrationally slows diusion o the most ecient water heater models. Further, the optimal replacement decision

varies by locale and depends on a number o local actors. The rebates, tax incentives, and inormation rom

advocacy groups seem tangential to the issues driving purchase and replacement decisions in this market.

The water heater market unctions, but is unresponsive to energy-eciency concerns.


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Low-Tech and High-Tech Solutions for Air Conditioning Load

Air conditioning is ubiquitous throughout the United States; in most regions, it is ound in almost

every home. Nationally, air conditioning accounts or 15 percent o total residential electricity

demand.17 In response to the heavy load air conditioning places on the power grid during peak

hours and hot days, utilities are implementing smart meters that cycle air conditioners o or 15

minutes per hour.18 At the same time, a recent study shows that air conditioning loads can be

reduced by 15 to 30 percent by the use o awnings that prevent sunlight rom reaching into the

home during the summer months.19 Alternately, homeowners can plant trees on the south and

west sides o their homes, shade their air conditioning units, or install window shades.20

Both low-tech and high-tech solutions are available to close the eciency gapbut the

connections provided by markets to stimulate change are missing.

17 U.S. Household Electricity Report,Energy Inormation Administration,U.S. Department o Energy, July 14,2005.

18 See, or example, the smart meter web page or Southern Caliornia Edison(http://www.sce.com/PowerandEnvironment/ami/deault.htm?=rom=redirect).

19 Awnings in Residential Buildings: The Impact on Energy Use and Peak Demand, University o Minnesota,Center or Sustainable Building Research, June 2007.

20 Donald R. Wulngho, Energy Efciency Manual (Energy Institute Press, March 2000).


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4. The Central Role of Private Investment Decisions

We now present our conceptual ramework or linking private investment decisions, emissions, and policies.

Public inrastructure plays an analogous role to private investment in this ramework. But it is dicult or

institutions to make decisions when aced with large and shiting uncertainties, so their role in a dynamic

and ast-changing environment is diminished. The private side o the eedback loop is where the action is.

Figure 4: Emissions Reductions: The Central Role o Private Decisions

Our ramework is shown in Figure 4. To trace through the links and fows, lets start at the bottom, with

the physical world o climate change. In the pre-industrial world, net emissions were near zero; carbon

emissions were in balance with the planets capacity to absorb carbon. In our modern world, net emissions

are signicantly positive, as carbon emissions are ar larger than carbon sinks. The large amount o net

emissions raises the stock o carbon in the atmosphere, which in turn raises temperatures and sea levels.21

The second level o the ramework shows the two main drivers o human emissions: behavior and capital

stock. Behavior (how much we drive, how high we set our thermostats, and so on) is fexible; behavior-driven

emissions can be reduced in the short run by simple modications. Our capital stock (cars, buildings, and thelike) is xed and leads to persistent emissions. One o the clearest examples o this was an experiment run in

a housing development in Lakeland, Florida.22 Two homes were completed in 1998 with the same foor plans

21 Paul Falkowski, et al., The Global Carbon Cycle: A Test o Our Knowledge o Earth as a System, Science, Vol.290, No. 5490, pp. 291206. Nicholas Gruber, et al., Interannual Variability in the North Atlantic Ocean CarbonSink, Science, Vol. 298: 2378.

22 See Building America: Research Is Leading the Way to Zero Energy Homes, U.S. Department o Energy(http://www.eere.energy.gov/buildings/building_america/pds/37547_zeh.pd).


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and orientation. Through specic energy-ecient choices during the building process, one home used only

10 percent o the power consumed by the other. With an expected service lie o orty to sixty years, there

will be a persistent dierence in energy consumption that even good habits cannot erase.

The third layer o our ramework fags the two deciders or capital stock: the individuals who make private

investment decisions and the institutions who make public inrastructure decisions. The challenge or

climate change policy is to make emissions concerns a signicant actor in private decisions, or as we saw

rom the water heater example, there are many other actors that drive capital stock decisions. The status

o public inrastructure also tips private investment decisions. For example, water in the Los Angeles basin

comes through a complex inrastructure, in which water is transported rom north to south through the

Caliornia Aqueduct and rom the Colorado River on the eastern border o the state to the coast. These

water suppliesvulnerable to earthquakes and energy-intensehave allowed the rapid population growth

o Los Angeles. Without this inrastructure, Los Angeles would not be nearly as large; the presence o public

inrastructure tipped private housing decisions.

The top layer o the chart closes the eedback loops. Markets, regulatory policies, and public institutions set

the stage or the economic considerations o private and public capital stock decisions. Climate outcomes,

such as rising temperatures or extreme weather, infuence policies. Eective organizations and institutions

at the top level can infuence private decisions toward reduced emissions.

In Figure 4, the lines connecting the markets and private investment decisions are darker than those

connecting institutions and public inrastructure. For several reasons, we see public institutions and

inrastructure playing a secondary role to private decisions and markets in the dynamic selection o clean

technologies. Here are some examples that cause us to question the decision-making possibilities o public

entities given the uncertain trajectory o climate change.

The problem is clear, but government action is not orthcoming:

U.S. sewers need $500 billion in repairs, but local governments are reluctant to raise taxes or a

problem voters cant see.23

The southeastern region o the United States is just months away rom running out o water and

local ocials are taking actions to drastically cut water use. Yet the Atlanta Journal-Constitution

reports that the problem was entirely oreseeable. A 2007 article noted that, Georgias water

shortage took decades to develop, with action thwarted by ocials short attention spans, euds

between states, and the alse assurance o rainy years.24

A prolonged lack o rain in the western United States led theNew York Times Magazine to wonder:

Will population growth and climate change leave the West without water? The West is the

astest-growing part o the country. Its also the driest.25

23 Deteriorating Sewer Systems: A Dirty and Costly Secret, Wall Street Journal, November 20, 2007.

24 Recipe or a Water Crisis: Plan. Fail. Repeat,Atlanta Journal-Constitution, December 16, 2007.

25 The Future Is Drying Up,New York Times Magazine, October 21, 2007.


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Scientists predict the collapse o 75 percent o the worlds sheries by 2050, which will have

devastating consequences or 1 billion people who rely on sh or their major source o protein.26

Yet coordinated global action on this international problem is entirely lacking, although the

challenge is more clear and the solution more simple than what we ace with climate change.

The problem is not seen by constituents:

Nobel Prizewinning economist Daniel Kahneman has observed: The potential consequences

o climate change are completely abstract, as ar as the population is concerned. Nobody is

eeling a thing, yet. To mobilize public opinion to get anything done is extremely dicult. One

has to question whether the social arrangements by which we live are adequate to cope with the

threat.27

Problems arise in maintaining the public policy/private markets balance ater extreme events. The insurance

markets are an example rom the ront lines.

Private insurers exited the Caliornia earthquake insurance market ater the 1994 Northridge

earthquake. The state established its own program, but high deductibles ($50,000) and large

premiums ($1,700 to $2,800 per year) have kept 89 percent o Caliornians rom buying in.

Meanwhile, Caliornians keep making the private decision to build and buy homes in areas with

high earthquake risk.28

In Louisiana, high insurance premiums and greater restrictions have made insurance unattractive

to homeowners ater Katrina. Insurers are not willing to cover parties new to the state, and this

has hurt recovery eorts.29

Floridas governor pleased voters by mandating lower insurance premiumsbut insurance

companies responded by dropping customers. The one company that is picking up customers isunder-capitalized, leaving insured and uninsured homeowners in the state vulnerable to nancial

ruin when the next large hurricane strikes.30

This list could go on, but our basic point is clear: climate change is a tough issue or public institutions to

tackle. Its uncertain trajectory, diuse costs, and complex causes make climate change ill-suited or public

decision-making in a timely or adaptive manner. Decaying public inrastructure is vulnerable to extreme

weather events, and ater such a disaster the path to recovery is not clear.

Meanwhile, citizens continue to make private decisions, and markets help them rapidly adapt to changing

conditions. For these reasons, we emphasize the eedback loop through market and private decisions that is

illustrated in Figure 4.

26 For a good summary, see Collapse: End o the Global Fish Stock by 2050?, an issue brie rom Globalization 101,the Carnegie Endowment or International Peace/the Levin Institute, December 2006(http://www.globalization101.org/index.php?le=news1&id=75).

27 From Global Warming to Weight Watching, Milken Institute Review, September 2006, p. 29.

28 Ater the Quake, Who Will Be the Chump? San Jose Mercury News, September 10, 2007.

29 Risky Business: Insurers See the Big Easy as the Big Loser, Fortune, August 20, 2007, pp. 7785.

30 Wishing the Wind Not to Blow, The Economist, August 11, 2007, p. 28.


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5. New and Reconnected Markets to Support Private Decisions

One o the most compelling eatures o the stabilization triangle analysis created by Pacala and Socolow is their

menu o technologies that are ready to scale to achieve substantial emissions reduction. In this section, we

will present a similarly immediate and compelling set o market opportunities to reduce emissions, including

companies and new markets already at work. Our survey o opportunities covers ve areas: service-based

business models; the creation o new markets through legislative and regulator at; the use o standards and

transparent metrics to accelerate market growth; modernization o the utility business model; and restricted

choices to integrate markets. When possible, in the discussion that ollows, the text provides the enduring

economic insights, while the gures summarize the current status. We expect the gures to become rapidly

out o date as the markets evolve.

ESCOsIn other new or ragmented markets, the market players and issues have been connected through a service

provider. Systems integrators played this role in past eras o the computer industry, providing expert knowledge

to companies struggling with their hardware and sotware purchases. As the water heater example above

demonstrated, there is a similar business opportunity in the energy markets.

In energy markets serving industrial and large commercial customers, this service model already exists in the

orm o ESCOs (energy service companies). An ESCO will perorm an on-site audit, recommend energy-

and water-reduction strategies, and then, i the client approves, implement the changes. Water heating is a

large end-use or this market segment, and there is a strong interaction between energy and water savings.

ESCOs are paid as consultants and/or or savings perormance.

Table 3 shows the current innovative market variations on the ESCO business model.

Table 3: Innovative ESCO Business Models

Service Model Sample Companies Target Customers

ESCO owns solar installation

on customers roo, sells solar

power back to customer.

Sun Run, SunEdisonHome owners, small and

medium-size businesses

Nonprot entity (unded byutilities) acts as ull-service

ESCO, including nancing.

Oregon Energy Trust, Eciency

VermontHomes and businesses

Peak demand aggregators

Energy Curtailment Services,

EnerNOC, Consumer Powerline,

Converge, Energy Connect

Businesses in targeted

geographic power markets

Nonprot ESCO is role model

o better practices.Clinton Foundation 44 cities around the world


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We have several comments on the current status o the ESCO endeavors. First, their market orce is growing

rapidly. For example, peak-demand aggregators currently manage 2,600 MW o peak capacity, the energy

equivalent o our and a hal average-sized coal plants. Second, there are some recent and important

innovations in the ESCO business model. The Clinton Foundation, or example, pools together projects in

a single city or a smoother construction schedule and increased purchasing power. The contract passes this

savings on to the building owners, signicantly reducing the cost o energy eciency.

Another innovative variant on the ESCO service model is the reworking o a xed cost to a variable cost.

Sun Run and SunEdison, or example, dont sell solar systems; they sell solar power. Instead o incurring

a large up-ront cost, the customer buys power as it is generated rom these companies; the companies

themselves own and maintain the rootop systems. A similar xed-to-variable cost transormation in the

insurance markets (pay-as-you-drive insurance) has decreased miles and emissions by 9 percent.31 Pay-as-

you-drive insurance is available in Europe, and a pilot project is underway in Washington state. Further

proposals include pay-as-you-pump insurance, so that drivers must requently conront the ull cost odriving. For both solar panels and auto insurance, the innovative service model uses a variable charge to

elicit the desired behavior.

31 Ian Parry, Pay as You Drive Insurance: A Better Way to Reduce Gasoline than Gas Taxes?, Resources or theFuture, April 2005.


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New Markets Created by Fiat

Several new markets or energy and emissions have been created at the state and regional level. Table 4

summarizes.

Table 4: New Markets or Emissions Reductions

Market Rationale Scale of Adoption

Renewable Energy

Credits (RECs)

State mandates renewable power

generation and allows utilities to

buy and sell RECs

to meet goals.

29 states, 1020% o local energy

markets.

White tags

State mandates energy eciency

and allows utilities to buy and sell

tags to meet goals.

Connecticut mandate; under

consideration in other states.

Needs verication protocol.

Carbon credits (U.S.)

Voluntary trading: More than

300 companies have joined the

Chicago Carbon Exchange (CCX).

34 million tons o CO2

eliminated

since 2003; $2$5 per ton.

Carbon credits

(Europe)Mandatory trading

100 million tons o CO2

traded per

month; $24$26 per ton.

Green pricing

Utility customers voluntarily agree

to increased rates to secure power

rom renewable energy.

Retail option in 44 states.

Incremental cost o 1.52 cents

per kwh. Average adoption rate o

1.5% to date.

The new markets or emissions reduction can be used in several ways. First, they smooth the costs o mandated

investments in renewable technologies, as the renewable energy credits (RECs) and carbon credits provide

fexibility over geography and time. Second, the credits accelerate clean-technology adoption when used

in project nancing. One example is the Oregon Energy Trusts use o voluntary carbon credits rom the

Chicago Carbon Exchange (CCX). The ESCO has been able to monetize 5 to 7 percent o the capital

improvements it subsidizes.32 Third, the markets are used to spur innovation.

32 Production Eciency Program, Best Practices, Oregon Energy Trust Presentation at the Joint West Coast PublicUtility Commissions 2006 Energy Eciency Workshop in San Francisco, December 1, 2006.


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Broadly, the new emissions markets are changing energy rom a single-dimensioned commodity to a multi-

dimensioned product. Imagine a host o sub-scripts on a unit o energy:

E BTU, RE, EE, PCO2, PK, STSt

BTU = price o energy content

RE = price premium or renewable energy (REC)

EE = price premium or energy eciency (white tag)

PCO2

= price premium or carbon reduction (carbon credit on CCX)

PK = price premium or peak demand reduction

ST = state where power is generated (so as to comply with local mandates)

With these sub-scripts, each unit o energy will be bought and sold in the emissions markets as well as on thecommodity markets. Fourteen Western states and eight New England states have ormed two wide trading

zones or RECs that will allow increased trading and arbitrage opportunities. This rich market inrastructure

will lead to more ecient energy use and greater reduction in emissions.

Standards

Inormation gaps oten lie at the heart o the market barriers to adopting energy eciency, but standards

can be used to insert inormation into the fow o commerce. For example, in early January 2008, the

Massachusetts State Senate passed a bill that would require home sellers to obtain an energy audit, so as to

inorm potential buyers o the homes energy costs.33

The European Union has had a similar measure in place since January 2006. 34 Figure 5 shows a certicate

required or each home in the EU at the time o sale or rent. In the box on the let, the home is given an

energy-eciency score, and a score or its potential. Each is accompanied by a letter grade. In the sample

certicate, the home is rated E but could improve to a C. For this home, the A grade remains elusive, most

likely due to retrot challenges. The box on the right shows the homes CO2

emissions rating.

33 Bill Seeks Home-Energy Use at Sale, Boston Globe, January 11, 2008.

34 http://www.ecorating.co.uk/eco-house/energy-perormance-certicate/deault.aspx.


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Figure 5: EU Home Perormance Ratings Make the Carbon Footprint Visible

Source: Energy Perormance in Buildings Directive

The EU standard does not require homes to meet a minimum level o perormance, but merely having

access to this inormation can change the decisions o buyers and renters. Homes that are more energy

ecient should command higher prices in the long run, as the energy savings are capitalized into the value

o the house. With more rapid turnover, the rental market will more quickly dierentiate, and rental prices

will all or homes and apartments with expected high energy costs.

Table 5 shows the multiple eorts to create standards in the U.S. market.

Table 5: Selected U.S. Standards Eforts

Standard Sponsor Adopters

LEED U.S. Green Building CouncilCommercial buildingsnationwide

GreenPoints BuildItGreenNew constructionin Caliornia

Home EnergyRating System (HERS)

Resnet Nationwide

Home Perormancewith Energy Star

U.S. Department o EnergyLocal organizations,19 states

International PerormanceMeasurement and VericationProtocol (IPMVP)

Coordinated with U.S.government agencies

Worldwide protocolor commercial sector


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There is a host o supporting technology to implement these standards, including test equipment, data loggers,

and sotware models. This in turn has led to the creation o several start-up companies that specialize in these

technologies, as well as market entry by established companies. Clean tech does not always mean power

generation, and as markets and standards develop, it will require the presence o supporting inrastructure

technologies.

Modernizing the Utility Business Model

Using less energy is a direct route to reduced carbon emissions. Forty percent o our nations energy

consumption fows through electric and gas utilities, under their pricing structures and rate-o-return

regulations.35 In most o the United States the only way a utility can increase revenues is by selling more

power. Their fat or even downward tiered pricing systems discourage conservation. But Oregon and

Caliornia have passed legislation that decouples electricity sales rom prots, making it possible or utilitiesin those states to prot rom the energy conservation o their customers.36 Ten states have similar policies to

encourage natural gas savings.37 Decoupling allows utilities to avoid costly new construction i it is cheaper

to purchase energy conservation and energy eciency rom its customers.

A second mechanism to encourage energy conservation is through upward tiered energy pricing. Time-

o-use pricing has been requently suggested as way or customers to pay their ull cost o service during

peak periods. Strong opposition to time-o-use pricing can be expected, however, rom those industries that

have heavily subsidized electricity rates under our current fat pricing scheme.38 Tiered pricing may be a

more palatable political alternative because it provides low-cost energy or a base level o usage. As Figure

6 shows, upward tiered pricing encourages energy conservation. In addition, research shows that upward

tiered pricing can be made revenue-neutral or the average customer, even as it encourages high-consuming

customers to be the early adopters o on-site renewable technology.39

35 Energy Basics 101, Energy Inormation Administration (http://www.eia.doe.gov/basics/energybasics101.html).

36 Martin Kushler, et al.,Aligning Utility Interests with Energy Eciency Objectives: A Review o Recent Eortsat Decoupling and Perormance Incentives, American Council or an Energy-Ecient Economy, October 2006,report U061.

37 American Gas Association.

38 Severin Borenstein, Wealth Transers rom Implementing Real-Time Retail Electricity Pricing,(September 2005). NBER Working Paper No. W11594 (available at Social Science Research Network:http://ssrn.com/abstract=800449).

39 Thomas Hu and Christy Herig, Electricity Rate Structures Can Be Used to Promote Solar PV: Lessons romCaliornia, June 19, 2002 (clean-power.com). For example, in northern Caliornia the early adopters o photo-voltaics are requently at the top price levels shown in Figure 12. For these homes, photovoltaics (at an average 22cents per kwh) are immediately cost-eective.


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Figure 6: Tiered Pricing Changes Consumption

8.25.4 5.1

11.413

22.7

31.7

36.4

16 66 kwh/day

/kwh

13 16 26 38 kwh/day

Pricing to encourage consumption

Otter Tail Power Co.

(Northern Minnesota)

Pricing to discourage consumption

PG&E

(Northern California)

/kwh

Restricted Choice Sets

Landlords buy appliances, but renters actually pay the electricity bills. The housing developer saves $2,000 in

construction costs, but it is the home buyer who will ultimately pay an extra $600 per year in heating bills due

to inadequate insulation. The uninormed consumer goes to the appliance store and saves $300 by buying the

low-cost unit, only to pay $75 per year in extra energy costs. An eective way to close these principal-agent

and inormation gaps is through appliance and building standards. Appliance standards are estimated to save1 to 3 percent o the nations energy use, but have an outsized impact, as sometimes a demand decrease o this

size can remove congestion in the natural gas markets and drop prices by 10 to 20 percent.40

During the energy crisis o the 1970s, Caliornia adopted the nations tightest building codes. Since then,

Caliornias per-capita energy consumption has remained fat, while the U.S. average per-capita consumption

has increased by 50 percent.41 About hal o Caliornias savings are estimated to come rom the states

building standards and eciency standards or appliances. The other hal o the savings came rom regulator

incentives to encourage customer energy conservation. Caliornias experience shows that local building

codeswhile not nearly as glamorous as solar and wind powerhave played an important role in decreasing

energy use.

40 Leading the Way: Continued Opportunities or New State Appliance and Equipment Eciency Standards,American Council or an Energy-Ecient Economy, March 2006. See also Jae, Newell, and Stavins, Energy-Ecient Technologies and Climate Change Policies: Issues and Evidence, Resources or the Future (r.org), 1999.

41 Caliornia Energy Commission presentation on March 4, 2007, to the Caliornia Assemblys Utility and CommerceCommittee (http://www.energy.ca.gov/2007publications/CEC-999-2007-010/CEC-999-2007-010.ppt#10).


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To conclude this section, we note that markets dier rom technologies in how they aggregate. While the

emissions-reduction capacity o technology is simply additive, market changes are synergistic. The many new

and reconnected markets listed above work together, and the presence o one market innovation can cause

others to grow aster and on a larger scale. Other market areas, not mentioned here, could do the same.

Broken Markets and Policy Stumbles

It is useul to briefy consider two policy stumbles, attempts to close market gaps that ailed:

solar hot water subsidies in Caliornia and energy-ecient mortgages. In response to the energy

crisis o the 1970s, Caliornia heavily subsidized solar hot water.42 This technology is much more

energy-ecient than photovoltaics, and a good match or this sunny state. But the programs

implementation stumbled at contractor certication and training and inspection o installations.

This led to a great deal o raud (only hal o installations still worked ve years later) and taintedthe solar hot water market. Only in 2007, thirty years later, did the state legislature reconsider

solar hot water subsidies.

Energy-ecient mortgages also ailed to catch on; a pilot initiative closed with little notice in

June 2007. The goal o the program was to expand the borrowing capacity o home buyers who

wanted to make home improvements to increase energy eciency. The ederally guaranteed

program added up to $15,000 to the amount borrowed or a home purchase. But it simply proved

to be too dicult to get the paperwork done during home-buying transactions. In a situation

with multiple bids on a home, program users were at a disadvantage because their paperwork was

processed more slowly than other bidders. Coordination between the ederal agency, the banks,

and mortgage brokers was dicult, so even eco-riendly mortgage brokers did not advertise the

program.43

These two policy ailures highlight how the natural stream o commerce dominates the transaction

fow. To be eective, policies must slot in to an existing stream o commerce and work at its

speed. Expecting to change the stream o commerce or a new attributeenergy savings or energy

eciencywont work.

42 Margaret Taylor, et al., The Role o Technological Innovation in Meeting Caliornias Greenhouse Gas EmissionTargets, Managing Greenhouse Gas Emissions in Caliornia, Caliornia Climate Change Center at UC, Berkeley(March 2006).

43 Source: Private communication, Tomek Randio, CEO o MortgageGreen, October 2007.


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6. Experiencing Climate Change Locally

A amous saying holds that all politics is local; the same is true or climate change. In this section we ocus

on the experience o living through climate change in a particular locale, and the actors that will shape

private decisions. We argue that the local environment has implications beyond simply the weather. For

example, the NIMBY (Not In My Back Yard) sentiment prevents local siting o coal and nuclear power

plants, leading to a plethora o lawsuits.44 Without these power sources, regions scramble or alternatives.

And as with the water heater/shower head example we cited in Part 3, local inrastructure changes local

costs and tips private decisions.

As citizens and residents, we are most concerned with the experience o local weatherwe typically have

only a passing interest in the big snowstorm somewhere else. But we also make large inerences about events

taking place elsewhere, such as linking Hurricane Katrina and the Caliornia wildres to climate change.

In a world o climate change uncertainty, it is easy to conuse local weather variations and a longer-termtrajectory. So part o the local experience is a large amount o uncertainty about the real eects o climate

change, and uncertainty tends to delay investment in new technologies. Local policies tailored to conditions

on the ground can reconnect markets and break through this inertia.

While it might seem that the enormous, ully integrated climate change models are the sum o many local

outcomes, they are in act high-level models that rely on smoothly growing trajectories. These trajectories

dier rom each other by relatively small amounts. Population growth might be 1.8 percent per year in

one scenario and 2.1 percent in another. But with 50- and 100-year horizons, these small dierences are

compounded, becoming a large change. By contrast, a local recessionsuch as the 20 percent drop in

employment experienced in Silicon Valley during the dot-com busthas no eect in the broader models.

But in real lie, it did impact responses. A local recession can halt new construction or a ew years, andwhen building resumes, a dierent technology set is available or capital stock decisions. Because o the long

service lives o buildings and machinery, this blip in investment patterns has local energy-use consequences

or years to come. So, unlike the smooth climate change models, the local experience is path-dependent;

the particular history o a locale matters or uture investment decisions.

Local Outcomes for Climate Change, Local Concerns

The University o Maryland recently completed a study on the variation o climate change by U.S. region.

Table 6 shows a ew illustrative ndings or three diverse regions.45 It highlights the large regional variations

and the many sources o local stresses rom a climate shit. The examples also illustrate the tight connectionbetween water and climate, with water issues hitting local economies hard. This is not surprising, as nearly

40 percent o water use is or power generation and 80 percent o the cost o water goes toward energy.46

44 Lawsuits Aim to Slow New Coal Boom, Associated Press, January 14, 2008; Strangers as Allies: Fight AgainstCoal Plants Is Creating Diverse Partnerships, New York Times, October 20, 2007.

45 The U.S. Economic Impacts o Climate Change and the Costs o Inaction, Center or Integrative EnviornmentalResearch, University o Maryland (October 2007).

46 Energy-Water Nexus Overview, Sandia National Laboratories (2006).


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Similar studies have been completed by a number o state and regional agencies, and a common nding is

that climate change presents a daunting challenge or local resources and inrastructure.

Table 6: Varied Local Consequences o Climate Change

West Great Plains Mid-Atlantic

Smaller snowpack in mountains;

less stored water or agriculture

and urban areas.

Higher temperatures increase

water needed or agriculture by

50%; water conficts decrease

arm income.

More requent hurricanes in major

metro areas; expected damages

$50$66M per event.

Lack o water causes armland

values to all by 30% or more.

Drought-stressed eco-systems

susceptible to invasive species;

crops destroyed.

Sea level rise o 20 inches; damages

o $8B$58B.

Rising sea water; $1.5B cost to

protect San Francisco Bay Area.

Decreased soybean productivity

(70% decline); decreased wheat

productivity (1050% decline).

Rising ocean temperatures and poor

water quality; $63B regional ocean-

based economy at risk.

Local Resources Color Local Experience

As we enter 2008, two acts collide at the local and state levels. Scientists are calling or climate change

policies that reduce emissions immediately. But state budgets are quickly alling into decits due to theslump in the housing market and stagnant income growth. Unlike the ederal government, states cant run

large persistent decits, so there is a conspicuous lack o resources or new climate change policies just as

the call to action has become acute.

The lack o local resources will change outcomes. One small but clear example can be seen in the resort

town o Sisters, Oregon. Surrounded by the Cascade Mountains, Sisters sits directly below a large mountain

lake that is nestled in a rock bed. Currently the rocks are held together with rozen ice. But as climate

change progresses, experts worry that the ice will warm and the lake waters will race down the mountain

and food the town.47 The population o Sisters (2,400 people) is too small to galvanize authorities into

building a dam to slow the food waters. Perhaps the town will put a sensor on the mountain lake to gain a

twenty-minute warning o the impending food. Local residents and institutions can see but not prevent this

potential disaster. I Sisters or another town in the area experienced a signicant food, property values or

vacation homes would all sharply, urther eroding the local tax base. The mountainside would be scraped

clean o trees and oliage, setting the town up or a stream o mudslides in years to come. Extreme weather

and local resources are signicantly mismatched.

47 Lake Threat Looms Above Sisters, The Nugget, August 1, 2007.


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Public Infrastructure Failures, Private Investment Solutions

Previously we noted the extreme drought in the southeastern United States. A similar prolonged drought

in Australia illustrates the role o private investment decisions in adapting to new conditions.48 During theAustralian drought, a water desalinization plant was constructed in Perth, but another one in Sydney was

rejected by voters. The government has responded to the water shortage by instituting rationing rather than

signicant increases in water prices. As a result o stalled inrastructure development and water rationing,

Australian companies have developed a number o interesting technologies to make the best use o scarce

water. These include small-scale wastewater recycling systems or agricultural use (purchased by armers);

in-home gray-water treatment systems (purchased by home owners); and oce water coolers that create

water through condensation (purchased by companies). These technologies illustrate the strong climate/

markets/private-decision eedback loop presented earlier in Figure 7.

In sum, local climate change is the version we actually experience, and the constraints and challenges

encountered at the local level are more acute than aggregate climate change models can capture. The

mismatch between local resources and the magnitude o the challenges presented by extreme weather

is worrisome. The technology innovations rom Australia illustrate the shit toward market and private

investment decisions in these cases, but they do not completely address the large public inrastructure gap

that is becoming more apparent as the climate shits.

48 Kathryn Marks, Australias Epic Drought: The Situation Is Grim, The Independent, April 20, 2007 (http://www.independent.co.uk/news/world/australasia/australias-epic-drought-the-situation-is-grim-445450.html).


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7. A New Geometry for Climate Change Policy

In Section 2 o this paper, we introduced the stabilization triangle and the wedge solution o Pacala and

Socolow (2004). In this section we bring together the insights about markets and private investment

decisions to create an alternate depiction o climate change policy.

To begin, we review the scope o policy action. Jeery Greenblatt and other researchers have reconciled the

stabilization-triangle ramework with the baseline scenarios o the IPCC.49 The IPCC baselines are known as

Business as Usual, and represent a climate uture i no policy action is taken. Figure 7 shows the result.

Figure 7: Expected Decarbonization Reduces the Role of Active Policy

Stabilization of Emissions Growth

Ex

trapolatio

nof

Hist

orica

lEmmiss

ions

Growth

IPCC BAU scenario

No climate policy

Active climate policy

The IPCCs BAU scenario does not depict an economy that is simply running on autopilot. It represents

expectations that: a) across the economy, units o commodity input per unit o output continue to decline

at historical rates; and b) there is signicant adoption o low-emission technologies, at rates that exceed

historical precedent. In contrast to the top line (labeled the current path), the BAU scenario actually

includes the eects o global modernization and substitution o renewables. Yet the very dismal prognosis

rom the IPCC is that the BAU outcome will bring signicant increases in temperature, ice melt and rising

seawater.50 So the BAU scenario represents a furry o activitybut not enough o it.

49 Jeery Greenblatt, et al., Wedge Analysis o IPCC SRES and Post-SRES Scenarios, Fourth Annual Conerenceon Carbon Capture and Sequestration, U.S. Department o Energy (May 2005).

50 See U.N. Chie Seeks More Leadership on Climate Change,New York Times, November 18, 2007, and InGreenland, Ice and Instability,New York Times, January 8, 2008.


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Figure 7 is divided by the BAU scenario. Four o the seven wedges prescribed by Pacala and Socolow are

above the IPCCs BAU scenario. Three additional wedges are needed or emissions stabilization, and these

will require policy action. But both above and below the BAU line, our economy must undergo signicant

change to deliver emissions reductions.

Figure 8 is a depiction o how markets and private investment decisions will ll the stabilization triangle.

Instead o the smoothly growing wedges o Pacala and Socolow, Figure 8 shows an almost chaotic mosaic

o shapes and colors: the result o rapid technology change in a dynamic market. Two geometric shapes in

the mosaic represent the demise o new technologies. The wedgelet, or small triangle, represents a small

growth in adoption ollowed by sudden displacement. (An example o such rapid demise is the ax machine,

once considered a breakthrough in communications; its sales plummeted once the Internet took hold.) The

diamond represents a small growth in adoption ollowed by a slow demise. (Think o phones with corded

handsets; these are slowly replaced as wireless handsets continue to take over the home market.) Over time

the stabilization triangle becomes a collage o new and then abandoned technologies.

On the right side o the gure are large right triangles. These are the ruits o intensive R&D programs

or clean technologies. The stabilization triangle is only the rst stage in emissions reduction. Under this

two-stage plan, aggressive emissions reductions are avoided until 2055, whenit is ervently hopednew

technologies will reduce emissions more cheaply. The right triangles represent technologies poised or rapid

and large deployment at mid-century.

The market dynamics create a collage o shapes above and below the IPCCs BAU scenario. To those

experiencing this economic transormation, it will appear that some emissions-reduction technologies are

cheap (these are in the area above the BAU line) and some are more expensive, requiring policy action

to tip private decisions (these are shown in the area below the BAU line). Regardless, the marketplacebecomes a rapid arbiter o winning and losing technologies.

Figure 8: The Mosaic o a Markets-Based Policy or Climate Change

Extrapolation

of Historical

Emissions Growth

Dominant Technology

New Technology,

Abandoned Slowly

New Technology,

Abrupt Displacement

IPCC

BAU

Scenario

Today 2050

Stabilization of

Emissions Growth


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While the Pacala and Socolow wedge approach ocuses on energy sources and energy eciency, the opportunities

to reduce emissions span a much wider set o decisions and technologies. Figure 9 is an abstraction o the ull

range o technologies that will be part o the market dynamics in the next hal-century.

Figure 9: A Broad Spectrum o Innovations Will Reduce Emissions

COMPANY EXAMPLES

ServicesRecycle BankPay customers to recycle

TransportationTesla MotorsElectric car

Eciency InfrastructureEnerNOCAggregate d emand reduction

Energy StorageUnited TechnologiesSolar with molten salt storage

Building MaterialsSerious MaterialsLow-carbon drywall for buildings

Recycling and WasteGreen CitizenCorporate recycling of electronics

WaterAir2WaterOce water cooler from condensate

Power GenerationNanosolarLaser-printed solar cells

MARKET TAXONOMY

The vertical layers in Figure 9 show the many market segments o clean, emissions-reducing technology.

The two layers marked with stars are the types o clean technology in the wedge ramework. But the six

other layers represent signicant opportunities or emissions reduction as well. Examples o companies

currently oering these services or products are to the right. While some o the carbon-reducing eatures o

the innovations are obvious, others are less so. This is a salient eature o the market-based approach: with

broad-based standards, innovations will emerge rom all quarters to supply reductions. For example, Recycle

Bank pays residential customers to recycle and splits the proceeds o selling the waste stream with local

municipalities. Serious Materials is a company that reduces the energy input and thus the carbon emissions

o drywall (used in construction) by 90 percent.51 Figure 9 illustrates that while we currently have a carbon-

based inrastructure, innovations are underway at many levels to make the shit to a non-carbon uture.

51 Eort to Build Greener, San Jose Mercury News, January 5, 2008.


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Buying an Option to Exercise in Mid-Century

Let us return or a moment to the large right triangles in Figure 8. Many voices have called or an intense,

ederally unded eort to accelerate research and development o clean technologies. In a recent speech,Proessor Socolow laid out a rough sketch o the sources o emissions in 2030. This mental model can also

be used to direct the resources o an all-out R&D eort to have their largest impact. Figure 10 is a stylization

o Socolows projections o where uture emissions will originate under the BAU scenario.

Figure 10: Focused R&D Delivers Results or 2030

Source: Socolow, E&ETV, March 2007; Pacala and Socolow, 2006.

The rst group in Figure 10 is made up o developing countries, regions with rapid population growth

and increasing levels o per-capita consumption. Emissions growth rom this group will be high, but with

signicant pieces o inrastructure yet to be built, there is an opportunity to install clean technology that

will reduce emissions or decades to come. (But that opportunity cuts both ways: missing this moment o

development will lead to the installation o dirty technology that will most likely remain in place, polluting

or decades to come.) A major R&D eort could have a signicant impact on this group.

Modernizing countries: 2.4 billion people

2007 emissions: 3.9 gigatons o CO2

per year


per year

Climate change investment goal:

New, energy-ecient inrastructure to support increased (clean) consumption

Industrialized countries: 1 billion people


per year


per year


Early retirement o aging (dirty) inrastructure and capital stock

Impoverished countries: 2.6 billion people


per year


per year


Clean and cheap cooking uel to improve indoor air quality

and eliminate the brown cloud over Southeast Asia


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Industrialized countries make up the second group. They are expected to grow their emissions rom 3.75 GtC

per year to nearly 7GtC per year during the next twenty-ve years. With capital stock and inrastructure in

place, clean technologies will only be adopted at a rapid pace i they t into the existing inrastructure and

oer such compelling economics that early retirement o the existing capital stock is justied.

The nal group consists o impoverished countries, which are expected to have no emissions growthbut

or harsh reasons. While 1 billion people in this group live in urban areas, they do not have reliable power

or indoor running water. The other 1.6 billion people in impoverished countries live in rural areas. Simple

and low-cost technologies or clean cooking uel, water, and on-site power or lighting could dramatically

change their lives. Despite their poverty, this group produces a particularly important source o emissions:

the soot and particulate rom cooking uel, which blocks the sun and is now believed to be a signicant

health hazard and contributor to global warming.52 R&D ocused on these problems could have a signicant

eect on climate change.

Consider the case o Tata Motors, the Indian car company that recently announced it was selling a vehicle

or $2,500.53 Called the Peoples Car, it is giving environmental leaders nightmares since it has the potential

to add so many cars to the road. A concentrated R&D eort or clean and cheap technologies aimed at the

developing worlds ast-growing middle class could ocus Indias considerable intellectual talentand the

brainpower o several countrieson these emissions problems.

As Figure 10 makes clear, an ambitious R&D eort could have a disproportionately large impact. For each o

the three groups o nations, private decisions will dictate the pace o changeand private decisions coupled

with cutting-edge research could have ar-reaching global benets. While policy analysts have assumed

that a clean-tech eort depends on increased ederal spending, this paper has shown that strengthening

markets and tipping private decisions in developing and impoverished countries could serve to draw outnew products based on privately unded R&D.

Our eorts need to limit themselves to technology alone. It is clear that technology is only hal the picture.

As Thomas Schelling, a Nobel laureate in economics, asks:

How well can people, businesses, governments, and communities adapt to the

climate changes, especially in countries heavily dependent on ood production,

in countries with poor educational and technological attainment, poor fscal or

legal systems?54

Although the task at hand is considerably less dened at this time, we need two eorts to run concurrently:

one or technology and one or organizations.

52 See the press release by the National Science Foundation describing the latest research on this topic athttp://www.ns.gov/news/news_summ.jsp?cntn_id=109712.

53 The $2,500 Car: An Environmental Nightmare?, ABC News, January 10, 2008 (http://abcnews.go.com/Business/GadgetGuide/wireStory?id=4113059).

54 Thomas C. Schelling, Climate Change: The Uncertainties, the Certainties and What They Imply About Action,Berkeley Electronic Press (July 2007).


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Beore concluding, lets be careul about the economics o an intense R&D and organizational eort. The

strategy is to invest in R&D today so as to create an opportunity or additional investment at mid-century.

While burdensome, todays cost is only the purchase o an option. Exercising that optionby deploying

mid-centurys brightest technologieswill be even more expensive. Despite the large costs, an option to

invest in the uture can be extremely valuable in an uncertain world. By ocusing our R&D and institutional

development eorts today, we can signicantly improve the lives o our children and grandchildren. Without

stabilization o emissions and R&D investments, uture generations will be making a set o dicult choices

in a world saturated with carbon.


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8. Conclusions

We have endeavored to bring a new and unique perspective to bear on climate change policy by putting

private investment decisions at the center o the analysis and examining policies, institutions, and

inrastructure rom that vantage point. Unlike technology prescriptions or climate change, this perspective

has a clear central actor: the individual who makes a huge number o consumption decisions every day.

A host o policies, new markets, and supporting technologies can tip many o those decisions toward a

greener outcome.

Our perspective is that climate change is experienced in micro settingsour homes, our communities, our

regionsso we need policies tailored to address local conditions. Globally, the way orward will be the sum

o decisions made by millions o individuals in response to the situation at hand.

We hope that this paper sparks discussion and action. National policies and global accords can accelerate

the positive trends identied here. But in the meantime, and as a complement to national policy, citizens

have the power to act both in their private decisions and in their demand or local policies to support new

markets and business models, unleashing the invisible green hand.


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About the Authors

Martha Amram is the CEO and co-ounder o GreenNow USA, a company that helps home owners save

energy and reduce carbon emissions. She is also a senior ellow o the Milken Institute. An expert on

valuation and strategy, she has had a wide range o business experience in management consulting, start-up

ventures, and academia. She is the author oValue Sweep: Mapping Corporate Growth Opportunities (Harvard

Business School Press, 2002; translated into ve languages) and the co-author, with Nalin Kulatilaka, o

Real Options: Managing Strategic Investment in an Uncertain World (Harvard Business School Press, 1998;

translated into ve languages). Amrams work is widely published, including recent articles in Strategic

Finance,the Harvard Business Review,and theJournal o Applied Corporate Finance.

Previously Amram was chie economist at PLX Systems, where her algorithms or valuing intellectual

property were incorporated into the rms sotware products. She also served as CEO o Vocomo Sotware

Corp., which provided sotware and services or voice applications. Amram was managing director atNavigant Consulting, where she was head o the real options practice area and managed strategy consulting

teams across a number o industries, rom consumer goods to energy to high-tech.

Amram was a co-ounder o Glaze Creek Partners, a consulting rm that was sold to Navigant in 1999.

She also served as an expert witness on valuation while vice president at Analysis Group and was a aculty

member specializing in corporate nance at the School o Management at Boston University. Amram holds

a Ph.D. in applied economics rom the Massachusetts Institute o Technology (MIT) and is a graduate with

honors in mathematics and economics rom the University o Washington.

Nalin Kulatilaka is the Wing Tat Lee Family Proessor o Management and Proessor o Finance in the

School o Management at Boston University. He serves as the research director o Boston Universitys

Institute or Leading in a Dynamic Economy. His current research interests include investments in clean

technology, the economics o business platorms, the valuations o early-stage rms, the role o energy

intermediaries, technology licensing, and nancial contracting.

Kulatilaka has published more than 75 papers in scholarly journals, and is the co-author o the book

Real Options: Managing Strategic Investment in an Uncertain World (Harvard Business School Press, 1998).

He received the Association or Investment Management and Researchs Graham and Dodd Award in

recognition o outstanding eature articles published in the Financial Analysts Journal. He also served as the

Bertil Danielsson Proessor at the Stockholm School o Economics and Gteborg University, and as theTamkang Chair at the Tamkang University in Taiwan.

Kulatilaka co-ounded Glaze Creek Partners LLC and International Internet Services. He received a

bachelors degree in electrical engineering rom Imperial College, London; a masters degree in decision and

control rom Harvard University; and a Ph.D. in applied economics rom MIT.

Documents

The Invisible Green Hand