Fossil Resource Markets and Climate Policy: Stranded Assets, Expectations and the Political Economy of Climate Change (FoReSee)

The FoReSee research project (Fossil Resource Markets and Climate Policy: Stranded Assets, Expectations and the Political Economy of Climate Change) analyzes the interplay between policies to mitigate global climate change and the behavior of various participants in financial and fossil fuel markets.

The main objective is to investigate how policies can be designed to overcome the inertia of the energy system and facilitate its transformation without excessive costs to society. FoReSee quantifies the redistribution of rents implied by various proposed climate policy instruments in sectors and countries vulnerable to asset stranding. It tries to understand private actors’ responses to current and expected, potentially uncertain, climate policies, and considers how climate policy design should take these responses into account. FoReSee puts emphasis on the interplay of actors, policies and information on fossil fuel and financial markets, while taking into account political economy and institutional constraints to effective climate change mitigation. In addition to traditional demand-side policy instruments, FoReSee investigates recently discussed supply-side climate policies and strives to suggest alternative instruments. The combination of empirical, numerical and applied theoretical modeling provides comprehensive guidance on appropriate and feasible policy design to correct inefficient market-side responses.

To ensure the applicability and relevance of its policy recommendations, FoReSee will engage in a multi-stakeholder dialogue with key players from the private sector (including firms in the energy sector and in finance/insurance), the public sector (including fossil-fuel producing countries and European policymakers) and the academic community. Transdisciplinary workshops and bilateral consultations integrate stakeholders’ incentives, strategies, and modeling input, thus ensuring the co-design and co-production of knowledge.

The results will be made available continuously over the project horizon in policy briefings, working papers, peer-reviewed academic journal articles, at international conferences and in integrative project workshops. The project will contribute to the education of junior researchers and actively engage with the national and international community of stakeholders and researchers in the economics of climate change.

„FoReSee is one of the projects financed by the BMBF under the funding measure Economics of Climate Change II. The funding measure is intended to strengthen competencies in the field of climate change economics and thus provide well-founded, solution-oriented knowledge. In order to support this knowledge transfer and to intensify the exchange between researchers and practitioners, the funding measure is accompanied and supported by the project "Dialogue on the Economics of Climate Change" (https://www.klimadialog.de/)“.

Work Package 1 (WP1)
- Inter-fuel climate policies and market reactions (HU)
  
  The main research question in WP1 is how different climate policies affect the distribution of rents between fuels and countries. Recent literature highlights the theoretical advantages of supply-side climate policies. It has been argued that for coal, supply-side policies may be less prone to carbon leakage, and that the green paradox could be eliminated with a supply-side policy that targets high-cost coal deposits. Among others, Harstad (2012), Collier and Venables (2014), Martin (2014), Richter et al. (2015), and Green (2016) have suggested novel climate policies. However, theoretical studies have so far considered all fossil fuels as one homogeneous good, and analysis of differentiated inter-fuel effects of various policies has been lacking.
  
  We test alternative climate policies in different settings. The results will inform policymakers on potential benefits and caveats of these policies. We will extend the existing theoretical literature on extraction rights, deposit markets, and rent distribution between fuels and countries in analytical models by studying the implications of different arrangements concerning property rights and by introducing inter-fuel effects. We will use partial equilibrium and game theoretical models and extend existing models to allow strategic interactions between fossil fuel asset owners. During the project period, the work in WP1 will proceed stepwise. After the models are set up, they will be extended to allow for the representation of inter-fuel policy effects.
  
  Project Website:
  Resource Economics, Humboldt University Berlin
  www.agrar.hu-berlin.de
  
  Project Team:
  Klaus Eisenack, Website
  Achim Hagen, Website
  Paul Neetzow, Website
Work Package 2 (WP2)
- Carbon bubble, expectations and policy shocks (ifo)
  
  This work package investigates which types of information shape investors’ expectations of stranding of assets, what are relevant signals from policymakers, and how companies react to climate policy risk and uncertainty. The current market valuation of companies owning fossil fuel-related assets does not seem to reflect the loss associated with these assets becoming stranded. This applies to extractive industries as well as to electricity companies with a large share of fossil-based generation, or firms with knowledge stocks in fossil-based technologies. Mispricing of stranded asset risk might lead to costly consequences for the whole economy. Policymakers must understand the drivers of financial markets and investors, especially the extent to which planned policies shape investors’ beliefs.
  
  We will econometrically analyze stock and bond prices and other firm-level and investor data. In particular, we will conduct event studies and other econometric analyses to investigate the market valuation of different types of fossil and clean assets in interaction with climate policies.
  
  Project Website:
  ifo Center for Energy, Climate and Resources, ifo Institute, Munich
  www.ifo.de
  
  Project Team:
  Marie-Theres von Schickfus, Website
Work Package 3 (WP3)
- Climate policy in resource curse-affected countries (DIW)
  
  This part of the project focuses on resource-dependent countries and their role in a climate-constrained world. We investigate how fossil producers shape the world, and how are shaped by it. Fossil-fuel-abundant economies may suffer from the resource curse, a set of adverse economic and political developments, often due to institutional constraints. A lack of economic diversification has led to resource rent dependency, such that falling revenues, e.g. from asset stranding, endanger growth and stability in curse-affected countries. Therefore, affected governments might be counteracting global climate mitigation efforts.
  
  Our efforts in this work package focus on understanding the effect of climate policy on fossil fuel producers, their internal dynamics, and the role of institutions in the interdependencies between good government, resource management, economic diversification, and climate change mitigation. The results will assist German and European policymakers in designing robust and consistent climate policies, actors in fuel-producing economies in establishing sustainable development, and researchers in finding better ways to model the behavior of resource producers. The work is undertaken in collaboration with representatives from resource-rich countries, especially from the Middle East and Latin America.
  
  Project Website:
  Energy, Transportation, Environment, DIW Berlin
  www.diw.de
  
  Project Team:
  Dawud Ansari, Website
  Franziska Holz, Website
Work Package 4 (WP4)
- Fossil lobbies and politically feasible climate policy (ifo)
  
  This work package assesses the political sustainability and credibility of climate policies, and designs policies that can be supported politically. Specifically, it considers strategic competition for political influence between different interest groups in the fossil energy sector, under the threat of asset stranding. Such strategic lobbying occurred, for example, in the run-up to the 2016 Paris negotiations. Further, WP4 analyses to what extent international coordination of climate policies is facilitated or hindered by the interests and the influence of multinational firms and other transnational lobby groups.
  
  The goal of this work package is to design policies that ensure the political sustainability of climate action: implemented regulations should not only aim at reducing emissions, but also take into account their effects on the viability of future regulation. The work package will develop stylized theoretical models of dynamic political economy to gain insight into the fundamental mechanisms of these questions. It will also seek to develop quantitative evaluations using calibrated models.
  
  Project website:
  ifo Center for Energy, Climate and Resources, ifo Institute, Munich
  www.ifo.de
  
  Project team:
  Waldemar Marz, Website
Work Package 5 (WP5)
- The role of uncertainty and beliefs in climate change policy (ifo)
  
  This work package addresses how uncertainty over future climate change and climate policy interacts with asset prices and technological investments. Climate change impacts and climate policy involve long-run uncertainties and related beliefs, thereby affecting investment decisions. Further, new information and changes in policy expectations create market volatility and adjustment costs. Poor information processing, market incompleteness and policy uncertainty result in inefficient resource allocations, raising the cost of climate policy and inhibiting the shift to a green economy. We design policies to address these long-run risks and to minimize the resulting cost of uncertainty to society. Identifying policies that can prevent inefficient investments in assets that end up “stranded” is a key goal of this work package.
  
  We will create a model that combines a disaggregated energy sector (i.e., with an explicit representation of fossil and clean energy assets) with a full-fledged stochastic dynamic programming model for decision-making under uncertainty. Such a model will allow a theoretically rigorous and quantitatively realistic investigation of stranded energy assets in a long-run climate cost-benefit framework.
  
  Project Website:
  ifo Center for Energy, Climate and Resources, ifo Institute, Munich
  www.ifo.de
  
  Project Team:
  Karen Pittel, Website
  Christian Traeger, Website

Area

ifo Center for Energy, Climate, and Resources