Essays on information and climate change: conclusion and summaryBy Ian Temperton1

Thermodynamics is the science of transformations2 and the science of systems.

We are concerned here with a number of systems: that which has been created by human-kind on Earth which provides us (most of us) with a substantially greater length and quality of existence than we would have had otherwise; the energy system which powers the development and maintenance of that human system on Earth; the financial system of money and information flows which powers the development of that physical energy system; and the wider planetary system in which we exist (of which our biosphere, atmosphere and oceans are the major part).

We are also concerned with a number of transformations of those systems. Our existence on Earth is the result of a number of accidents in geological time which have lead to the Earth’s systems being amenable to human development and habitation within this particular inter-glacial period. While operating in the full knowledge that meteorite impacts, long-period oscillations around the sun, volcanic activity or the eventual expiry of the sun will one day lead to the extinction of the human race on Earth, we are concerned with preserving our current state of civilisation and its generally positive trajectory for as long as possible. This being our deeply felt ethical obligation to the generations which come after us (actually it is probably a genetic predisposition). It is also true to say that the events which will otherwise destroy us currently seem likely to happen only on a timescale which is orders of magnitude greater than known human civilisation and hence substantially beyond our ability to comprehend.

The only known prospect of the Earth’s wider systems being transformed in a way which threatens the human-dominated

system and the abrupt end to the current benign state of that system is the result of the almost instantaneous (in geological time) release of substantial quantities of gases with enhanced warming characteristics into the atmosphere.

We fear a transformation of the Earth’s system which is consistent with those which have happened previously in geological time, where a dramatic and abrupt change in the composition of its atmosphere has caused major changes to its sea level, glaciations levels, temperature, and weather patterns. We fear the destruction of the Greenland and Antarctic Ice shelves; we fear sea level rise; we fear the deglaciation of the Himalayas; and major changes in our weather systems. Such transformations, when they have occurred in periods where life existed on Earth, have created mass extinctions and hence massive changes in the biological systems of the planet.

We fear these transformations, not necessarily for their own sake, but for the impact they have on the human systems in which we have invested so much historical resource and on which we crucially depend. Our human system, while apparently dominant on the planet, is both critically wedded to the wider planetary systems and in a constant battle for survival against them3.

Amongst the many ironies of climate change is the fact that the transformation we fear is the result of the most productive transformation in human history, which was, itself, the product of a great transformation of the planet’s system by its interaction with biological life.

We owe much to the organisms of prehistoric times which contributed to the transformation of the Earth’s

References:1. Ian Temperton is Head of Advisory at Climate Change Capital. From late 2009 to early 2011, he was a Visiting Business Fellow at the Smith

School of Enterprise and the Environment at the University of Oxford. This is one of a collection of essays that are the result of his research during that time. I would like to thank everyone at the Smith School and Oxford (especially Cameron Hepburn) and those who have read early versions and provided comments. These include Rupert Edwards, Malcolm Keay, Rick Jefferys, Walt Patterson, Ben Caldecott and Robert Ritz. All errors and omissions remain entirely mine.

2. This is a quotation taken from Enrico Fermi the Nobel Prize winning physicist, but I think it is also a general statement. See (Fermi, 1936).3. See (Lovelock, 2006) and (Lynas, The God Species: How the Planet can Survice the Age of Humans, 2011) and while I have focussed in these

essays on the transformation since the industrial revolution see (Ruddiman, 2005) for some fascinating work on the fact that we have been at it since we were cavemen.

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References:4. I appreciate that mines were not a mile deep (in fact even now I don’t believe there are any actually mile deep mines) and that entropy wasn’t

discovered until late in the nineteenth century. Allow me the occasional bit of artistic licence, if you will.

system into one habitable by human civilisation through the extraction and sequestration of carbon in the Earth in the form of hydrocarbons such as coal, oil and gas. This pre-historic transformation, in part, provided us with the benign atmospheric situation which we inhabit today.

The ability of the human race to impose itself so dominantly on the planet in the last 250 years or so has involved the reversal of that pre-historic transformation. The creation of the great order and capacity for useful work within the human-dominated system of the planet has enhanced human life and caused an exponential growth in almost every measure of human existence (including and especially population).

The second law of thermodynamics tells us that disorder must always increase (and hence capacity for useful work decrease), and hence as we have increased the order and capacity for useful work in the human systems of the Earth we have increased the disorder and reduced the capacity for useful work of the rest of the systems in the universe. With the whole universe as our sink for disorder then this should not be a concern. However, it is not. The consequence of the release of greenhouse gases into the atmosphere is that our planet becomes a more thermally closed system, and hence it can only expel sufficient heat to the wider universe to balance the sun’s incident energy by being at a higher temperature. One consequence of our current transformation is that we are closing ourselves off, thermally, from the wider universe and in the process retaining greater disorder in the planet’s systems as we increase the order and capacity for useful work of the human-dominated systems of the planet.

Our challenge now is to transform the energy system on which the human dominated systems of the planet rely into one which is no longer dependent on the use of stored hydrocarbons and hence which does not increase the state of disorder in the wider planetary systems. We have, if you like, the thermodynamic definition of sustainable development, and that is development of the human systems of planet Earth without the creation of disorder in the wider planetary systems.

How come the transformation of our human system has been so dependent on hydrocarbons? Some would say that this is obvious, and is a simple consequence of the cheap and abundant nature of hydrocarbons as an energy source. This may be true, but I do not believe it is as obvious as it seems.

Hydrocarbons are abundant, and in some parts of the world cheap to extract, but no-one should under-estimate the scale of the investment which has been required over the last 250 years to access that energy. The entrepreneurial endeavour, capital deployment and political turmoil which have surrounded the development of our hydrocarbon energy system have been immense. In no way did investments in coal mining in eighteenth century England look the sure thing that they may now appear in hindsight for instance.

Surely the sun and wind and other renewable resources were equally apparent to our forebears and so was it really a simple matter of cost which saw hydrocarbons win out? I do not believe so. There is one renewable energy resource which required large amounts of capital and the taking of major risks in order to exploit, but which was pretty much exploited to the full in all practical instances and that is hydropower. Hydroelectric power is an example of a renewable energy resource which was harnessed at least contemporaneously with much hydrocarbon development. So was it cost? And why were so much more obvious sources of energy such as sun and wind ignored? Standing back, and removing our historical prejudices for a moment, it seems very strange to imagine a eighteenth or nineteenth century entrepreneur walking in the hills of England on a sunny day with the wind buffeting him as he walked and him thinking to himself: “I know what, I will dig a mile underground and see if I can find a store of low-entropy energy”4.

Of course, hydroelectric power is not the only example of humans looking to harness renewable resources. Long distance transport (in the form of sea travel) was dominated by the wind until only 150 years ago, and wind and water mills ground corn for centuries. So it must just have been that hydrocarbons turned out to be a lot cheaper. Right?

Wrong. I frankly don’t know whether hydrocarbon energy is, has ever, or will ever really be cheaper than clean forms of energy. However, I am completely certain of one thing and that is that hydrocarbons deliver us that energy in a much lower state of entropy than that in which we can harness most clean energy resources. Hydroelectric dams are the renewable energy exception because they have inherent

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References:5. Anyone who does actually believe this is has either never met anyone from these three categories of individual, or has been one a little too

long.6. This makes for an interesting reflection on many of the ethical issues in climate change, but that is for another time.

storage capacity and hence the ability to move energy in time, and therefore it is no accident that they were developed at scale at least contemporaneously with hydrocarbons.

The transformation that has occurred in the world’s energy systems from 1750 or so onwards is not one of the discovery of new energy sources. It is the discovery of low-entropy sources.

So the transformation we need to make in our energy system is not about energy at all, it is about entropy. It is about no longer increasing the entropy of the planet’s systems through the release of stored energy in the Earth, but instead harnessing the sun’s incident energy in all its disparate forms and delivering it in space and time for the use and convenience of humankind.

The reliance we need to wean humankind off is not as often quoted, the reliance on cheap polluting energy, but it is the reliance on low-entropy sources of energy, and the ease with which they allow useful work to be done at the place and time of our convenience. This means the transformation we need to create in our energy system is the ability to instantaneously reduce the entropy of that system at any given place and time such that it can provide the same level of useful work as the current hydrocarbon energy system does.

Throughout this final essay I will highlight areas where I believe that the current mantra of the environmental movement is self-defeating. The first, of course, is that we do not have an energy crisis, we have an entropy crisis. Unless we understand this, we will never understand how we got to the system we have today and we will also never understand how we create the transformation which we wish to see in our energy systems. It is the entropy problem which is hard to solve and the reliance on low-entropy energy sources which is so hard to break, not the energy itself.

Second is that our choice of energy system to date has been completely logical and based on the low-entropy state of hydrocarbon fuels and the additional convenience that we can generate from such fuels. It is the replacement of this low-entropy system which is the most daunting task. The hydrocarbon economy, I am afraid, is not maintained by a conspiracy of hydrocarbon company executives, western politicians and middle-eastern autocrats5. It is maintained by its inherently low entropy state: pure and simple.

This leads to the third failing of the environmental movement and that is that they have a habit of saying that we have all the technologies we need to migrate to a low-carbon energy system. We do. But that simply isn’t the point. What we do not have is all the technologies that we need to transform our energy systems to a low-carbon one while maintaining its current low state of entropy and hence its ability to deliver useful work in space and time. I do believe however that we now have the potential to create such technologies, from the knowledge we have available to us today6.

The mechanism for the reduction of the entropy of the energy system is the use of information. Information, which we know to be equivalent to entropy in a thermodynamic and information theory sense, is the crucial component of the low-carbon energy system. It is not sun and wind which will replace oil, coal and gas, it is information. Only information has the capacity to transform the high-entropy captured incident energy of the low-carbon system and turn it into useful work in space and time.

Storage and interconnection are crucial new components of the energy system, as they allow us to act on information. Both of these new components of the energy system, you will note, consume energy, and hence my fourth gripe in almost as many paragraphs. Thermodynamically, the reduction of entropy in a defined system requires energy to be expended. Given that today we get our energy in a low-entropy state for free then it is clear that a low-carbon energy system of the future will use more energy, not less, even if we ignore all the increased demands we expect on the energy system. Hence while I agree that energy efficiency investments are important, environmentalists need to stop saying that the answer is using less energy. Thermodynamically this simply isn’t true. Using more energy is the answer to our low-carbon energy dreams.

So it is indeed true that if we transform our energy system to include clean energy and energy efficiency investments, we will create a system which creates less disorder in the wider planetary systems, but we will also create chaos in the human energy system and the reduction in the convenience provided to humankind by the energy system will not be tolerated by the wider populous.

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Information therefore has a role crucial in both the energy system itself and in the financial system that directs capital to the investments required in that energy system. The low-carbon and low-entropy energy system of the future will be vastly more capital intensive than the energy system we have today. This means that the systems of climate change finance must cause the efficient deployment of vastly more capital than has been deployed in today’s hydrocarbon-based system. This is evident from all we see in the market, but it is also close to a thermodynamic fact given that we have been getting our energy in a low-entropy state for free (or more correctly at the expense of the planet and hence of future generations). The scale of this capital deployment and the fact that we have an entirely new challenge of developing a low-entropy energy system in the absence of hydrocarbons are perhaps the two things about climate change which are the most daunting, given the time we potentially have to solve them.

Let us deal first however with the role of information in the low-carbon and low-entropy system of the future. Information systems in many applications allow for the increase in the utilisation of systems through their intelligent and efficient use and hence the delivery of greater utility from the same capital investment. Outside the energy sphere one can think about the utilisation of communications infrastructure and within the energy system one can think about the shared use of grid and other infrastructure. Information therefore is crucial in reducing the required amount of physical energy capture, use, transmission and storage investments which are required in the low-carbon and low-entropy energy system. It is also crucial in optimising that system on a minute by minute basis.

Because information can therefore lead to a less capital intensive system, it appears that as well as being equivalent to entropy, information is also equivalent to capital in the energy system, in that there is some trade-off between further capital investment in the low-carbon energy system, and the enhanced use of information.

The low-carbon and low-entropy energy system of the future will need to manage vast quantities of information on the available energy resources of the system (is the sun shining

on the solar panels, can we turn the nuclear power station on quickly, is the wind blowing etc?), the energy needs of the human uses of the energy system (bath time in an hour, granny is cold this winter, I need the car tomorrow afternoon etc), and of the energy stored and available for use. This requires a massive increase in the bandwidth of information in the energy system, and it will require that information to be digested and processed in a way which allocates the available energy resources to the needs and preferences of the users of the system.

If we assume that this system will be a form of market then this information will be brought together by that market (or collection of markets) and that allocation of resources will be substantially arbitrated between the myriad of agents in that market by price. In information theory terms we will need a high bandwidth market which will therefore be of inherently higher entropy because ex-ante there will be a very wide range of uncertain outcomes, and it is absolutely essential to the stability of the overall system that it is capable of receiving low probability, but then high information content, messages.

Markets then reduce the entropy of the system at the point of settlement. In information theory while the communication channel may be one of high entropy, and hence the receiver is in a state of high uncertainty before the message arrives, the entropy of the receiver is reduced by the receipt of the message. Similarly the low-carbon energy system has high entropy and has a state of high uncertainty before the market clears, but the market clearing allocates the resources appropriately and reduces the entropy of the system for the users of energy.

Information is therefore what turns a high-entropy system of energy capture and use, into a system of low entropy for the users of the energy system as they are delivered their required utility from the energy system in space and time. A consequence of the high- entropy information system is that the allocations will be made by a price which must be inherently more volatile and have a greater range than we are used to. Again this is close to a thermodynamic fact.

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If we are to replace our “free” low-entropy energy sources with high-entropy sources, then the information system which bridges the gap between those high-entropy sources and the desires of users must be able to absorb a much wider range of information and must have much greater ability to allocate resources based on a wider range of uncertain price.

There is an increasing trend in energy market design to “create certainty” of price. This is in some respects well meaning as we will see in the rest of this essay, but it is also completely misguided, if misapplied. As we have shown, the energy system of the future will need to have a system of allocation of resources which has much more volatile and widely ranging prices at least in the short-term or we simply will not be able to have the informational ability to reduce the entropy of the energy system to a useful state for its users.

Numerous of the remaining gripes about the environmental movement and the energy market intelligentsia will be about their apparent desire to destroy both information and the ability of economic agents to communicate with each other. If there is a recurring sin of the environmental movement it is certainly the desire to destroy information and its associated communication.

This trend for the introduction of certainty into energy markets is the first of these. If regulatory systems are established which prevent the transmission of sufficient information between agents in the low-carbon energy system via price or other mechanisms then it will simply be impossible to create a system which reduces the entropy of the energy system to a state equivalent to that we have inherently in the hydrocarbon-based system.

Increasing short term energy price volatility is an essential part of saving the planet.

The reason for this trend in the development of price certain mechanisms, as noted above, is well meaning (if somewhat misguided and infuriating), and it derives from a rudimentary understanding of the next issue in the use of information in the low-carbon energy system and that is in the direction of capital to low-carbon investments. Policy-makers have recognised that ex-ante price uncertainty, that essential feature of a low-carbon, low-entropy energy system, can create an incentive to delay investment, or put another way, increase the opportunity cost of investment above the level of the NPV of the investment.

This is completely true and is further exaggerated in the case of low-carbon investments such as clean energy and energy efficiency as they have a high degree of capital intensity and a high ratio of average to marginal cost. The investment decisions that agents make are therefore highly irreversible (another concept borrowed from thermodynamics, you may notice) and hence the prospect of new information in the future in the form, for instance, of price volatility, causes there to be a substantial opportunity cost associated with investment today compared to delay.

The simple fact is that most energy capture and usage (reduced usage) investments in a low-carbon energy system have very little use for information in the future and hence it is completely true that future uncertainty at the point of investment simply puts the cost of investment up above the cost of the real NPV of the investment and hence causes the investment to be more costly than it otherwise would be. This premium to NPV which is due to the value in delay can be seen as a cost of information. In other words it is the cost of being able to observe an agent making an investment decision in the presence of uncertainty in the future. You don’t get to observe the NPV of the investment but you do get to observe the circumstances under which the agent will invest.

The premium paid above the NPV of the investment is created by the value of waiting to see future uncertainty resolved and hence the value of receiving future information before the investment decision is made. Hence when we pay this premium we can see it as the price we have to pay to create action today in the presence of uncertainty, or the value to us of observing investment today compared to the investment agent observing information in the future.

Hence it is not that price certainty is inherently good, but it is true that in the presence of price certainty, price certainty is good.

To unpack this. Price certainty is good for two reasons. Firstly, if the investment itself cannot react to the future price signals then the information contained in those price signals is clearly useless to it (for instance a wind farm is going to produce energy when the wind blows whatever the price is in the market). Secondly, the reason for price uncertainty to exist in the incentive mechanism for investment in low-carbon energy is to account for the fact that those setting

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the parameters of the mechanism might not know what the price actually is. In this case price discovery is a good thing, but we have done enough thermodynamics now to know that nothing is ever free, and so the observed price discovery will come at a certain cost. Information has a cost and that cost is the premium over NPV created by the inherent price uncertainty at the point of investment.

Hence it is possible only to observe the price at which an investment is made; it is not possible to observe the NPV of an investment. The simple paradox is that in order to observe an act of uncertain value today, a premium must be paid above the real cost of that investment, and that premium itself is created (at least in part) by the fact that we have to create a system with price uncertainty in order to observe uncertain prices.

Taking the first form of price certainty first. If the investment being made has no use for the information in the market over its asset life, which is the case for most capture and use investments in the low carbon energy system, then there is little point in exposing them to that price uncertainty at the point of investment. To do so simply creates deadweight cost in the system, as investment agents wait, or require to be remunerated with the opportunity cost of waiting in order to invest, due to future information on which it cannot act anyway.

Hence there is little point in exposing a wind farm, solar farm, or home insulation investment to our ever more volatile short-term energy price because they have no capacity to act on the information they will receive. Such investments are the creators of disorder in the energy system. They create information but they cannot use it.

Hence the “price certainty” people have a point in this regard as there is no point in exposing investments made today to future price uncertainty to which they cannot react, but which will cause an information cost to be reflected in the initial investment cost (the deadweight cost). This is what we referred to as “asset matching” in our first essay. However such investments must be allowed to communicate their information into the energy system to the fullest extent, as someone else has to use that information to reduce the entropy of that system such that the energy captured or used can be done so usefully.

In the presence of certainty about the price of investments, therefore, those who advocate price certainty win, with the qualification that they are right that the investment in question should not be required to be the receivers of information, but they must not be prevented from transmitting their information into the wider energy system. If you like, the difference between many low-carbon energy investments like say a solar farm, and a hydrocarbon based one, say a coal-fired power station, is that the former can only transmit information, it cannot usefully receive it. A coal-fired power station can both transmit and receive information in the market (more correctly it can react to receiving information). This difference in their capacity to participate in the information flows of the energy system is a function of the starting state of entropy of their energy sources (the sun being high, and the coal being low). Again we have an information equivalence of entropy, inherent in the design of our energy system.

We are not certain, however, of the cost of investment of the majority of the investments which are to be made in order to transform our energy system. Hence it is less obvious that price certainty is a good thing in the second regard which is observing the true cost of investment in low-carbon energy systems.

If we are uncertain as to the NPV of an investment then we can set a certain price at that certain NPV and hence stimulate investment at the lowest deadweight cost to society, because we will not be paying for future uncertainty or suffering delay in investment due to that uncertainty. However in a world where we are not certain as to the true investment cost then we must establish a system that has inherent price uncertainty in order to discover the price at which people will invest. We will, as a consequence of this, suffer information costs, because that price discovery is not going to be free.

This is another fundamental failing of the environmental movement and that is its inherent aversion to anyone making a profit, or heaven-forbid, a super-profit.

Well it is a simple fact of the need to stimulate investment in things which have uncertain costs that it will require the value of the investment to be above the NPV, because the information deficit which is inherent in doing something new and hence of uncertain cost means that we have to

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pay for the information resolution. Another example of the environmental policy community destroying its very life-blood, information, is the constant attack on any environmental investment which appears to be making profit above its NPV. This profit embodies the very information which the environmental movement needs in order to manage the transition to the low-carbon economy.

Having said this, it is responsible policy-making to limit the level of uncertainty and hence information cost (super-profit) in order to properly manage the limited resources we have to deal with the transformation of the energy system. Hence we should look hard at the degree of uncertainty we put into the systems which we design in order to discover the information as to the cost of making economic agents invest.

This basically involves managing the ex-ante entropy of the information channel used to discover the price of investment, and there is an inherent trade-off between designing a system which can capture all low-probability outcomes and one which minimises the costs of obtaining that information.

As an aside, but an important aside, for the most part in these essays I have been describing genuinely unknown costs of investment, rather than information asymmetries between investors and policy-makers. There is a whole issue of information asymmetry in policy-making, of course, but industry and the investment community have proven themselves to be pretty poor at predicting the real cost of wind, solar, nuclear and various other forms of low-carbon investment over very recent times and so I see the information deficit we face as being inherent rather than the product of different levels of information between different actors in the market.

So, for instance, if you are a UK policy-maker then you can be pretty certain that in order to achieve a high level of production of renewable energy in your energy system you are going to have to harness offshore wind power at scale. The cost of offshore wind power is uncertain, but there are some data points of relatively limited statistical relevance, but they exist all the same and (today) are at the level of around £3m / MW of investment cost. Costs have been £1.5m / MW in the not too distant past and there are people in the market saying costs could more than halve again, and there are those who say they could need to be £4m / MW to make some of the deeper water applications sufficiently attractive.

Given this (not particularly good) information and knowing that the higher the ex-ante entropy of the incentive system then the greater the cost of observed information (in the form of investment decisions) at all levels then as a UK policy-maker you probably would not devise an incentive scheme that had the potential for the value of an offshore wind farm to be zero to £10m / MW. If the system embodied uncertainty in this range then the cost of observing investment and hence the cost of information would be very high, and, of course, the observed cost would be quite far from the true NPV value, and hence there would be a high cost associated with a relatively low quality of information.

If you fix it at £3m / MW however, given the relatively recent uncertainty in price then you stand a high chance of being wrong, and hence seeing no investment or stimulating a large amount of investment without the opportunity to observe any indication of the obviously truly lower cost.

Hopefully these essays have well and truly buried the idea of a single global carbon price as a stimulant for large-scale investment in low-carbon energy generation, but just in case we can play the argument through this example of offshore wind in the UK.

We have shown that for investment in entities incapable of the receipt of information then price signals which change over the life of the asset simply create deadweight cost. Hence a carbon price which is formed on an annual (or even more frequent) basis provides information which is only creating deadweight in the investment in offshore wind in the UK.

Furthermore, a global carbon price has to have the ex-ante entropy required to capture the cost of observing investment in every form of low-carbon investment in every country and in every carbon-saving technology throughout the world. Hence it has an inherent uncertainty, due to the high potential information content, which would cause investments in UK offshore wind to suffer an unnecessarily high cost of information given that we simply know that in the UK we have to harness the offshore wind resource and that it has recently cost around £3m / MW (give or take a bit this is around a £250 / tonne CO2e carbon price by the way for those who think I am mixing my units).

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This clearly makes no sense.

Instead, in such circumstances, it is better to implement a system which attempts to discover investment cost, but then does not expose the investments in question to price volatility over their lifetime.

The question then becomes: how can policy-makers discover investment cost?

We are in the fortunate position with most low-carbon investments, that they are inherently capital intensive and hence most of the cost is incurred at the point of investment. This increases the potential for ex-post regret on the part of the investor but it also means that policy for investment cost discovery can be focussed on costs today, while retaining flexibility for the future.

The approaches taken to investment cost price discovery to date have been two-fold. Either people have continued down the misguided route of relying on quantity-based instruments with high inherent volatility and hence high information costs and they have observed only the highest possible margin investments taking place; or they have adopted what a British person would call the “suck it and see” approach.

So we know the first approach has failed. The second however has a varied history. In the case of the feed-in tariff regimes of Europe, for instance, governments have tended to set a price which is fixed over the life of the asset (hence getting the asset matching bit right) and then waited to see what would happen. As the price is fixed, then one of two things happen, of course, either people invest or they don’t. Now fortunately non-financial issues like local democracy’s effect on the planning consent rate and the availability of grid connections have meant that in the cases where investments have occurred the quantity has been constrained and hence the binary outcome has not been too harmful.

However there are well-documented examples where setting price and seeing what happens has lead to an excess of quantity over what policy-makers had intended (the situation in the Spanish solar market being the best known example in the investment community7).

This is basically because, while systems that set price have many advantages in terms of asset matching and the reduction of informational deadweight cost, there is no mechanism in a price-based incentive for taking the market through some sort of clearing and settlement process. This means that unlike a quantity-based market (such as a cap-and-trade or carbon pricing system) where the market mechanism brings the whole market together regularly to determine a clearing price, a price-based system can let quantity grow unconstrained, with little information flow to the policy-maker (or anyone else). This means that in such price-based systems, quantity can get out of control.

In many, but not all, cases the combination of a price-based system, with a “suck it and see” approach, constrained inadvertently by other factors such as grid and planning, has lead to policy-makers being able to reduce or increase the prices for future investments in line with the observed success or otherwise of the current tariff level. The truth however, is that this has been ad-hoc and certainly not part of a concerted strategy on the part of policy-makers to embody their observed information in future policy-making. It is also true that a successful fixed price incentive system simply tells the policy-maker that they can probably make the price a bit lower next time, but it does not tell them by how much.

There are other approaches to the same problem, and some governments have created implicit or explicit quantity criteria along-side their price-based systems. The implicit ones being often based around a time limit which, when factors such as planning, grid and the availability of resources are taken into account, defines a quantity limit. The UK’s Renewable Obligation system had the potential to set a financial limit on the combination of price and quantity, but it was, in effect, converted into a feed-in tariff relatively early in its life8.

What policy-makers have generally failed to do is to be explicit about their strategy for information management within their incentive arrangements. Policies should be set to expose the required range of information at an acceptable cost, and should then have the inherent flexibility to react to that information in setting the next set of incentives.

References:7. In 2008 the Spanish energy market saw some 2,000MW or more of investments in solar PV power stations based on a price-certain tariff

which was only ever intended to stimulate 300-400MW of investment. Given the high cost of PV systems at that time, the 2008 Spanish solar investments are likely to rank amongst the highest.

8. In 2003 I suggested that the UK’s Renewable Obligation should be modified to give price variability over a certain short period of investment (a “vintage”) and then this would be systematically converted into a certain price for assets of that vintage, while the rules for the next vintage could be set on the basis of the information received. Instead they basically turned the RO into a feed-in tariff without asset-matching for the investments, and with regular pricing reviews, or about the worst of all worlds in other words. See (Temperton, 2003).

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For large-scale investments therefore the market is in reality defined by the interaction between policy-makers and the agents of investment. There is a periodic exchange of information which it is the policy-makers job to manage the cost of, but to be clear, it will have a cost which will show up as super-profit for well-managed investments. In this exchange, it is the policy-maker who makes the first move in setting a price, or a price range, defined by what is likely to be relatively poor quality information (not to mention biased given where most of it will come from). The job of the policy-maker is to make an intelligent observation of the effects of this shot in the dark and to harvest better quality information on which to make a more considered (but never perfect) judgement as to the parameters for investment incentives in the next phase. Any intelligent policy-maker is likely to build inherent risk management into such a system in order to limit or credibly observe the quantity of investment taking place under the price-based system.

The most important design consideration in this interaction is the creation and productive use of information with respect to investment decisions, and to ensure that the investments which are created can transmit their information into the energy market in such a way that allows for the reduction of entropy of the overall energy system. The interaction between the agents of investment and policy-makers should be aimed at reducing the entropy of that interaction over time through the exchange of ever higher quality information.

One of the key aspects of this interaction is that the set of exchanges is initiated by policy-makers making a wild stab in the dark in the pursuit of an overall climate change objective. This is the inherent nature of markets, and is a key factor which is ignored by those who believe that we can analyse our way to a solution to the climate change problem.

Markets tend not to tell you what to do. They tell you if what you are doing or what you have done is good or not. The economic ecosystem rewards certain species of economic activity and causes other to become extinct. If you like, the back-drop of the markets in which we operate is causing our endeavours to be constantly observed and those that fit well in the current eco-system tend to succeed and those that do not, do not. No inventor, innovator, entrepreneur or the like, ever really does a rational analysis of the right thing to do before they do it: they simply believe in the right course of action and, the good ones, react to, and adapt to, the interactions they

have with the wider economic ecosystem. However, despite all the money spent on analysing markets in the world, the first act, is always a wild stab in the dark, based primarily on belief.

Hence if we are to transform our financial system such that it creates the signals which direct capital to investments in the low-carbon and low-entropy energy system which we need for the future, we also need to create a system which observes and rewards activities which contribute to the development of that new energy system.

Such a system will be rich in information and will create mutually reinforcing communication between the actors in the market (both governments and private economic agents). Such a system will also help create the global collective action which is clearly required in order to deal with the global collective action problem that is climate change.

We have seen how the information exchange between policy-makers and investors on large, capital intensive projects can be created through the management of information, observation and intelligent change in policy over time to reflect valuable information where it can viably be used. We have also seen however that in this interaction no market really forms price; that is left to the interactions of the policy-makers and the investment agents, and as such the ex-ante entropy is low and the potential information content of the communication channel is similarly low. Inherently in this exchange we have decided to make the compromise of a somewhat awkward system of market settlement and observation based on quantity in a trade-off for the reduced costs of information that comes with asset-matching and low ex-ante uncertainty for investors. We do this based on the information the policy-maker has as to its physical investment options and its (imperfect) knowledge of current investment costs.

While this is the right trade-off for specific cases, nothing in the above paragraph allows for observation outside of the narrow communication channel of that policy interaction and nothing allows for wider communication and economic interaction with those outside a specific country or technology.

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This is where quantity-based systems such as cap-and-trade systems are essential. All the things which make such systems inherently bad at stimulating large-scale, capital-intensive investments in low-carbon energy production make them an essential part of the overall eco-system of climate change finance.

Quantity-based systems, such as cap-and-trade, involve a wide range of countries and sectors and hence have the potential to include a wide range of national and industrial solutions to mitigating carbon emissions. Their scope makes them inherently uncertain as to price ex-ante and their settlement on a (say) annual basis, does not match the lifetime of any large-scale investment project. However, in bringing together all the parties in the system and enforcing settlement at a point in time such systems cause the creation of information on the progress of the transformation of the energy system, and hence reduce the entropy for all observers.

Such schemes are the accounting systems of the low-carbon economy. It is only through the provision of an economic incentive to produce high-quality and accurate information that we will even begin to understand the real quantity and sources of emissions in the world economy. This is the essential information basis from which we can start to target solutions and it quite simply does not exist today. It will be created by the development of schemes which pay people to create that information through the creation of economic benefit simply in the delivery of accurate information at the time of settlement9. This is why in the majority of credits in such schemes are given away to those who pollute in the first instance. This creates a cost to the consumer and a benefit to the majority of those who pollute in the short-term, but in exchange for that economic rent, we receive information as to the emissions of the polluter involved.

In the case of cap-and-trade systems in developed countries such as the EU ETS the development of this information basis has been paid for substantially by the consumer via the mechanism described above. In the case of the developing world, if we are to create the information basis which we so desperately need, then it is likely to be the case that the developed world consumer or taxpayer will also pay for the establishment of that information set (as they do in part through the CDM at the moment).

This brings us again to some truths which the environmental sector simply has to get used to. We have no idea how much people really pollute and we won’t unless we pay them for the information, and the best way to achieve this is through carbon trading systems. This will mean that those who currently pollute the atmosphere and create climate change will initially profit from the development of the very schemes which we implement to attempt to avert dangerous climate change. This is a simple consequence of such polluters holding the most valuable commodity we need in that fight against climate change and that is information. To get that information we are going to have to pay them. Monitoring, reporting and verification (the famous MRV beloved of climate negotiators) is a consequence of participation in global carbon trading schemes, not a pre-requisite for joining. If it is a prerequisite we will simply never establish a scheme with sufficiently rich information content.

Carbon trading is the accounting systems of the planet and yes, there will be scandals, as there have been in accounting systems for as long as they have existed, and which there certainly have been in the development of carbon trading schemes in the developed countries in the world who have implemented them to date.

This doesn’t matter10. It would matter if we were reliant on global carbon trading to stimulate investment in large-scale, capital-intensive clean energy infrastructure, because then the volatility which would be created by the scandals and mis-information would cause delay and unnecessary excess return in such investments. However, as we have seen, we are not reliant on carbon trading for those investments and we should not be.

Once we unshackle carbon pricing from the unrealistic expectation of providing a single global (or even regional or national for that matter) investment signal to all clean energy investment then it is able to do its real tasks so much more effectively.

Firstly, we want to use carbon trading to lay down the information basis of emissions in the world, and as such we want it to be as broad a system as possible, encompassing as many countries and industries as practical11 and settling

References:9. This we could call the “pay the polluter” principle rather than the “polluter pays” principle. Think it will catch on?10. OK, it matters, in the specific case, but not at a macro level. No-one suggests that we all stop doing audits of companies because that might

lead to accounting scandals in the future.11. Transaction costs (real transaction costs not information costs) probably limit the realistic coverage.

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on a regular basis. Hence we want as wide a communication channel as possible and the highest possible state of ex-ante entropy in the system, which is a level of uncertainty which is resolved to all observers at settlement of the market. It doesn’t matter if we initially grandfather polluters’ rights to pollute, as we are not expecting this to be any major incentive for them to invest in non-polluting technologies, and we know that information costs money, and so if we don’t pay them somehow we simply won’t get the information. It also doesn’t matter if the price of credits turns out to be low for the same reasons. In fact, we probably want the price of credits to be low because there is no point in paying more than we have to, to those who pollute, for information. This therefore means that we don’t really mind what the cap is to begin with, we just care that there is one. We are also more concerned that countries and industries participate than that investments are created and hence the starting point for participation in any scheme can be determined solely by the need to manage parties’ ex-post regret at entering into such a scheme. Hence we should focus on getting the deal which brings the most participation, as quickly as possible.

Secondly, carbon trading provides for some limited ex-post reward for those who do invest in low carbon investments. This helps create an economic environment which rewards low-carbon actions ex-post in a way that the general economic system tends to reward good ideas. This will send something of a signal to economic agents that the economic environment is being tilted towards rewarding those who take low-carbon actions. Ex-ante, of course, the uncertainty in the level of carbon pricing will create delay for both polluting and non-polluting investments, as option value is determined by volatility not NPV, and volatility is no respecter of the direction of the impact on NPV.

We should not, however, belittle the impact of ex-post reward in a world where the major actions on climate change will need to begin as wild stabs into the informational darkness.

Thirdly, carbon trading has a major role to play in the facilitation of collective action. Such schemes allow for the regular exchange of information between economic agents through trading and between economic agents and governments through both trading and the regular settlement process. That information allows the mutual observation of action and the costs of action with respect to climate change mitigation in different countries and difference sectors. In order to achieve a phase transition in the global energy system we need all parties in the energy system to experience mutually

reinforcing economic exchanges with each other which will build up to a transformation of the energy economy globally.

So we can see that where specific national actions are logical and reasonably well defined then that information exchange is best managed based on a price-based system between policy-makers and investment agents.

However, this means countries and industries taking individual actions in the absence of knowledge of what others are doing, which is unlikely to lead to continued action as it does not pay to be too much of a leader when the problem is global in nature. Hence we need the constant reassurance and reward that comes with a regularly settled system of trading, not focussed on stimulating investment, but through which we observe and experience what others are doing and hence hopefully receive mutually reinforcing information which encourages continued and robust individual action.

This is what makes the US position on cap-and-trade schemes a bit baffling. Subject to a bit of pork-barrelling which is just part of the rough and tumble of politics, the US appears to get the whole individual action thing. However, they seem to be completely against being part of a scheme which would provide them with all the information they need on what others are doing and what is happening across their own economy. Particularly given that many of the wild stabs into the informational darkness come from the state level, it seems bizarre that the US wouldn’t want to implement an over-arching information system and hence create the eco-system to which such individual actions should adapt, and with it create the national and international information basis for understanding the continued logic and effect of individual action. Surely real commercial trades with the Chinese would provide much better quality information than a bunch of reports filtered through a UN bureaucracy.

You can take a horse to water….. but anyway.

A transition to the low-carbon, low-entropy economy looks like a system of individual actions, moderated by ever higher quality information, within an international economic eco-system of carbon trading that provides mutually reinforcing information on the action of others and that holds all concerned regularly to account.

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This is all very well, but nowhere so far have we addressed who actually pays for all this transformation of the energy system, particularly as we have realised that it is a thermodynamic fact that a low-carbon, low-entropy energy system will be more expensive than the hydrocarbon one which we have today.

Paying for the transformation has become an ever more contentious issue in the global climate change debate. At the time of the Kyoto Protocol there was a relatively clear principle that it was a rich country issue to solve the climate change problem and it was clearly unethical to expect the poor to pay. In the complex international debate on climate politics, two things have become abundantly clear about the poor of the world. The first is that a lot of them won’t be poor by the time we need to do a lot of the climate mitigation in their countries or more importantly by the time they start to benefit from the sacrifices of today’s generation in solving the problem. Secondly, there are simply rather a lot of them. Hence it seems relatively unlikely that, whatever the historical moral imperatives, the rich of the world are going pay for a low-carbon, low-entropy energy system for 9 billion people by the middle of this century.

The good news is we don’t have to. Believe it or not, the good news is that this is a collective action problem.

What matters to the developing economies of the world is their competitive position and hence if everyone moves to a low-carbon, low-entropy energy system then, one could argue, that nothing has changed very much. Hence in the same way that such countries are going to manage to maintain or adapt their competitiveness while having greater degrees of human rights, more workers’ rights, less child labour, the greater empowerment of women, and all the other things that we seem to have while we still struggle on in the West, they will also be able to maintain and adapt in a world where they have a low-carbon and low-entropy energy system.

Getting there requires three things.

Firstly, it is clear that the only people who are going to pay for it in the developed world are the developed world and so we may as well just get on with it.

Secondly there needs to be the information technology capable of creating a low-entropy energy system from a low-carbon energy system. As noted previously, I am not sure that

clean energy is any more expensive than dirty energy, but it is clear to me that the low-entropy state of hydrocarbons explains their dominance in the world’s energy system today. Creating the information systems required to manage a low-entropy energy system during the transition of the western economies might well create a situation where information systems are available which make it a close to straight fight between clean and dirty energy sources for the developing world and in that case they have everything to gain from taking the clean option. Essentially if our development of information systems is such that they are indeed a major substitute for capital then we even the playing field for the rest of the world12.

This makes the debate on wind power intermittency in the UK for instance very interesting. Many people will tell you that the system in the UK simply cannot deal with a third of its power coming from wind. There are two counter-arguments. The first is that it simply has to, so get on with it. The second is that when it does we will have cracked the secret code of the low-carbon, low-entropy energy economy and other people in the world might find that useful. Hence my view is that wind power intermittency on a large island in north-west Europe, while a challenge, is an immense opportunity.

Thirdly, we need to create the information basis for emissions in the world. This means a global system(s) of carbon trading which creates accountability, ex-post reward and mutually reinforcing economic interactions on the part of actors all over the world in the energy market.

My contention is that the developed world as traditionally defined cannot and simply will not pay for the development of a low-carbon and low-entropy energy system for 9 billion people. This I am afraid is another one of those slightly other worldly beliefs of the environmental movement, which they would do well to forget because it makes the task at hand simply unachievable.

However, I similarly contend that we can and should in our own self-interest pay for the three things described above. Clearly, we have to transform our own energy system. In doing so we will develop the information systems required to replace hydrocarbons with information (for that is what we are doing). And, in order to bring the rest of the world

References:12. I appreciate that I am implying that such information systems cannot be developed in the developing world faster than they can in the

developed. Take this as just a part of the narrative. There is indeed a high chance that supposedly developing world technologists will get there first.

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with us we need to fill the informational void which currently exits and as described above, we will need to pay people to bring them into that information system. Information is expensive, but I believe that the developed world can afford to pay for the development of that emissions information and accountability system as part of the general economic eco-systems of the financing of the low-carbon and low-entropy economy.

So if the US position on cap-and-trade is baffling, the EU one is simply bizarre. The purpose of a quantity-based trading system, as we have seen, is clearly not to stimulate highly capital intensive investment, and clearly is to lay down an ever greater information and communication system for the low-carbon economy. The EU is currently engaged in a policy to restrict the importation of international credits and attempt to force up the carbon price. This shows a complete lack of understanding of the purpose of the instrument, restricts the very communication channel to the rest of the world that is so crucial to mobilising collective action, and runs the risk of significant and unnecessary deadweight costs in the EU economy.

The three actions we have described here in effect embody leadership, information technology development, and economic information development through markets.

What is interesting is that the last two actions are analogous and could only have become possible in recent times. One is the development of the information systems which can instantaneously maintain a low state of entropy of an energy system satisfying human wants and needs in space and time but based on high-entropy forms of energy capture. The other is the economic system which causes our state of entropy with respect to the knowledge of emissions of greenhouse gases (and hence entropy) into our planetary systems to be reduced on a periodic basis through trading and eventual settlement.

Hence we are in the business of developing two analogous information systems of a type and complexity which could not have been contemplated until recent times, simply because the underlying information technologies which will be required for both did not exist. It is only over perhaps the last decade or so that we could have realistically contemplated either.

As we look to risk manage the existence of humans on Earth this latter observation raises some interesting issues. Many of us who operate in the climate change arena feel, probably rightly, that action on mitigating emissions is far too slow and we fear that what we observe in the planet’s systems

today does not even begin to tell us the damage that we have already wrought in those systems. However, it is true that the explosion of technological development and the imposition of human order on the planet which began only those 250 years ago with the beginnings of the harnessing of low-entropy hydrocarbon energy, has lead to a point today where only now can we begin to contemplate the technological and economic information systems required to wean ourselves off the very hydrocarbons to which we owe so much of the current state of our existence.

Are we then in a self-defeating race to maintain the entropy level of our existence?

The question is, is it possible for an advanced species such as the human race to develop the technological and economic ability to sustain itself on a planet like Earth? Can we become sufficiently advanced in those technological and economic systems such that we can preserve and enhance human dominated order on the planet before we have expelled too much disorder into the wider planetary systems? Or will we fail? Will we overrun the budget accidentally left for us in pre-historic times? In so doing we would expel so much disorder into the planet’s non-human systems that we will not have the capacity to maintain and enhance the current level of human existence against the forces which the planet’s systems unleash upon us.

Without hydrocarbons we would not have been able to create the order in human existence and the capacity for greater human enrichment that we have, but we only have a certain budget for increasing the entropy of the planet’s other systems before all the resources at human disposal will not be able to maintain our version of order against the associated disorder which it created.

We have seen that in the absence of high quality information the first act is always a stab in the dark, and in the case of climate change we know that there is a high probability that observable effects lag cause by quite some time, and hence when we receive definitive information it may already be too late. There is no archaeological evidence that advanced species have imposed themselves on the planet before in the history of Earth, and we have not yet communicated with or experienced other planets with such advanced species, and hence we have little experience to learn from. Our attempts therefore to maintain order in our systems on our planet are a first-of-a-kind effort, with all the informational issues which come with that. It may

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be that our few hundred years of extreme colonisation of the planet do little more than leave a legacy from which the next advanced species to evolve, in say a billion years, can learn as they attempt to dominate the planet in a similar way.

If we are to learn fast enough to maintain order against the powers of the planet, then it is for the environmental movement, in all its forms, to seek to increase the power of the information in the world’s energy systems, even if that means confronting some difficult facts including that information is costly, and often transmitted in the form of a profitable decision.

It is information which will allow us to transform our energy systems to deliver low-carbon and low-entropy energy for our use and convenience. This will require a transformation in our financial system to reward, account and communicate in ways which direct capital to investments in that low-carbon and low-entropy system.

It is also then information which, in place of low-entropy hydrocarbons, will allow us to maintain and expand the transformation of the Earth which we are in the process of executing, without creating forces in the planet’s other systems which we cannot resist.

For a while longer, at least.

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