Case Study — The Road to Clean Energy (EVs, Lithium and Coal)

Case

Question 1: The road to clean energy

Extract 1: Climate change

2019 was the second warmest year on record. Carbon dioxide (CO₂) levels and other greenhouse gases in the atmosphere rose to new records in 2019. Climate change is affecting every country on every continent. It is disrupting national economies and affecting lives. Weather patterns are changing, sea levels are rising, and weather events are becoming more extreme.

Saving lives and livelihoods requires urgent action to address both the coronavirus pandemic and the climate emergency. The Paris Agreement, adopted in 2015, aims to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels.

Source: United Nations.

Extract 2: Going Green — What’s good for the planet is good for business

Increasingly, businesses around the world are responding to a global imperative and consumer demand to go green. More than 80 per cent of people respect companies and brands that adopt eco-friendly practices, according to an international survey. More than half boycott companies with unsustainable practices or products.

“Consumers want to make responsible ‘green’ purchases, but do not always have the means to do so,” the report says. “For brands, this is an opportunity.” Shoe company Adidas, for instance, produced 7,000 limited edition sneakers made completely from plastic trash retrieved from the ocean. The sneakers sold out instantly.

Source: Forbes, 14 May 2019.

Extract 3: China cuts electric vehicle subsidy for 2021

In December 2020, the Chinese Ministry of Finance announced the new electric vehicle (EV) subsidy policy for 2021. This included a 20 per cent reduction year on year as planned. Under the new policy for 2021, the subsidy for pure electric vehicles (PEVs) with a driving range of 300–400 km will be lowered to 13,000 yuan per vehicle, from 16,200 yuan in 2020.

The outbreak of the coronavirus early last year put huge pressure on China’s EV industry, with output and sales falling by more than 50 per cent year on year in the first three months of 2020.

Source: Fastmarkets, 5 Jan 2021.

Table 1: Price and cross-price elasticity matrix for gasoline cars and battery electric cars

Cross price elasticity of demand	With respect to price of gasoline cars	With respect to price of battery electric cars
For gasoline cars	-1.08	0.19
For battery electric cars	0.36	-1.27

Source: European Transport Research Review, 04 Jan 2021.

Extract 4: The global lithium market

The global lithium market is estimated to grow by around 8 to 10 per cent annually from 2019 to 2024. Lithium is needed to manufacture glass, ceramics, and lithium-ion batteries that power electric vehicles (EVs).

Australia, Chile, and Argentina account for nearly 89 per cent of global lithium production. Lithium is predominantly sourced from brines such as salt lakes and salt flats as it is cheaper to extract compared to hard rock ores and salt deposits.

China is the biggest consumer of lithium — making up more than 55 per cent of global demand — and is the largest manufacturer of lithium-converted products. The lithium-ion battery sector accounts for about 60 per cent of lithium demand in China, with EVs and portable electronics as the largest demand drivers.

EVs made up less than 1 per cent of the world’s cars in 2019. However, according to investment bank UBS analysts, EVs will reach price parity with gas-powered cars by 2024. For this reason, UBS projects that EVs will make up nearly half of all new car sales by 2030. UBS estimated that the lithium market will grow 8 times by 2030.

Where will the world get all the lithium to produce lithium-ion batteries? Lithium is not a rare metal. There’s plenty of it, but it needs to be mined, using large-scale operations to extract it — and these might take years to explore and set up. Since 2018, lithium prices have crashed 60–70 per cent to rock-bottom lows. The drawdown forced miners to cut back on operations and call off the exploration of new mines.

Sources: GEP.com (accessed June 2022) and Forbes, 7 Dec 2020.

Extract 5: Lithium supply

The supply base for lithium is expected to diversify over the next decade, even as South American and Australian output increases. As of 2020, brine-based lithium sources were in various stages of development in Argentina, Bolivia, Chile, China, and the US, and mineral-based lithium sources were being developed in Africa, Australia, South America, Canada, and Europe, according to the US Geological Survey. In addition, new mining techniques and types of deposits are expected to supplement traditional sources.

However, investors have been somewhat hesitant to commit to new mines due to doubts over the duration of the boom in lithium demand. New battery technologies could begin to replace lithium-ion in 15 years.

Source: Physics Today 74, 5, 20 (2021).

Table 2: Lithium market balances (tons)

	2018	2019	2020	2021	2022	2023*	2024*
Demand	268 362	300 429	340 662	429 484	584 989	722 701	899 622
Supply	278 508	323 988	343 712	403 340	461 953	563 375	711 683
Market balance (+surplus / −deficit)	10 146	23 559	3 050	−26 144	−123 035	−159 326	−187 939

* The figures for 2023 to 2024 are estimates. Source: Physics Today, 74, 5, 20 (2021).

Extract 6: Asia Pacific must phase out fossil fuel subsidies

The extent to which Asia-Pacific is planning on decarbonising will make or break the global fight against climate change. Asia-Pacific is home to 60 per cent of the world’s population and the main engine of global economic growth. However, since the early 2000s, Asia-Pacific has been the main carbon dioxide emitting region, producing about half of the world’s total emissions.

All in all, coal in China and India is currently the single biggest contributor to global greenhouse-gas emissions. China continues to subsidise coal for the following reasons: (1) to provide cheap electricity and heating to citizens, as coal plants remain a low-cost electricity supply option compared to natural gas and offshore wind; (2) to foster international industrial competitiveness by using cheaper electricity for production; and (3) to support the coal industry, which employs about six million workers, mainly in north-eastern provinces that suffered most growth-wise since 2015.

Source: Brink News, 7 June 2021.

Extract 7: China has no choice but to rely on coal

China President Xi Jinping said that the country’s carbon emissions would begin to decline by 2030, and that the country will reach carbon neutrality by 2060. In the meantime, policymakers are making clear that economic growth remains a top priority — and that growth depends largely on coal power.

“China’s energy structure is dominated by coal power. This is an objective reality,” said Su Wei, deputy secretary-general of the National Development and Reform Commission. He added that coal is readily available, while renewable energy needs to develop further in China.

Source: CNBC, 29 April 2021.

Questions

(a) Explain how an effect of climate change could be considered an external cost. [2]

(b) Explain why a firm’s transition to low carbon activities could impact its total revenue positively. [3]

(c) Using a diagram, explain how a reduction in subsidies for electric vehicles (Extract 3) will affect consumer surplus in the market for electric vehicles. [4]

(d) Explain how the information in Table 1 could be used to explain that a reduction in subsidies for electric vehicles could accelerate climate change. [3]

(e) Discuss the extent to which the price of lithium can be expected to rise beyond 2024. [8]

(f) Discuss the case for and against the subsidisation of coal by governments of countries like China. [10]

[Total: 30]

Answers

(a) Explain how an effect of climate change could be considered an external cost. [2] (explain)

Referring to Extract 1, climate change causes rising sea levels and more extreme weather events. This can cause loss of crops through flood or drought, reducing the income and profits of farmers. This is an external cost: the farmers are third parties who are not involved in the consumption or production of the CO₂ emissions that drive climate change, yet bear a cost from it.

Marking points: identify a relevant external cost associated with climate change; explain that it is an external cost because it falls on third parties.

(b) Explain why a firm’s transition to low carbon activities could impact its total revenue positively. [3] (explain)

Referring to Extract 2, more than 80 per cent of consumers respect companies that adopt eco-friendly practices. This signals a change in tastes and preferences — a non-price determinant of demand — making consumers more willing to buy from firms that go green. By lowering carbon activities, such firms raise the demand for their product, shifting demand right from D₀ to D₁. Price rises from P₀ to P₁ and the quantity exchanged rises from Q₀ to Q₁, so total revenue rises from P₀ × Q₀ to P₁ × Q₁.

Marking points: firms respond to a change in tastes and preferences; effect of the rise in demand on price; correct diagram.

(c) Using a diagram, explain how a reduction in subsidies for electric vehicles (Extract 3) will affect consumer surplus in the market for electric vehicles. [4] (explain)

A reduction in subsidies raises the unit cost of producing electric vehicles (EVs). Supply falls from S₀ to S₁, raising the price of EVs from P₀ to P₁ and lowering the quantity exchanged from Q₀ to Q₁. Consumer surplus — the area below the demand curve and above the price — falls from area ABP₀ to the smaller area ACP₁.

Marking points: effect of subsidy reduction on cost of production; impact on supply; impact on consumer surplus; correct diagram.

(d) Explain how the information in Table 1 could be used to explain that a reduction in subsidies for electric vehicles could accelerate climate change. [3] (explain)

Table 1 shows that the cross elasticity of demand of gasoline cars with respect to the price of battery electric cars is +0.19 — a positive value, indicating that gasoline cars and EVs are substitutes. When the cut in subsidies raises the price of EVs (as in part (c)), motorists switch towards gasoline cars, raising the demand for them. Since gasoline cars emit more CO₂, this accelerates climate change.

Marking points: identify the relevant value from Table 1; interpret the positive XED as substitutes; link rising demand for gasoline cars to climate change.

(e) Discuss the extent to which the price of lithium can be expected to rise beyond 2024. [8] (discuss)

Introduction. Whether the price of lithium rises beyond 2024 turns on whether demand grows faster than supply. The thesis is that both demand and supply will rise; the judgement hinges on their relative speeds.

Thesis — demand factors push price up. Lithium demand is likely to keep rising because of rising demand for the goods it serves as an input to. Extract 2 reports tastes and preferences shifting towards green goods, and Extract 4 projects EVs reaching nearly half of new car sales by 2030. Because lithium is a key input to lithium-ion batteries, the rising demand for EVs raises the derived demand for lithium. The demand curve shifts from D₀ to D₁, and, taking supply as fixed, price rises from P₀ to P₁.

Anti-thesis — supply factors push price down. Supply is also expected to rise beyond 2024. Extract 5 states the supply base is “expected to diversify” as many countries develop new sources, raising the number of producers; new mining techniques lower the cost of production. Both raise supply from S₀ to S₁, exerting downward pressure on price from P₀ to P₁.

Evaluation and judgement. Beyond 2024, the price of lithium is more likely to fall, because supply is set to grow faster than demand. On the demand side, the rise may slow: Extract 5 notes new battery technologies could replace lithium-ion within 15 years, so EV makers may switch away from lithium, weakening its derived demand. On the supply side, Extract 4 stresses that lithium “is not a rare metal” — plenty exists to be mined — so supply is not constrained by natural scarcity and can expand substantially once investment resumes. With supply rising faster than demand, the net effect is downward pressure on price.

(f) Discuss the case for and against the subsidisation of coal by governments of countries like China. [10] (discuss)

Introduction. A coal subsidy is a government payment that lowers the cost of producing coal. The case for and against is weighed in terms of efficiency and equity. On balance, for a country like China the case against subsidisation is stronger.

Thesis — against subsidisation (it worsens inefficiency). Coal use generates a negative production externality: external costs such as CO₂ emissions and global warming. Profit-maximising firms ignore these, supplying along their marginal private cost (MPC), so the free-market output is Qₘ where MPC = MPB. The socially optimal output is the lower Qₛ where marginal social cost (MSC) = marginal social benefit (MSB). The market over-produces by Qₘ − Qₛ, generating a deadweight welfare loss (triangle ABC) because, over that range, MSC exceeds MSB. A coal subsidy lowers MPC further to MPC′, raising market output to Qₘ′ where MPB = MPC′. Over-production worsens to Qₘ′ − Qₛ and the welfare loss enlarges from ABC to ADE.

Anti-thesis — for subsidisation (it improves equity). China may subsidise coal to help poorer households afford energy. The subsidy lowers the cost of production and raises supply from S₀ to S₁, putting downward pressure on price from P₀ to P₁ and raising quantity from Q₀ to Q₁. Because coal is China’s main energy source (Extract 6), it is a necessity powering heating and basic electrical needs; keeping coal — and hence energy — prices low improves equity, since low-income households can still afford energy.

Evaluation and judgement. For China the case against subsidisation is stronger. Although a subsidy improves equity, it does not address the root cause — income inequality; reskilling and retraining workers would close the income gap more directly. Moreover, less distortionary instruments can secure equitable energy access: targeted transfer payments or rebates to low-income households deliver the equity gain without the additional over-production and welfare loss that a producer subsidy on a pollutive good imposes. The efficiency cost of subsidising a negative-externality good therefore outweighs its equity benefit.