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The Great Carbon Arbitrage: Going short on coal and long on renewables

Key Takeaways

  • The net gain from replacing coal with renewables under a conservative estimate is around $78 trillion.

  • To achieve this gain, we propose climate financing to replace coal with renewables as a complement to incomplete carbon taxation.

  • We quantify how much climate financing would be needed to replace coal with renewables, in every region and country of the world.

  • We propose to use blended financing structures to leverage public money.


When Pakistan and northeastern India experienced an intense heat wave in early May, the two countries responded by increasing electricity production from their coal-fired power plants to keep the lights on and air conditioners running. Energy use was so high that without the expanded energy production, extended power outages were guaranteed. But the response was ironic at best. And detrimental at worst. Making coal-fired plants work harder only puts more pollutants in the air, ensuring continued global warming and more heat waves. The Guardian responded with an article headlined: “We are living in hell.”

How can we stop this infernal cycle of more energy demand leading to more carbon emissions and a hotter planet? As hard as international negotiators have tried to reach an agreement to phase out coal (and despite the promise of a historic breakthrough at the COP26 in Glasgow), everything has failed. In response to the war that Russia started against Ukraine, even the countries that had given up on coal, such as Germany and the Netherlands, have been revising their stance. The most common concern with phasing out coal that is voiced is that it would be too costly. We are told that replacing coal with renewable energy would be too expensive. 

The Great Carbon Arbitrage

In “The Great Carbon Arbitrage” (Adrian, Bolton, Kleinnijenhuis 2022), we undertake a systematic quantitative analysis of this claim1.  We calculate the costs of replacing coal with renewable energy, and the social benefits from phasing out coal, to obtain an estimate of the net gain from this energy transition. 

We include in the costs of replacing coal with renewable energy the capital expenditure costs of building a renewable energy capacity that is equivalent to that from burning coal as well as the costs of compensating coal companies for their lost future earnings when they are shut down. 

The benefits from phasing out coal are related to the lower expected future damages from climate change and harm to people’s health. We calculate the present value of these benefits by estimating the size of avoided emissions from phasing out coal and by applying a carbon price to those emissions. In this way we obtain an estimate of the economic gain from phasing out coal. When we subtract from the present value of these social benefits the present value of the costs of replacing coal with renewable energy, we obtain as our baseline estimate a net total gain for the world from phasing out coal of around 78 trillion U.S. dollars (see Table 1). 

This represents around 1.2 percent of current world GDP every year until 2100.  Per ton of coal, this represents a net gain of around $125. Per ton of avoided coal emissions, this represents a net gain of $55. Far from finding that replacing coal with renewable energy would be too expensive, we uncover a huge economic benefit from phasing out coal, what we refer to as the “Great Carbon Arbitrage.” 

Table 1. The Great Carbon Arbitrage

Table 1. The Great Carbon Arbitrage

The flaw with the argument that phasing out coal is too costly is that it ignores the benefits from lower carbon emissions. 

These benefits are real economic gains in terms of lower expected physical damages from climate change, leaving aside all the attendant benefits to economic activity and innovation that the investments in renewable energy will bring. Economic efficiency stipulates that the carbon price should be set equal to the social cost of carbon (SCC). We build on the sizable literature on integrated assessment models (IAM) that provides quantitative estimates of the SCC to determine the carbon price to apply to avoided emissions. If all carbon emissions were priced under an efficient global emissions trading system (ETS), the equilibrium carbon price in this market would be equal to the SCC. It would then be possible to generate a total gross revenue from phasing out coal equal to the carbon price (SCC) times total avoided emissions. By shorting coal and going long replacement renewables it would then be possible to generate an arbitrage gain similar to the net social gain we have estimated from phasing out coal.

We calculate avoided carbon emissions from phasing out coal starting in 2024 by subtracting from the carbon emissions under a business-as-usual scenario, the lower carbon emissions that would be generated if instead coal were to be phased out in line with the Net Zero 2050 scenario of the Network for Greening the Financial System (NGFS). Our baseline estimate of the social benefit of phasing out coal takes the SCC to be equal to $75 per ton of CO2, in line with the lower end estimates of the SCC in Vernon et al. (2021) and lower than the current price of carbon allowances in the EU ETS. 

Reduce coal, increase economic and social gains

The net economic benefits from ending coal are so large that a general policy implication from our analysis is that efforts should be redoubled to achieve a global agreement to phase out coal as soon as possible. Even faced with “high transaction costs” and “poorly defined property rights,” to use the language of the Coase Theorem (Coase 1960), it is surprising that a Coasian bargain of such proportions has not yet been exploited.

A global agreement to phase out coal has not been reached at the COP26. The 197 parties of the convention could only agree on accelerating independent efforts toward the phasedown of unabated coal power. But what is needed is a far more ambitious agreement to phase out coal that links investments in renewable capacity to replace coal, along with financing of these investments, and compensation of coal companies for lost profits. From a Coasian perspective it is sound economics to compensate losses incurred from phasing out coal, to account for capital expenditures needed to replace the energy from coal, and to set all these costs against the social benefits of avoided emissions.

Climate financing for swapping coal for renewables

To gain further insight into the size of the financing that may be required to pay for the replacement of coal with renewable energy, we break down on a regional basis where these costs would be incurred. We find that the present value of total climate financing needs to end coal globally are around $29 trillion, in line with renewable investment needs estimated in other studies. This represents an annual global climate financing need between half a trillion and $2 trillion, with a front-loaded investment this decade, which we estimate to be up to $3 trillion (see Figure 1). 

Figure 1. Annual Climate Financing Needs

Figure 1: Annual Climate Financing Needs

Note: Annual financing needed to replace coal with renewables (50% solar and 50% wind), split by region and level of development. The annual amounts are not discounted. A computational tool for estimating annual climate financing needs can be found here.

We estimate that 46 percent of the total climate finance needs are in Asia, 18 percent in Europe, 13 percent in North America, 13 percent in Australia and New Zealand, 8 percent in Africa, and 2 percent in Latin America and the Caribbean (see Figure 2). 

Figure 2. Climate Financing Needs by Region

Figure 2. Climate Financing Needs by Region

Notes: The present value of financing needed to replace coal with renewables (50% solar and 50% wind), split by region and level of development. A computational tool for estimating the present value of climate financing needs can be found here.

Large heterogeneity exists across countries in terms of climate financing needs, depending on their current and projected extent of coal use for energy provision (see Figure 3).

Figure 3. Country-Specific Climate Financing Needs

Figure 3. Country-Specific Climate Financing Needs

Notes: The present value of financing needed in each country to replace coal with renewables (50% solar and 50% wind). A computational tool for computing the present value of country-specific climate financing needs can be found here.

A public-private partnership dedicated to ending coal

The sheer size of the financing needed to put an end to coal energy production clearly represents a major challenge. But our analysis shows that the social gain from these investments far exceeds the cost. Some prominent commentators have argued that no government in the world has enough money to make such sizable investments and have called on the private sector to steer the required funding to renewable energy investments. 

Most of the funding for these investments can indeed come from the private sector but a significant amount of public money to enhance these investments will still be needed (see Arezki et al. 2016 and Bolton et al. 2020). We provide ballpark estimates of the size of public funding that is required if for every dollar of public funds nine dollars of de-risked private financing can be tapped through blended finance arrangements and conclude that the overall strain on public finances (at around $2.9 trillion; 10 percent of $29 trillion) is not inordinate especially considering the large social benefits (at around $107 trillion, see Table 1) from phasing out coal. 

The public sector

Broadly speaking, it’s in the interest of a government to finance 10 percent of its country’s total costs to replace coal with renewables if this amount is less than its resulting social benefits in terms of lower climate damages and harm to human health. A back-of-the-envelope calculation suggests this holds true for nearly all countries. Considerations of fairness, a country’s fiscal position, or both, may in certain cases call for foreign contributions to finance 10 percent of a country’s costs to phase out coal. 

The private sector

To date, the market size for ABSs is not sufficient to finance a green transition away from coal at scale. Currently, the ABS market is only about $2 trillion globally. In principle, one could envision a substantial increase in market size over the next decade, but it would remain to be seen how quickly such scaling toward at least a $26 trillion market (90 percent of $29 trillion) could happen. 

Asset managers, insurance companies, pension funds, and sovereign wealth funds are potential investors in the senior tranches of ABS. The proposed structured would have to appeal to those institutions from an investment point of view, in terms of riskiness, yields, and ESG considerations.  While many buy-side institutions have adopted ESG type investment mandates, the total market size for ESG assets remains fairly small, below $3 trillion at the time of writing, globally. 

To scale up the capacity of capital markets to phase out coal, further collaboration between the public and private sector is necessary. International development banks (such as regional multilateral banks, IFC, and so on) would have to significantly scale up their capacity to invest in the junior (equity) tranches of ABSs, based on increased government funding. Private-sector initiatives — such as those led by the Glasgow Financial Alliance for Net Zero (GFANZ) representing $130 trillion of assets under management (roughly 40 percent of global financial assets) and the World Economic Forum — would have to work with their members to develop markets for investment grade tranches. 

To finance the phaseout of coal in a Coasian coalition it must be in the interest of governments and investors to participate. Governments must be willing to invest around 3 trillion dollars into junior tranches of ABSs. Governments and investors must be willing to collaborate to develop a market size of at least 26 trillion dollars for senior tranches of an asset class dedicated to shorting coal and going long renewables. Such public-private partnership then enables the realization of the great carbon arbitrage identified in this paper.

Tobias Adrian is the Financial Counsellor and Director of the Monetary and Capital Markets Department at the International Monetary Fund.

Patrick Bolton is Professor of Finance and Economics at the Imperial College London. He is also the Research Director of the Centre for Climate Finance and Investment (CCFI) at the Imperial College Business School.

Alissa M. Kleinnijenhuis is a Research Scholar at SIEPR. She is also a Senior Research Fellow at the Institute of New Economic Thinking at the Oxford Martin School (INET).


[1] A computational tool and extra analysis can be found at


Adrian, T., P. Bolton, and A. Kleinnijenhuis (2022), “The Great Carbon Arbitrage,” IMF Working Paper No. 2022/107.

Arezki, R., P. Bolton, S. Peters, F. Samama, and J. Stiglitz (2016), “From global savings glut to financing infrastructure: The advent of investment platforms,” International Monetary Fund Working Paper WP/16/2018.

Bolton, P., X. Musca and F. Samama (2020), “Global PublicPrivate Investment Partnerships: A Financing Innovation with Positive Social Impact,” Journal of Applied Corporate Finance 32, no. 2 (2020): 31-41.

Tobias Adrian
Patrick Bolton
Alissa M Kleinnijenhuis
Publication Date
July, 2022