Factoring carbon in US decision-making. Faisal Abubakar

Transcription

1 Factoring carbon in US decision-making Faisal Abubakar Friday 10th February, 2012

2 1. INTRODUCTION Carbon has over the last years become an important topic in the energy and climate change debate. Everyone agrees that action needs to be taken to combat climate change; the problem is deciding the pace. Carbon pricing can be done in many ways for example the EU Emissions trading scheme uses market prices per tonne of carbon in traded sectors, government applied carbon taxes or prices used by governments in policy assessment to define carbon and its weight in comparison with other impacts of possible policies. Valuing carbon for appraisal is a much-debated issue. In support of its use, it is argued that there are choices between opposing objectives and decision-making can be helped by explicitly pricing carbon for appraisal. However, there is controversy as to which method to use in setting the price. Similarly, they are opinions that no one method is clearly superior or more realistic to another and maybe there is need for a new and different approach (Friends of the Earth, 2008). 2. WHY VALUE CARBON? The fundamental reason for putting a price on carbon is to ensure an objective, consistent and evidence-based approach to appraising government policies. Carbon values are used in cost-benefit analysis to gauge whether certain policies could improve or reduce general societal welfare given the costs and benefits that include climate change impacts. In order to guarantee that government takes into account fully the impacts of climate change in public policy and project evaluation, a robust method to carbon valuation is fundamental. Policies usually compete with alternatives and choices need to be made. A carbon value helps to make sure such choices are made in the most cost effective and transparent manner (DECC, 2009). 3. METHODS OF CARBON PRICING Carbon emissions are a negative environmental externality. They are very hard to monetise especially as there is no market that currently covers carbon emissions across all sectors of an economy. Nevertheless, there a few methods of pricing carbon discussed briefly below. 3.1 The Social Cost of Carbon (SCC) The SCC is an approximation of damages monetized that are caused by an increase in GHG s in a specified year. In other words, SCC is an estimate of the benefits of reducing GHG s today and thus preventing future damages. When estimating the SCC, there is a need to find the physical and human damages caused by the increased GHG s and subsequent climate change. This would involve all sorts of researchers trying to find for example how increasing GHG s affect the climate both in the short and long term. SCC estimation is an imperfect process; more emphasis should be on climate science, SCC not a gospel. There is need for better understanding of the frequency and nature of future or potential catastrophes. Complex economic models are used to estimate the SCC. These models try to approximate everyday issues that cause damages as well as benefits to society and therefore assess the economic processes at play. In calculating the SCC, the unit of measure of emissions is the metric ton of carbon dioxide (CO 2 ) The Marginal Abatement Cost (MAC) The Marginal Abatement Cost of Carbon (MAC) commonly known as avoidance cost is the cost of reducing emissions by one unit (Stern, 2007). Abatement may involve switching fuels, or newer technology development. The figure below shows MAC curves for the US. This is an expert opinion MAC. It shows possible abatement options. It shows costs of abatement in ascending order from left to right. MAC like SCC is associated with uncertainties

3 Figure 1: US MAC Source: Bloombery New Energy Finance, 2010) 3.3. Market prices They are prices such as prices from the EU Emissions Trading Scheme ETS. These are real prices. They genuinely affect business decisions of companies involved. They are much easier to use. The permit prices relate to set targets. 4. PRICE OF CARBON IN THE US The US has been dragging its feet when it comes to climate change and basically not doing enough about. Well, finally they ve joined in the global drive to combat climate change. Although they haven t ratified any international treaty on emissions reduction, they have non-binding targets agreed upon during the Copenhagen accord, which is to cut 17% emissions on 2005 levels by This is a step in the right direction even though it is small compared to the EU target of cutting emissions by 20% on 1990 levels by the same Small policies rather than huge policies have been pursued to meet the above targets but they can only reduce so much. Therefore there is the need to for the government to set out a rational climate policy. a key step is to determine the damages related to incremental increase in carbon emissions and monetize them. This is referred to as the social cost of carbon. The US estimates SCC as opposed to the MAC used in the UK. The estimates are as a result of law. Executive orders require all projects and policies of government be appraised before they are finally executed 1. Before 2009, ranges of numbers were used as SCC estimates and were not consistent. The Obama administration decided to standardize the SCC estimates and came up with interagency working group (IWG) 2. The IWG comprised of various government departments and agencies involved directly and indirectly with energy and climate change. 1 Under Executive Order 12866, agencies in the Executive branch of the U.S. Federal government are required, to the extent permitted by law, to assess both the costs and the benefits of the intended regulation and, recognizing that some costs and benefits are difficult to quantify, propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs. 2 The Council of Economic Advisers and the Office of Management and Budget convened the interagency process, with regular input from the Council on Environmental Quality, National Economic Council, Office of Energy and Climate Change, and Office of Science and Technology Policy. Participating agencies included the Environmental Protection Agency, and the Departments of Agriculture, Commerce, Energy, Transportation, and Treasury.

4 The IWG panel or committee recommended a range of SCC values, $5, $21, $35 and $65 per tonne of CO 2. The US values are not as stringent as the UK estimates. The last UK estimates of SCC were between $41-$124 per tonne of CO 2 (Bell & Callan, 2011). The difference in the values depends on the assumptions made as well as the discount rate. Different rates used across agencies. EPA uses a different figure. The discount rate is subjective. An Example of when the SCC estimates have been used in appraising policy is the Regulatory Impact Analysis for DOT/EPA rules imposing miles-per-gallon automobile fleet standards (CAFE). The new rules require carmakers to improve fuel economy and reduce emissions by around 5 per cent per year all across all fleets. Another example is the Department of Energy (DOE) regulations concerning energy efficiency standards. Stricter energy efficiency standards for water heaters were announced. It is required that starting 2015, water heaters be 47% more efficient and gas heaters to use 30% less energy. The DOE estimates huge savings as well as significant emissions reduction. Table 1: Annual SCC Values: (in 2007 dollars per ton) Source: IWG Report, (2010) The table above shows the SCC prices from 2010 to Its shows the three discount rates used and also the 95 th percentile which is used as the worse case scenario. $21 is the central limit. 4.2 US SCC Calculation This was done through the use of complex economic modelling or as there are commonly referred to as integrated assessment models (IAM). The US used three distinct models 3 : DICE Dynamic Integrated Climate and Economy FUND Climate Framework for Uncertainty Negotiation and Distribution PAGE Policy Analysis of the Greenhouse Effect 6. SUITABILITY OF COST-BENEFIT-ANALYSIS A lot of concerns have been raised about the suitability of cost benefit analysis and its use in environmental decision-making. The most notable is the issue of uncertainty that surrounds climate change. The uncertainty is not about whether climate change will occur or cause harm but on who it will affect, how, 3 William Nordhaus, an economist at Yale University, developed DICE. Chris Hope, of the Cambridge University Judge Business School, developed PAGE. FUND was developed by Richard Tol, a professor at the Economic and Social Research Institute in Dublin.

5 when, where and how much weight to attach to such harm or damages in a cost benefit analysis. Without such information, it would be an impossible task to conduct a proper cost-benefit analysis (Masur & Posner, 2010). Climate change is an international issue. Emissions affect almost everyone and this leads to another issue referred to as international leakage. This is to do with the fact that if emissions are reduced, the benefit of such reductions would be enjoyed by everyone and probably more so by people outside the country bearing the abatement costs. So who do you account for such benefits conferred to people outside a country when conducting a CBA. 7. FINDINGS The US, one of the largest emitters of carbon in the world is actually getting involved in climate change regulation, contrary to common belief. It may be slow but is definitely a step in the right direction. The SCC figures developed by the IWG are too small and rife with too many uncertainties. Therefore, a periodic review is needed. This will take into consideration any changes in the assumptions and conditions used in the initial calculations and ultimately give room for improvements. In terms of carbon valuation, the US could learn from other friendly developed countries, particularly the EU and the UK who have more experience when it comes to valuing emissions. A possibility is moving to the use of marginal abatement costs which as mentioned before seem to have fewer limitations than estimating SCC while also conducting further research and development in pursuit of an even better methodology should be considered. Putting a price of carbon should be seen as one way of tackling climate change and policy formulation and should be used in conjunction with other policies to meet set targets (Stern, 2007). International leakage is a problem and cooperation is needed. Countries working alone will reduce carbon emissions but not adequately. Acknowledgements I would like to thank my supervisor Dr Aidan While, of the University of Sheffield for proposing the project and the guidance given. REFERENCES Ackerman et al. (2010). The Need for a Fresh Approach to Climate Change Economics. Pew Climate Workshop proceedings. Ackerman, F., and Stanton. E. (2011). Climate Risks and Carbon Prices: Revising the Social Cost of Carbon. Economics for Equity and the Environment. ments.pdf. Anthoff, David, Hepburn, Cameron and Richard S. J. Tol. (2008). Equity weighting and the marginal damage costs of climate change. Ecological Economics 68(3), Baneman, Dan. (May 4, 2010). Estimating the Social Cost of Carbon: A Numerical Approach and Sensitivity Analysis. Yale University. nordhaus.econ.yale.edu/documents/econ331_baneman_finalpaperscc.pdf Bell, R.G., and Callan. D. (2011). More than meets the eye: The social cost of carbon in US climate policy, in plain English. World Resources institute.

6 Bloomberg New Energy Finance. (January 2010). Carbon Markets North America Research Note. bnef.com/whitepapers/download/25 Dietz, Simon. (2007). Review of DEFRA paper: The Social Cost of Carbon and the Shadow Price of Carbon: what they are, and how to use them in Economic Appraisal in the UK. London School of Economics and Political Science (LSE). Friends of the Earth, (2008), The Price of Carbon: What should it be and why, Seminar, Mercer Suite, Royal Society, Meeting Summary, Greenstone, Michael, Kopits, Elizabeth and Ann Wolverton. (2011). Estimating the Social Cost of Carbon for Use in US Federal Rulemakings: A Summary and Interpretation. National Bureau of Economic Research. Kesicki, Fabian. (2010). Marginal Abatement Cost Curves for Policy Making Expert-Based vs. Model- Derived Curves. Energy Institute, University College London. Available at: Masur, Jonathan S. and Eric A. Posner. (August 2010). Climate Regulation and the Limits of Cost-Benefit Analysis. John M. Olin Law & Econ., Working Paper No. 525, Public Law and Legal Theory, Working Paper No Price, Richard, Thornton, Simeon and Stephen Nelson. (December 2007). The Social Cost of Carbon and the Shadow Price of Carbon: What they are, and how to use them in economic appraisal in the UK. Department for Environment, Food and Rural Affairs (UK). Stern, Nicholas. (2007). The Stern Review: The Economics of Climate Change. Cambridge University Press. Tol, R. S. J., and Lyons, S., (2008), Working Paper 247, Incorporating GHG Emission Costs in the Economic Appraisal of Projects Supported by State Development Agencies, ESRI, Tol, Richard S. J. (2009). The Economic Effects of Climate Change. Journal of Economic Perspectives 23(2), UK Department of Energy & Climate Change. (2009). Carbon Appraisal in UK Policy Appraisal: A Revised Approach. UK Department of Energy and Climate Change. (October 2011). A brief guide to the carbon valuation methodology for UK policy appraisal. Watkiss, P. (2006). The Social Cost of Carbon. Paul Watkiss Associates, UK. Presented to OECD Global Forum on Sustainable Development: Economic Benefits of Climate Change Policies, 6 7 July 2006.