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Climate change: the cost of carbon


 

AEA Technology Environment: Methodological approaches for using social cost of carbon estimates in policy assessment

Abstract

The UK Department for Environment, Food and Rural Affairs (Defra) initiated this research project to evaluate the approaches to and estimates of the social cost of carbon (SCC) to inform policy decisions. The key messages from the report are the following:

There are a number of different applications for the use of the SCC across Government

The project identified four potential applications for the use of SCC estimates:

  • Project appraisal (project cost-benefit analysis);
  • Regulatory Impact Assessment (policy cost-benefit analysis);
  • Input for economic instrument (input to the setting of taxes or charges);
  • Long-term objectives or targets.

There has been widespread use of the current SCC estimates across Government for the first three of these applications, though the exact approach has varied. A wider review has found that the UK government appears unique in its widespread adoption and implementation of a SCC estimate in policy assessment, though interest in SCC estimates is increasing internationally.

Monetised SCC estimates are useful but a wider framework is necessary for setting long-term targets.

The benefits of climate change policy should be considered when setting long-term targets and goals. Some benefits can be directly estimated as monetary values, but a wider framework is needed to take all relevant effects into account. This recognises that the current SCC estimates do not quantify all the impacts of climate change (including risks of major events) when compared to the full risk matrix for climate change identified in the study. The wider framework should include a disaggregated analysis of impacts and economic winners and losers by region and sector. Extensive uncertainty analysis is also recommended, with consideration of discount rates and equity weighting. Ancillary effects (e.g. air pollution benefits) are important and should be considered, though these should be assessed separately. Detailed policies (and shadow price estimates) should follow, and be consistent, once a long-term goal is set.

No single value of the SCC can be estimated with confidence.

The companion report ‘Social Cost Of Carbon: A Closer Look At Uncertainty’ by the Stockholm Environment Institute reveals that SCC estimates span at least three orders of magnitude, reflecting uncertainties in climate, impacts and valuation, coverage of sectors and extremes, and choices of decision variables. The report concludes that it is not possible to provide an illustrative central or upper benchmark of the SCC for global policy contexts, though the risk of higher values for the social cost of carbon is significant. The report however suggests that a lower benchmark in line with the lower end of the range recommended by the GES paper (£ 35 tC) is reasonable for a global decision context, consistent with a modest level of risk aversion to extreme events, relatively low discount rates and equity weighting.

However, cost-benefit analysis of projects and policies requires shadow price estimates. On the basis of the available evidence it is possible to define ranges of illustrative shadow prices.

The report explores the way forward on the choice of shadow prices for use in day-to-day project and policy appraisal. It compares and contrasts alternative approaches including the use of “pure” SCC estimates (i.e. estimates of marginal damage costs), or information on marginal abatement costs to achieve pre-ordained policy targets. However, there are problems with both approaches. The companion report sets out the issues on the SCC estimates (see above paragraph). There is also no agreement on the relevant marginal abatement costs (MAC) for the existing long-term targets, and indeed the range of MAC estimates varies by more than an order of magnitude. As a result, the consultants recommended a pragmatic approach, as an interim step until further analysis is undertaken, to increase the confidence in the SCC or MAC values. This approach combines the information on the SCC and MAC estimates. The report presents an example of this approach, and an example range of illustrative shadow prices with existing information, but recognises the limitations of available evidence on marginal abatement costs and SCC estimates. The consultants also summarise available evidence on “pure” SCC estimates through a range of values, for possible input to future assessment of long-term targets, but with the strong caveat that any such application of these estimates should recognise the limitations in the SCC values (the omission of major categories of impacts) and be consistent with recommendation above – notably that when setting long-term climate change targets and goals, a wider framework (including the full risk matrix) is needed.

Uncertainty on shadow prices can be addressed through a multi-step approach

The estimates derived in the study can be presented as a single illustrative value or a range. There is a trade-off between providing a central value to ensure consistency across all areas of appraisal, and providing a range to take into account all the inherent uncertainties. To address this, the report recommends a stepped approach, where the degree of sensitivity analysis on the range of SCC estimates varies with application:

  • for project appraisal, a single central illustrative value could be used;
  • for policy appraisal affecting greenhouse gas emissions, a central range could be used, allowing some consideration of uncertainty; and
  • for major long-term policies, e.g. for climate change policy or for a revised Energy White Paper, a full range and additional sensitivity analysis could be used.

There are a number of important research priorities

The report identifies a number of research priorities. These are particularly important given the continued uncertainty around SCC and MAC estimates. The study identifies the need for disaggregated estimates of the impacts and costs of climate change, further work to progress the analysis of all impacts (for the full risk matrix), further uncertainty analysis around the key parameters (e.g. equity), and a need to improve the long-term MAC estimates.

Full report

Some of the peer reviewers have agreed to publish their critical comments alongside the reports:

Page published: 22 February 2006  
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