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Climate Change Blog

  • 19
  • July
  • 2016

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U.S., Canada, and Mexico Agree to Use Similar Measures for the Social Cost of Carbon to Value GHG Reductions

On June 29, 2016, President Barack Obama, Canadian Prime Minister Justin Trudeau, and Mexican President Enrique Peña Nieto made a trilateral energy and climate announcement during the North American Leadership Summit in Ottawa. The announcement included an Action Plan of “deliverables,” such as striving “to achieve a goal for North America of 50% clean power generation by 2025.” The countries also agreed to align their approaches for estimating greenhouse gas (“GHG”) impacts, including by using similar Social Cost of Carbon (“SCC”) methodologies. Because there is a wide variation in the values that different SCC methodologies assign to reductions in CO2 emissions, the decision to use similar methods could have a meaningful impact on how climate change policies are assessed in each of the three countries.

What is the Social Cost of Carbon?

As discussed in this previous post, environmental economists have been trying for the past several decades to develop a way to quantify the impact of GHG emissions in present economic terms. Competing SCC models attempt to quantify the incremental climate impact that the modelers think will result from a unit of carbon dioxide (“CO2”) emissions so that an economic value can be assigned to the emissions. That value is then used as a point of comparison for actions that reduce CO2 emissions, such as regulations to limit GHGs. A number of competing models exist, each of which makes different predictions about future interactions between human behavior and the climate. These models tend to include predictions regarding changes in net agricultural productivity, human health, property damages from increased flood risk, and the value of ecosystem services due to climate change. The models attempt to calculate impacts over the next several hundred years, and then to apply a discount rate in order to determine what the future impact means in current economic terms.

Federal agencies in the U.S. use a particular set of values for a ton of CO2 emission. This set of values was developed by an Interagency Working Group (“IWG”), which has attempted to integrate three different SCC models known as DICE, FUND, and PAGE. The IWG issued a revised report in 2013, increasing the SCC estimates for 2020 to $12, $43, $65, and $129/metric ton CO2 (in 2007 dollars) at different interest rates. For practical purposes, this means federal agencies are currently valuing the SCC at about $37/metric ton of CO2, which is based on a 3 percent discount rate. According to a recent GAO report, these 2013 figures raised public interest because they were approximately 50 percent higher than the 2010 estimates. The new report has also sparked a debate about the use of SCC values to analyze the effects of regulatory action. Critics on both sides have argued that the current IWG values are either too high or too low to accurately reflect GHG impacts. The methodology developed by the IWG and used by U.S. federal agencies is currently under review by the National Academies of Sciences.

From an industry perspective, the use of the SCC to value reductions in GHG is controversial in part because it allows agencies like the EPA to assert that costly regulations aimed at reducing GHGs will actually have a net economic benefit. For example, in its recent methane regulations for the oil and gas industry, EPA concluded that the rule has a net economic benefit. EPA’s conclusion was largely based on its use of a model called the Social Cost of Methane, which is a variation on the SCC. Based on the model and the 3 percent discount rate that EPA used in the cost effectiveness analysis, EPA determined that every ton of methane emissions that this rule prevents was worth $1,100 in 2015. As a result, EPA estimated that this rule will result in “methane-related monetized climate benefits” of $360 million in 2020 and $690 million in 2025 using the 3 percent discount rate. By placing such a high price on each ton of methane emissions that the rule would reduce, EPA was able to calculate an economic benefit from the regulation that dwarfed the high compliance costs associated with the rule.

Critics have also questioned whether any model can accurately project impacts that will happen hundreds of years into the future. In addition, because these models project so far into the future, the present dollar value that they place on a ton of CO2 is highly susceptible to the discount rate applied. For example, the table below provides the IWG’s valuation of a reduction of a ton of CO2 for different years. Each of these figures is the result from the same model used by IWG to assess future impacts. As this table of the IWG figures demonstrates, a few percentage points in the discount rate can have a big impact on the value assigned to emissions even when using the same model.

CC Blog_07192016_Chart

North American Leadership Summit

As part of the Action Plan, the U.S., Canada, and Mexico have agreed to “align analytical methods for assessing and communicating the impact of direct and indirect greenhouse gas emissions of major projects.” Notably, the Action Plan specifically references the use of the SCC to estimate the costs and benefits of climate policies: “Building on existing efforts, align approaches, reflecting the best available science for accounting for the broad costs to society of greenhouse gas emissions, including using similar methodologies to estimate the social cost of carbon and other greenhouse gases for assessing the benefits of policy measures that reduce those emissions.” The reference to “other greenhouse gases” suggests that the three nations may also attempt to align their methodologies for calculating the Social Cost of Methane.

Because the dollar value placed on a single ton of CO2 is highly contingent on the model and discount rate used to calculate it, the method selected by these three nations will have a big impact on the benefits that the three countries attribute to reducing GHG emissions. Some researchers have argued for placing a much higher value on each unit of reduced emissions, including Stanford University scientists who say that CO2 should be valued at $220/ton. Others have argued that the appropriate discount rate is seven percent — at which point, the value of reducing a ton of CO2 would be negligible. Many of these decisions are not purely scientific. Instead, they are policy decisions about how we value future impacts. As the U.S., Canada, and Mexico grapple with climate policies, they will also have to decide on a common methodology that they can use to assess the costs and benefits of their policies. 

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