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Climate Hustle

The Economic Damage of Climate Denial

Posted on 3 October 2012 by dana1981

When you start talking about economics, the eyes of many a climate science geek (present company included) begin to glaze over.  However, this is a critical subject.  When you ask a climate contrarian why they won't support climate action just in case they are wrong about the science, the contrarians will invariably assert that pricing and reducing carbon emissions will harm the economy.  However, this assertion is in direct contradiction with the body of climate economics literature, which actually shows the opposite is true.

This post examines a new paper by Johnson and Hope (2012) which evaluates the overall cost of carbon emissions via climate change damages.  Key points when these costs are taken into consideration:

  • current estimates of the overall costs of carbon emissions (via damage from climate change) are generally too low
  • when those costs are taken into account, solar energy is already cheaper than coal, and wind is probably cheaper than natural gas (both are already cheaper than coal)
  • by failing to put a price on and reduce carbon emissions, and by continuing to rely on fossil fuels, we are damaging the economy

The social cost of carbon (SCC) is effectively an estimate of the direct effects of carbon emissions on the economy - it estimates how much damage our emissions cause via climate change, or how much it will cost us to adapt to climate change.  The SCC takes into consideration such factors as net agricultural productivity loss, human health effects, property damages from sea level rise, and changes in ecosystem services.

The SCC is a difficult number to estimate, but is key to any cost-benefit analysis of climate legislation.  The main argument against putting a price on carbon emissions is that doing so will harm the economy.  The only way to evaluate this assertion is to compare the costs of carbon pricing to the benefits (the avoided costs from climate change damage), and the benefits are measured via the SCC.

A new paper by Johnson and Hope 2012 (JH12) notes that the U.S. Interagency Working Group on the Social Cost of Carbon (hereinafter "Working Group") published its first SCC estimates in 2010, with a central value of $21 per metric ton of CO2, suggesting that economic analyses also be performed for SCC values of $5, $35, and $65.  JH12 note that these figures have been criticized as too conservative for several reasons.

"These estimates have been criticized for relying upon discount rates that are considered too high for intergenerational cost–benefit analysis, and for treating monetized damages equivalently between regions, without regard to income levels."

JH12 re-estimate the SCC values using a range of discount rates and methodologies they consider more appropriate for the very long time horizons associated with climate change.  As a result, they estimate the SCC is several times higher than the Working Group estimate.

Equity Weights

JH12 note that the Working Group approach did not assign “equity weights” to damages based upon relative income levels between regions.  In this approach, a dollar’s worth of damages occurring in a poor region is given more weight than one occurring in a wealthy region.  This is because as JH12 note,

"poorer regions are expected to have far less income to cope with damages than are wealthier regions, a problem compounded by the fact that they are also expected to bear more of the damages while having contributed the least to the problem"

That poorer regions are expected to be the most impacted by climate change was demonstrated by Samson et al. 2011 (Figure 1).

vulnerable

Figure 1: Per capita emissions vs. vulnerability to climate change, from Samson et al. (2011)

In their paper, JH12 do apply equity weights in their SCC calculations.

Discount Rates and Roberts Otters

The term 'discount rate' refers to the time value of money - how much more  a dollar is worth to us today than next year, related to interest rates.  A high discount rate means we would much rather have money today than in the future.

This is a key variable in determining the proper SCC.  The costs of emissions reductions are primarily incurred in the short-term, whereas the economic benefits of emissions reductions (the avoided costs from climate change damage) mainly occur in the future.  Thus if we say a dollar is worth much more now than in 30 years, emissions reductions costs are weighted much more heavily than the benefits of avoided climate damage, resulting in a lower SCC. 

For example, JH12 note that 25 years from now, for a 5% annual discount rate, $100 worth of climate damage has a present value of only $30 ($100/[1.0525]), due to the effect of compound interest.  The present value of $100 worth of damage falls to 76 cents 100 years in the future if using a 5% discount rate.  Thus the lowest SCC estimates, for example from economists Richard Tol and William Nordhaus, tend to result from assuming very high discount rates (3 to 5%).

There are two main justifications for using a high discount rate - the assumption that future generations will be wealthier than today's (and their increased wealth will more than offset the costs of climate change), and the opportunity cost of foregone investments (money spent reducing emissions could have been invested elsewhere).

JH12 criticize the Working Group for selecting relatively high discount rates.  The Working Group used 2.5%, 3%, and 5% (recommending 3% for estimating the SCC central value), based on current market interest rates, which they argued avoids the need for imposing subjective values.  But that's a problem because climate change has costs that are difficult to quantify economically - for example the value of human life, and thus the cost of people dying of starvation if there is insufficient food as a result of agricultural damage from climate change.  Using a 3% discount rate completely neglects the "subjective" cost of human suffering and human life.

JH12 also argue that the Working Group did not consider the full range of consumption interest rates observed in markets, nor intergenerational discount rates established in the economics literature and recognized in government guidelines.  They note that in a 2008 technical support document, the U.S. Environmental Protection Agency (EPA) suggested a discount rate between 0.5% and 3%, noting:

"A review of the literature indicates that rates of three percent or lower are more consistent with conditions associated with long-run uncertainty in economic growth and interest rates, intergenerational considerations, and the risk of high impact climate damages (which could reduce or reverse economic growth)"

As discussed above, one of the main justifications for using a high interest rate is the assumption that future generations will be wealthier.  However, as the EPA notes here, major climate impact damages could prevent that from happening, if we have to devote major financial resources to adapting to climate costs.

As one counter-example to the Working Group, the Stern Review for the British government used a 1.4% discount rate.    There are many other reasons for using a lower discount rate, for example the fact that money isn't everything, and as noted above we also need to consider the climate-related suffering of future generations.  Dave Roberts has a good discussion of discount rates along with photos of otters to keep your interest, since this isn't the most enthralling subject to read about.

bored otter

In their study, JH12 use discount rates of 1%, 1.5%, and 2%, and compare their results to those in the Working Group's analysis with higher discount rates.

What is the Appropriate Discount Rate?

So JH12 argue for a discount rate between 1% and 2%, whereas the Working Group used 2.5% to 5%, the Stern Review used 1.4%, and more conservative economists use 3% to 5%.  But which is right?

Well, the answer is somewhat subjective, which is why the Working Group decided to try and remove subjectivity and simply choose conservative market-based values.  But as discussed above, there is a very strong case for lower discount rate values.  What if we split the difference?

Weitzman (2007) in discussing the Stern Review notes that for interest and discount rates, splitting the difference is mathematically not the same as taking the average.  In his terminology, "r" is the interest rate (emphasis added):

"A chance of r = 6 percent and a chance of r = 1.4 percent are not at all the same thing as splitting the difference by selecting the average r = 3.7 percent.  It is not discount rates that need to be averaged but discount factors.  A chance of a discount factor of e−6 a century hence and a chance of a discount factor of e−1.4 a century hence make an expected discount factor of 0.5e−6 + 0.5e−1.4 a century hence, which, when you do the math, is equivalent to an effective interest rate of r = 2 percent...with the above numbers it is a lot closer to the Stern value and is not anywhere near the arithmetic average of r = 3.7 percent."

So this also strenghthens the case for using discount rate and SCC values in the JH12 range.  We should note that Weitzman (2007) ultimately argued for discount rates in the 2–4% range, as opposed to the 6–7% range.  However, now that we are considering discount rates in the 1–5% range, splitting the difference would result in a discount rate of ~1.7%.

Results and their Importance

JH12 find central SCC values of $266, $122, and $62 per metric ton of CO2 using discount rates of 1%, 1.5%, and 2%, respectively.  They also estimated SCC using declining discount rate schedules (UK Green Book and Weitzman), finding central values of $55 and $175 per metric ton of CO2, respectively.  These central SCC values exceed the Working Group central value by factors of 2.6 to 12.7.

So what does this mean?  Well, the break-even point between carbon emissions reductions' costs and benefits is estimated at around $5-10 per ton of CO2 (Figure 2), meaning that if the real-world cost of carbon emissions exceeds $10 per ton, the benefits of carbon pricing will exceed the costs.  

$10 per ton is essentially the lowest possible value for SCC, if we use a very high discount rate of 5%.  Using more justifiable discount rates, SCC is between $55 and $266 per ton of CO2.  In other words, the benefits of reducing CO2 emissions far outweigh the economic costs.

Figure 2: Costs (light blue and red points) and Benefits (dark blue and purple points) vs. SCC values ($ per ton of carbon dioxide) using two economic models (ADAGE and IGEM), from New York University School of Law's Institute for Policy Integrity.  Note the x-axis label contains a typo - SSC should read SCC.

Note that even exceptionally conservative economists like William Nordhaus - whose SCC central estimate is only around $9 per ton of CO2 (in current dollars) - argue that carbon emissions reductions will benefit the economy.  Nordhaus has frequently been cited by climate contrarians, and his work misrepresented to argue against reducing emissions.  Nordhaus recently decided to set the record straight:

"My research shows that there are indeed substantial net benefits from acting now rather than waiting fifty years [to reduce CO2 emissions]...the loss from waiting is $4.1 trillion."

And remember, those results are based on an SCC of around $9 per ton of CO2 emitted, whereas JH12 argue that more appropriate discount rates put SCC between $55 and $266 per ton.  There is simply no question that putting a price on carbon emissions will result in a net savings and benefit the economy, even under the most conservative estimates.

Which Energy Sources are Actually Cheapest?

A frequent argument from opponents to emissions reductions and carbon pricing, for example John Christy, is that "cheap" fossil fuel energy is key to the development of poorer nations.  However, in claiming that fossil fuels are cheap, this argument neglects the climate impacts from associated greenhouse gas emissions - the SCC (not to mention neglecting the fact that poorer nations tend to be most impacted by climate change, as illustrated in Figure 1). 

This raises an important question - when we include the SCC, which energy sources are actually the cheapest?  JH12 examine this question for coal, natural gas, wind, and solar photovoltaic (PV) energy technologies (Table 6), with some caveats that their break-even SCC values are conservative.

"New natural gas and wind are competitive over new coal absent any pollution costs, and therefore no SCC is required to make them cost-effective. An SCC...of $50, would justify building solar photovoltaic over coal...An SCC of $215 would justify solar over natural gas....Wind would require an SCC of $74 to be cost-effective over natural gas."

"The break-even SCCs presented here are conservative in three respects. First, the SCC grows over time, whereas the SCCs used here are for 2010.  Accounting for the growth of SCCs over time would increase the cost of generation (inclusive of carbon damages) with coal or gas for a given starting SCC, reducing the 2010 SCC that corresponds to break even generation costs. Second, technological innovation may continue to drive down costs of wind and solar in the future, further lowering the break-even SCC. Third, we do not account for externalities other than air emissions from the power plants, such as methane emissions from natural gas wells and land disturbance from coal mining."

table 6

According to their results, solar PV energy is already cheaper than coal if we use a discount rate of 2%, and the price of solar PV technology is also falling rapidly.  Wind energy is also cheaper than natural gas if we use a discount rate between 1.5% and 2%, and solar PV is cheaper than natural gas for a discount rate between 1% and 1.5%.

Summary

There are several very important points we can take from this research.

  • The current range of SCC values used by the U.S. government is too conservative.  An appropriate central estimate would be around $100 per ton of CO2, with a range between $21 and $266 per ton.
  • This central estimate exceeds the break-even point between carbon emissions reductions costs and benefits ($5-10 per ton) by an order of magnitude.  The break-even point also falls below the range of appropriate SCC values ($21 to $266 per ton).  This means we can be very confident that reducing carbon emissions will result in a net economic benefit.
  • Even the most conservative economists agree that reducing carbon emissions will result in a net economic benefit.
  • Solar PV energy is probably already cheaper than coal energy, and wind is probably cheaper than natural gas, when carbon emissions costs are considered.
  • Overall, by failing to put a price on and reduce carbon emissions, and by continuing to rely on fossil fuels, we are damaging the economy.  Those who argue the converse are failing to account for the costs of damage caused by climate change.

It's also worth noting that a new report from the Congressional Research Service concluded that a much more modest carbon tax of $20 per ton of CO2 - on the very low end of the appropriate SCC range - could cut the projected 10-year deficit in the USA by 50 percent, from $2.3 trillion down to $1.1 trillion.  Another new report by the DARA group and the Climate Vulnerable Forum, written by more than 50 scientists, economists and policy experts, and commissioned by 20 governments estimates that climate change is already contributing to the deaths of nearly 400,000 people a year and costing the world more than $1.2 trillion annually, wiping 1.6% from global Gross Domestic Product every year.  So the costs of failing to price carbon and reduce emissions are already very real.

Note: this post has been incorporated into the Advanced rebuttal to the myth CO2 limits will harm the economy.

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Comments 51 to 54 out of 54:

  1. funglestrumpet - While it's certainly a voluminous writeup on renewables, I would suggest considering that the writer (Leo Smith, MA) has some, shall we say, "skeptic" attitudes:
    ...if you are not Concerned About Climate Change (and let's face it, a world with no electricity at all is a lot more terrifying than one a degree warmer) there's several hundred years of coal, which the Chinese will be burning anyway.

    Curious capitalization... A fairly quick look on the InterWebs indicates that the author of this paper has a history of claiming that AGW is an incorrect theory. That doesn't bode well for his other work.

    I would suggest that you look at some of the SkS threads and references on renewable baseload power, such as here or here. Many of the opinions expressed in the Smith paper are discussed, and (IMO) shown to be mistaken.

    You might also look at a very interesting study by Archer & Jacobson 2007 - they found that connecting multiple wind plants (19) over a reasonably large geographic area (MidWestern US) would provide between 33-47% of the average output was reliable as baseload power by current availability standards. Add solar (with different availabilities) and that percentage will only rise.

    Power density? There's enough area to supply our electrical needs hundreds of times over with either solar or wind power. Widely separated power plants are actually easier to balance than large centralized ones. Intermittency/dispatch? See the Archer et al paper above - distributed sites across more than weather pattern can manage quite well.

    The McKay study (McKay book) he references is quite worth reading on its own - there he looks at area, power density, and the possibilities of sourcing all UK power from available UK renewable resources (hardly a global perspective). And I believe McKay is quite correct that the UK is too densely populated, too small, and rather too far north for that to be possible within UK borders. On the other hand, there's plenty of space in North Africa, and in Eastern Europe - and if the UK finds itself a net importer of energy, it will hardly be alone in the world in that respect.

    Note: The myth (which you repeat) that renewables require more fossil fuel use than the original fossil fuel plants they replace is complete nonsense, from (mis)analyzing single-site renewable sources, when a distributed grid is the correct system to evaluate.

    Finally: On a personal point of view, I would much prefer windmills and solar farms to coal strip-mines - eyesores that poison the local water table, and never ever recover to anything approaching the original land quality. I grew up in coal mining country - portions of it resemble a moonscape. Those mines (and oil fields, and fracking regions, and...) represent an unavoidable land area/power that has to be considered in balance to the area required by renewables. Outside my hometown there are a group of windmills on a ridge across the highway from a strip mine.

    IMO the choice is obvious.
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  2. I haven't gone through funglestrumpet's link in detail, but (apart from the general polemic tone of the writing) I did note that he makes a big deal about "energy density" as if this automatically is some sort of death blow to renewable energy. I've seen this kind of thinking elsewhere as well, ignoring the following facts:

    1. While the area required for wind is large, that area doesn't need to be exclusively used for wind. In fact, every wind farm I've ever seen has been on land that was also being used for agriculture, and as far as I could tell (and from what I've read) the wind farm has little to no impact on the use of the land for its original purpose.

    2. The area required for a coal-fired power station might be small, but it's ignoring the area required for mining that coal, which is incredibly large. See SourceWatch for one attempt to calculate some figures for the US. The bottom line is that the area that has been already disturbed by coal mining probably exceeds the total land area required to power the entire USA by solar thermal alone, and apparently nobody thought that was an obstacle to the use of coal. On top of that, coal tends to be found in forested and agricultural areas whereas the best sites for solar thermal tend to be deserts.

    I agree with KR that McKay's book is a good read. I also agree that it's important to put it into context -- the UK is unusually dense, small, and far from the equator. The idea that the UK should be able to take advantage of a switch to renewables to wean itself off energy imports seems fanciful -- it imports energy now, and it will need to continue doing so in future. Conclusions that apply to the UK hardly apply to the majority of the world.

    Another general tendency I've seen is for magic bullet thinking, and to rule out any technology that can't economically provide 100% of future needs. This is an unrealistic and unnecessary hurdle. After all, none of the current technologies are attractive if you scale them up to 100%. We use a mix of technologies right now precisely because of this. While we argue about whether wind or solar are viable at high levels of grid penetration, we miss out on the opportunity to bring them up to their optimal levels of grid penetration while giving us more time to solve those problems or find better alternatives.

    What are the optimal levels? Well, according to the NREL, at penetration rates of up to 6%, solar PV is actually beneficial because it allows less usage of peaking power generators. At higher rates, however, it’s generating so much power at peak times that it causes a problem because the existing baseload generators have difficulty scaling back output, and scaling them back to their minimum output, then adding in wind plus solar PV, actually results in generation greater than the load.

    However, replacing traditional plants with solar thermal plants with heat storage actually increases the penetration ability of PV because the solar thermal plants have higher ramp rates and lower minimum outputs than traditional large thermal plants. The solar thermal plants increase grid flexibility and its ability to accommodate wind and PV, to the extent that a total solar contribution in excess of 50% (PV + CSP) becomes viable.

    Adopting solar thermal, solar PV, and wind on a large scale while researching fusion and trying to make thorium reactors economically viable seems like a good strategy to me.

    Complaining about how wind farms and solar powerplants look while ignoring how coal mines look seems rather selective. Like KR, I'd much rather have the former nearby than the latter.
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  3. funglestrumpet notes:
    The more of those ugly wind turbines we have peppering our once beautiful landscape

    Others have pointed that wind turbines are a fair sight more attractive than, say, coal mines, but I would suggest most of the fixtures of modern fossil-fuel civilization are also unpleasant compared to wind farms.

    At the city where I live (Ottawa, Ontario), our old-school shopping centres near the city centre (Rideau Centre & St Laurent centre) are hideous concrete blocks. The building where I work is a squat metal box. The main highway through town (provincial highway 417) is a long strip of pavement marring the landscape.

    How are wind farms any uglier than most of the modern accountrements of affluence?
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  4. This model has received play at The Economist. It seems, at first glance, to take an oversimplified view of climate change by reducing it to the relationship between temperature and agricultural output in a select range of major crops. In may get play in deniersville because it appears to make the argument that moderate change (~2C) will be beneficial (as long as migration is embraced).
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