Market Forces

Farmers’ bottom lines at risk as growing conditions change

This blog was originally posted on EDF’s Growing Returns.

Iowa currently finds itself in a “Goldilocks climate,” with just the right measure and timing of humidity, rainfall and heat that help make the state a national leader in corn and soybean production. However, new research shows that climate change threatens to upset this balance.

Small shifts in rainfall and temperature can have considerable impacts on crops and farmer livelihoods. To better understand how these shifts could impact farmers, Environmental Defense Fund partnered with K·Coe Isom, an agricultural accounting and business advisory firm, to produce an in-depth report that quantifies the potential localized economic impacts from these shifts that Iowa corn and soy farmers could face as soon as the next 10 to 20 years.



Millions of dollars at stake in Iowa alone

Researchers found that farmers could see statewide gross farm revenues reduced by as much as $4.9 billion over the course of a decade — a loss of 3.6% of Iowa farm revenue from sales of corn, silage and soy.

Because with climate change agricultural prices are likely to rise, relative to without climate change, the impact to gross farm revenues from yield impacts will be offset to some degree by higher prices. Additional research is needed to understand how much agricultural regions like Iowa stand to offset yield losses through climate change-induced price increases.

With this caveat on unknown price increases, nearly every county in Iowa could experience decreases in gross farm revenues with losses of more than $50 million in almost half of the state’s counties in that same timeframe, and losses of more than $100 million in some western counties that are projected to experience higher yield reductions than the rest of the state.

Reductions in revenue would likely imply reductions in capital investment and off-farm spending. As a result, Iowa’s annual economic output could be reduced by between $367 million and $733 million, causing a statewide loss of 1,270 to 2,530 jobs, and reduce annual state revenue collections by $4 million to $8.3 million.

“A less desirable choice for the next generation”

The analysis drills down further by modeling how these crop yield impacts might affect a real representative family corn and soybean operation in central Iowa. The researchers obtained financial data for the farm, including harvest, sales and capital expenditure data, and modeled the impact of projected yield reductions on farm revenue over a five-year period (2014-2019).

When the anticipated crop yield declines from climate change were retroactively applied to the past five years, researchers found that the family farm would have lost between $50,000 and $90,000 in revenue per year, equaling a total potential loss of $360,000 over the five-year period.

As the farm owner observed, this reduction in revenue would have also made “returning to the farm a less desirable choice for the next generation,” and would have been “especially hard on those families newest to farming.”

Near-term solutions to avert economic loss

Much can be done to address climate change and minimize the financial impacts on farmers, and this report identifies a few ways federal, state and local governments can help mitigate emissions and help farmers further adapt to climate change.

Public funding and private sector programs can incentivize management practices that limit greenhouse gas emissions, improve soil health and build resilience in agriculture. For example, the federal crop insurance program could incorporate incentives for farmers that adopt practices that reduce crop yield risk.

Additionally, public funding could support the development of climate-resilient seed varieties, improvements to nutrient management and other climate adaptation strategies. Investing additional funding in Iowa’s public university systems to assist with the creation of practical, publicly available research could also help farmers put these strategies into practice.

Iowa’s farmers have adapted to changing farming conditions in the past, but climate change poses a more significant shift that requires a proactive response. Policymakers can help ensure farmers have the resources they need to withstand the growing risks posed by climate change and to protect the livelihoods and revenues that make Iowa a global agricultural leader.

For more information, download the full report.

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How can economics contribute to decarbonizing power markets?

Electricity system operators balance supply and demand precisely at every moment of every day through market design grounded in economic principles. As the share of variable renewable resources like wind and solar electricity on our electricity system increases, system operators, policy makers and energy market regulators are facing new questions on how to design the rules governing our electricity market to support decarbonization of our energy system.

Christopher Holt, PhD student in agricultural and resource economics at the University of Maryland, recently published an EDF Economics Discussion Paper, in which he reviews these new questions in wholesale electricity market design and identifies a number of areas where economic research can help inform decision-makers to facilitate decarbonization.

Chris wrote this paper during a summer pre-doc fellowship at EDF and Kristina Mohlin, who hosted Chris during the fellowship, recently chatted with him about his paper and his experience as a pre-doc fellow at EDF.

Kristina: What was your starting point for this pre-doc fellowship?

Chris: State and local leaders have been setting ambitious decarbonization targets. More recently, President Biden has pledged to make US electricity production free of carbon by 2035. My starting point was to try and understand how electricity market practitioners are working to change and refine the sophisticated set of rules governing wholesale markets, so that these targets can be met.

During my time at EDF, I spoke with industry representatives, policy makers, external economists, and other stakeholders at policy meetings, conferences, through video chats, and over countless cups of coffee. I also learned a lot by chatting with the highly talented folks internal to EDF. These conversations alerted me to many gaps in the applied economics literature, which I then described in the paper.

Kristina: One defining characteristic of electricity markets is that consumers do not respond to wholesale price fluctuations in real time. How can markets be designed to enable and encourage price-responsive demand?

Chris: California’s Demand Response Auction Mechanism (DRAM) is a promising example of how market design can reward innovation that encourages response to prices at the individual user level. This mechanism, still in its pilot form, allows companies to bring together demand across a group of electricity consumers, e.g. by coordinating power drawn from their appliances. The aggregator can then curtail demand when electricity is scarce at a minimal loss to consumers, who may be compensated for their agreement to participate. Wholesale market prices are kept low by way of the curtailed demand, benefitting all consumers of electricity (not just the participating ones). This is a “win-win”: lower prices for consumers and a profitable return for the aggregator. Importantly, this arrangement would not exist without the wholesale market design.

While the incentives are powerful, getting the design right is not easy. Projects like DRAM have a long way to go before they are approved for permanent integration into market operations—which is exactly why additional research is needed.

Kristina: Another key defining characteristic of electricity markets is that electricity is not storable. How will utility-scale storage affect market operations?

Chris: Yes, storage is not yet available at large scale, but this seems likely to change in the near future. The Federal Energy Regulatory Commission’s landmark Order 841 is intended to facilitate the participation of storage resources in energy markets. Some firms have already begun to complement variable renewable generation assets with large-scale battery technologies, and industry forecasts suggest major cost reductions for batteries in the near future. When storage technologies are deployed at scale, short-run market operations will require a new set of rules, which must be guided by economic research.

Kristina: Could you explain to our readers what this has to do with decarbonization?

Chris: Both price responsive demand and storage are closely tied to decarbonization because they allow consumers to buy electricity when it is cheap and clean rather than when it is expensive and carbon intensive (this is most apparent when there is a price on carbon). Electricity from wind and solar is essentially free once investment costs have been incurred and the plants have been built. Currently, when electricity is scarce, carbon-intensive peaker plants are needed to maintain reliability. These peaker plants, which are also relatively expensive to run, are increasingly needed to complement the variability of renewables, e.g. when the sun goes down in California, or the wind stops blowing in Texas. Unlocking price responsive demand and introducing storage capacity will reduce the need to rely on peakers.

Kristina: How will long-run investments be affected by increased participation of electric storage and price-responsive demand?

Chris: Changes to demand-side price response and the storability of electricity have crucial implications for how firms plan to invest in new generation assets and retire old plants. If consumers are able to pre-empt the high prices associated with peaker plants, why invest in peaker plants at all? Storage may bring benefits in helping to reduce emissions, but will firms be incentivized to invest in it? Regulators in New York, for example, have set considerable storage capacity targets. Experts suggest many ways to reach such targets and to ensure that more storage capacity indeed translates to decarbonization (carbon pricing is central among them).

The difficult task of guiding efficient long-run investment is further complicated when an electricity system spans political jurisdictions with differing policies. The simple fundamentals of electricity market economics are of value here, reminding us that proper pricing is often the key to efficiency—pricing that reflects resource scarcity, the value of quickly dispatchable resources and demand response, and the harm imposed by carbon pollution. Through my EDF pre-doc fellowship, I found that we need new research to connect these classic fundamentals to the new challenges associated with scaling up renewables.

Kristina: Finally, what would you like to tell other PhD students who have the opportunity to apply for an EDF pre-doc fellowship about your experience at EDF?

Chris: The pre-doc fellowship is a great way to focus in on the questions you might want to address in your dissertation. My job market paper was inspired in large part by my time at EDF. Having access to the network of experts that the fellowship offered was an ideal way to become more familiar with certain areas and overcome the steep learning curve associated with my field. EDF also values their alumni—I have continued to keep in touch with folks I met through the fellowship and attend EDF workshops. Overall, I would highly recommend the fellowship!

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Barriers to tapping the potential of carbon markets for agriculture

An EDF analysis of carbon credits for rice growers shows great climate and cost-savings potential, but is that enough for farmers to participate?

In 2015, rice became the first crop for which agricultural carbon credits were valid for compliance in the California cap-and-trade system. Unfortunately, as of September 2020, no compliance credits have been generated. A newly released report by EDF explores the reasons why.

In the U.S., agricultural greenhouse gas emissions comprise approximately 10% of the economy-wide total emissions. The share of emissions from agriculture is larger for non-CO2 GHGs, making up approximately 78% of the U.S. total for nitrous oxide and 38% for methane.

Policymakers are eager to find mitigation opportunities in the agriculture sector, best evidenced by the bipartisan Growing Climate Solutions Act, which seeks to enable voluntary credit markets for producers to mitigate climate change.

As both policymakers and producers eye the potential of the agriculture sector to grow climate solutions, it’s worth taking a closer look at both the opportunities and the challenges that must first be addressed to tap this potential.

A case study of carbon credits for rice

EDF’s work on agricultural carbon credits began in earnest in 2007 after receiving the first of several U.S. Department of Agriculture grants to investigate how to bring agricultural emissions reduction credits to market. The objective was to design crediting systems that achieve the dual benefits of reducing GHG emissions while also providing meaningful revenue opportunities to landowners.

An EDF discussion paper summarizes some of the underlying analytics of these efforts for a series of crops and geographies. One specific example from the paper — rice in California — highlights both the carbon- and cost-saving opportunities associated with conservation practices like bailing and drainage, and the challenges associated with agricultural credits as a viable abatement measure.

The opportunity: Lowering costs and emissions

Rice is a GHG-intensive crop. It emits twice the amount of emissions per calorie as wheat, three times that of maize, and accounts for 5-20% of global methane emissions. EDF’s research focused on the nation’s two most intensive rice production regions — California’s Sacramento Valley and Mid-Southern U.S. These regions produce 26% and 72% of the domestic rice supply, respectively.

Our analysis began by using a biogeochemical model, DeNitrification-DeComposition (DNDC), to assess the abatement potential for current (baseline) practices and other lower-GHG alternatives in the California rice region. This led our scientists to discover a fairly large overall mitigation potential of more than 0.6 MMt-CO2e-100/year, or approximately 15%, of overall California rice emissions.

We then developed estimates of abatement costs by practice through cost budgets and consultation with agronomists. Combining this with the GHG modeling yielded the following marginal abatement cost curves (one for each practice).

Marginal Abatement Cost Curves for Rice Practices in California. Abbreviations: N (number of fields); WF (winter flooding of rice paddies); NWF (no winter flooding). WF/NWF practices follow a 60/40% distribution, historically, and play a role in determining the scale of achievable reductions.

These graphs illustrate that for all but one practice there are negative abatement costs with averages ranging from -$29.45/acre to -$0.45/acre, suggesting potential savings for farmers from implementing practice changes. For yields, the DNDC model projected that yields would remain relatively unchanged, aside from dry seeding, for which growers would experience an average 4.5% decrease.

These findings show great promise in terms of GHG abatement potential and cost savings for producers with minimal yield impacts (dry seeding aside). So, why aren’t growers already pursuing these practices? What barriers are getting in the way?

Three key barriers to entry

Our analysis identified a few potential barriers for farmers to generate carbon credits.

  1. Weak price signals

Understanding why growers are passing up potential cost savings from practices that reduce GHG emissions requires a closer look at farm economics. Adam Jaffe offers a useful typology for the various barriers to adoption, some of which I have identified below.

Putting the practice costs and yield impacts together, we can imagine a scenario where we have a carbon market in place and a carbon price of $10/ton (the California spot price at the time this work was carried out). In this instance, we’d find that with an average 0.7 ton/acre reduction, most rice growers would be looking at potential revenue from the market of approximately 0.5% of their overall crop sales revenue (typically $1,500/acre), or 2.6% of their net profit (approximately $250/acre), not including further potential gains from the negative abatement costs of certain practices and locations.

Unfortunately, in context of the overarching farm economics, this makes for a weak incentive.

If we now imagine a new scenario with a carbon price closer to today’s social cost of carbon ($42/ton), we find that the potential revenue from participating in the market rises closer to 2% of crop sales revenue and 11% of net profit. At this price, the incentive appears to be substantially more robust, which tells us that, from a social standpoint and with a strong price signal, the market could be viable. But as it currently stands, conditions are falling short of this potential.

  1. Large transaction costs

Another critical consideration for engaging in any market is transaction costs — for GHG markets in particular, monitoring, reporting and verification (MRV) costs.

Our analysis found transaction costs to be significant on a per-grower basis at approximately $14/acre for an average 1,000-acre California farm. At a market price of $10/ton, transaction costs are double the average expected return from carbon markets of $7/acre, providing a steep disincentive. Even with credits priced at the higher social cost of carbon ($42/ton), transaction costs would still equal nearly 50% of potential revenue, essentially cutting their expected financial gains in half.

Further economic modeling showed the importance of allowing a way to aggregate projects for MRV transations due to the very large third-party fees incurred to verify reductions. However, even if growers use aggregation as a means to cost-share, it will be critical to find ways to use technologies like remote sensing and automated data generation and analysis to streamline this process, realize savings and still guarantee accurate verification.

  1. Changing behavior is an obstacle in itself

Finally, behavioral factors represent a hurdle that cannot be ignored — the hidden additional cost of switching practices. This cost is difficult to quantify precisely, but we know from experience that behavior is hard to shift and farming practice changes typically require planning and close coordination with a number of consultants and business partners.

Understanding this, we performed a survey for corn and almond growers, asking how much participants in a carbon market would need to be paid to reduce fertilizer applications, and thereby decrease nitrous oxide emissions. To isolate the behavioral barriers, we designed the survey to encourage the farmers to assume no additional costs, risks or yield impacts.

Their responses ranged from $18-40/acre, when a representative farmer might only receive $7/acre in returns with a $10/t carbon price. This gap in the valuation likely represents factors such as personal or cultural values and aversion to risk and uncertainty that may be very difficult to overcome using market incentives alone[1].

Managing risk and risk perceptions is a challenge that must be addressed to see widespread uptake of mitigation practices.

Where do we go from here?

The agricultural sector has the potential to play a key role in contributing to national climate goals.

Crediting systems are just one tool to support this, but more research and pilot programs are needed to help overcome the barriers to entry, increase confidence in high-quality and cost-effective credits, and also evaluate and correct for potential inequities and injustices.

EDF is launching a new phase of research dedicated to this work, in addition to developing complementary finance and policy tools that correct for existing disincentives and inequities to create a more just and resilient food system.

With the right combination of tools in the toolbox, we can unleash the power of carbon markets to boost long-term resilience on the farm and beyond.

 

[1] It is important to note that all of the numbers depicted above represent averages, and there are certainly cases for which incentives are large at the individual level, and some growers may have zero or even negative switching costs, so many farmers have ripe potential for carbon market participation.

 

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Costs of climate change are rising: New research shows how local communities could be strained in the near-term

This blog post was co-authored with Nina Donaldson

Much of the existing research on climate change impacts focuses on end-of-century projections across nations, but this misses the very real costs that everyday Americans are already facing daily and will continue to face in the months and years ahead. Case in point today: While most Americans believe that climate change currently affects the U.S., only about a third of the adult population believes that local effects of climate change directly impact their personal lives.

And perceiving that threat on an individual level is a key motivator for pushing meaningful action.

While the impacts of climate change can sometimes feel abstract, the reality is that communities across the country are bearing the burden of climate damages here and now through heat waves, severe thunderstorms, wildfires, and flooding – to name a few – even if they are not making a direct connection themselves between those events and climate change. A new research series by Environmental Defense Fund underscores specifically where and how the potential costs could impact individual counties as soon as the next 20 years.

Behind the research

The Costs of Inaction research series draws on data from multiple sources, including a first-of-its kind study by Hsiang et al. 2017, developed through the Climate Impact Lab, which highlights climate costs and impacts from key sectors. Our research also draws from the Union of Concerned Scientists’ Underwater report and First Street Foundation’s Flood Factor data.

From these studies, we extract locally relevant data for several U.S. states projected to experience severe impacts, such as in Florida and Arizona. We examine an array of climate change impacts, including loss of property tax revenue from flooding, increased heat-related deaths, higher electricity costs, and declining crop yields. These represent only some of the detrimental effects that many already experience today and that we can expect to see worsen over the next 20 years and beyond.

International challenge, local costs

For example, Floridians already pay 13% more than the national average for electricity, but without ambitious action on climate, they can expect to see increases of more than 5% annually, paying up to an additional $122 on their electricity bills every year over the next 20 years. This will be especially straining on low-income households, which already spend roughly 10% of their income on electricity costs – three times the proportion of what the average household typically spends on electricity costs.

Arizonians will also face similar annual increases in their electricity bills to keep their homes cool as more extreme heat days occur. Exposure to extreme heat can be deadly, causing heat stroke, dehydration, and other serious issues. With two of the fastest-warming cities in the nation, Arizonians face an increasing threat, particularly in urban areas where dark pavement, buildings, and other structures that absorb heat make temperatures even hotter. In Maricopa County, home to Phoenix, a 64% increase in heat-related deaths could occur every single year over the next 20 years. This puts our children, elderly, and sick at great risk as well as those who lack access to air conditioning.

Mapping the costs

As part of this research series, EDF also created new interactive maps of Florida and Arizona that highlight the near-term costs of climate inaction, which allow the user to explore additional costs at the county level for these two states. These costs include estimated heat-related mortality (additional deaths per 100,000 people), electricity expenditure increases (estimated using a version of the EIA’s National Energy Modeling System (NEMS) both for businesses and individual households), and losses in crop yields and property tax revenue. All estimates assume a high emissions scenario in which fossil fuel-intensive economic growth continues and no ambitious climate action is pursued. These interactive maps are designed to allow local policymakers, advocates, and stakeholders to explore the impacts in their county.

EDF also commissioned an in-depth report from RTI International, a Raleigh-based research institute, to use these data to show how climate change impacts will impose significant costs on North Carolina’s residents and its economy. The report showcases the projected costs that eight major sectors of the state’s economy may face within the next 20 to 30 years if measures to curb climate-warming pollution are not taken.

EDF’s research series makes clear that the costs of climate inaction are being felt in our lifetimes and will only grow exponentially worse over time. It’s crucial we enact ambitious climate policy to mitigate the most severe impacts. To explore how climate change will impact your local community, visit the Cost of Inaction Research series.

 

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How innovative policies can help clean the transportation sector

As climate week gets underway, policymakers should prioritize ways to reduce emissions from one of the biggest contributors to greenhouse gases: the transportation sector. A diverse group of stakeholders recently came together to discuss opportunities to do just that.

Transportation accounts for nearly one third of all greenhouse gas emissions in the U.S. and a substantial share of local pollution in urban areas. Not only do these emissions greatly contribute to climate change, they can cause significant health concerns, from respiratory and cardiovascular illnesses, to premature mortality. Furthermore, communities of color and low-income communities have suffered much more from the health and well-being impacts of transportation-related air pollution than non-disadvantaged communities. Thus, it is both a social and environmental imperative to clean our transportation system.

However, cleaning our transportation system is not a trivial task—the effects of pollution vary widely in space and across different communities; the impacts of pollution are felt locally, regionally and globally; and multiple challenges across many different sectors of our economy to achieving this goal still exist. We will need a coordinated, multi-sector approach, with major investments and targeted policies.

To discuss these solutions and explore opportunities, Resources for the Future, Environmental Defense Fund, and Duke University’s Nicholas Institute hosted a two-day virtual workshop in July 2020. We invited individuals from all over the country, and from different sectors, including local governments, non-governmental organizations, stakeholder and community groups, industry, and academics, in an effort to increase communication across sectors, explore diverse policy solutions, and hear from different points of view.

Though we heard diverse approaches and assumptions from the different speakers and participants, we all agreed on the following: Cleaning our transportation system is a necessary and urgent action, and we can leverage this transformation to achieve even more improvements in social outcomes, above and beyond those caused by the transportation sector.

Panel I: Effectiveness and Behavioral Responses to Carbon Pricing and Vehicle Regulations under Existing Policies  

The first panel of the day discussed the effectiveness of carbon pricing and vehicle regulations on cleaning the transportation system, given existing policies and the nature of our “business as usual” future.

One of the main takeaways: though carbon and gasoline taxes can and have had an impact on reducing gasoline consumption, these taxes won’t be enough to achieve the major structural changes needed for the sector.

Other policies, such as vehicle efficiency standards and scrappage programs (like cash-for-clunkers), can help ensure older vehicles are replaced with better, more efficient (or even electric) alternatives, and can also work in conjunction with gasoline and carbon taxes to help achieve a cleaner transportation system. However, these programs may cause some unintended consequences if not pursued cautiously or developed jointly with policies that increase access to alternative modes of transportation.

Panel II: Distributional Effects of Transportation Policy

The workshop’s second panel focused on how to structure transportation policies to reduce the inequalities that transport-related pollution creates among different communities. The speakers highlighted the many different types of inequalities created by unjust and problematic housing and transportation policies, magnified by disadvantaged communities’ greater exposure to pollution, and how the transformation of the system can be leveraged to improve these distributional outcomes.

To be able to achieve these improvements, several steps must be taken, including:

  • Use data and modeling to identify disadvantaged communities most affected by transportation pollution;
  • Actively engage with community and environmental justice groups from the beginning when setting policy in order to identify their most pressing issues and concerns and ensure they have a seat at the table;
  • Conduct research to identify the most beneficial policies and actions for these communities and address their concerns;
  • Work to avoid unintended consequences of transportation policy that may harm disadvantaged communities in our quest to green the transportation system.

Panel III: Investments on Carbon Revenue: Efficacy and Impacts Across Groups

Our third panel explored the many avenues for investments of revenue raised from policies such as a carbon tax. There exist almost infinite options for investments- in both the private and public sectors, to individuals or corporations, for education and behavior modification, to infrastructure and technology, and so much more. Identifying the investment that provides the largest bang for buck is a challenge worth pursuing in order to maximize the benefits of our clean transportation transformation.

One of the difficulties is understanding the distributional impacts of investments. It is important to identify who will benefit the most from these investments, and whether there are important spillovers such as job creation. When the benefits of an investment are diffuse or long term, this can create a political challenge in its implementation. Furthermore, understanding the policy context around the investment is key: non-transportation-related policies such as zoning or housing regulations can affect the benefits of any investment in this space. For example, changing zoning rules could improve access to alternative modes of transportation, making investments in electric vehicle charging stations and public transit more effective at shifting driving away from private, fossil-fueled vehicles.

Panel IV: Changing the Rules: State and Local Policies and Potential Interactions with Carbon Pricing

The final panel of the day discussed how non-carbon pricing policies at the state and local level may interact with existing carbon policies, such as the Regional Greenhouse Gas Initiative (RGGI, a regional cap and trade program covering GHG emissions from 10 states in the northeast). Though cap and trade or carbon pricing sends a price signal to reduce carbon emissions, it alone may not be enough to achieve the large transformation required.

Alternative policies, such as the low carbon fuel standard, congestion pricing, or even policies outside of the transportation sector can help to bring about even greater reductions of transportation emissions, especially when combined with carbon pricing policies.

Electricity sector policies are an especially important one to get right. As our transportation system becomes less reliant on gasoline and more reliant on electricity for fueling, we need to ensure that the electric sector is clean (and carbon pricing can play an important role in achieving this outcome), while also implementing policies to reduce the costs that charging vehicles can place on the system.

A Vision for a Clean Transportation Future

This workshop made a strong case for urgent action—the emissions associated with transportation are too large and affect too many vulnerable communities to allow the status quo to continue unabated. Many different types of policies can be implemented, and even in the face of political challenges – particularly at the federal level – cities and states across the country are already taking action.

The speakers envisioned a future where transportation is clean; where all individuals across the country, regardless of where they live, have mobility access and alternatives in their modes of travel; where investments are made with an eye towards maximizing the public benefit and ensuring those most disadvantaged are uplifted; and where all communities have a voice in shaping the path of this clean transformation. This clean future exists; now it is up to us to shape policies in order to achieve it.

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How Climate Economics supports the Paris agreement temperature targets

New research building on Nobel Prize winner Nordhaus’ past contributions shows reaching UN climate targets is a good investment for the planet

Two years ago William Nordhaus was awarded the Nobel Prize in Economic Sciences for his pioneering work on “integrated assessment modeling” (IAM) and his Dynamic Integrated model of Climate and the Economy (DICE)—a framework designed to analyze the interplay between the economy and climate change, and used to assess economically optimal CO2 emission pathways and the social cost of carbon (SCC). Now a new paper published in Nature Climate Change demonstrates that a 1.5 to 2 degree target in line with the UN Paris agreement is economically optimal when the DICE model is updated to reflect newer research and latest expert assessment.

As I described in a blog about Nordhaus’ Nobel Prize two years ago, there were several ways new research could strengthen the results from Nordhaus’ DICE model and other IAMs. In this new paper, Martin C. Hänsel and co-authors (including Daniel Johansson, Christian Azar and EDF Senior Contributing Economist Thomas Sterner) made a number of such modifications to the baseline assumptions to update the results coming out of Nordhaus’ DICE model.

Two of their key updates relates to the economic assumptions/inputs to the model:

  • Updating the damage function (the assumed relationship between climatic changes and economic damages) to reflect a recent meta-analysis of climate damage estimates; and
  • Updating how equity between present and future generations is taken into account in DICE by revising the parameters determining the social discount rate. The choice of discount rate has a large impact on the results coming out of IAMs, since it determines the weight given to the climate damages affecting future generations.  This has spurred a long-standing debateespecially since the value of at least one of the parameters typically discussed is based on value judgments. Hänsel et al therefore chose to update the values of the parameters determining the social discount rate according to a recent survey of expert opinions.

The authors also made a number of additional updates to reflect new research in climate science and thereby improve the assumptions determining the relationship between greenhouse gas (GHG) emissions and temperature change (which include assumptions with respect to the global carbon cycle and the energy balance model translating radiative forcing to temperature impacts).

The authors also considered the impact of:

  • NETs (negative emissions technologies) such as afforestation, Biomass Energy with Carbon Capture and Storage (BECCS), and direct air capture. By providing the additional option of negative emissions after 2050, NETs further reduce the optimal equilibrium temperature, but also leads to a lower SCC in 2020 since the availability of NETs makes it optimal to postpone some emission reductions. However, it’s important to note that the potential magnitude of NETs available and on what timeline is debated and, for some strategies, still to be demonstrated.
  • Emission pathways with higher abatement of non-CO2 GHG emissions (which are not determined inside the DICE model) and make even lower equilibrium temperatures attainable. This illustrates the value of also addressing short term climate forcers such as methane emissions.

Both these latter updates contribute to a reduction in the economically optimal equilibrium temperature in DICE (i.e., the long run global average temperature which would provide the theoretically optimal balance between the social cost of climate damages and the costs of emission reductions).

The combined results of all these updates – reflecting recent findings in the climate economics and climate science literature – to the baseline assumptions in DICE are:

  • The SCC in 2020 is twice as high with all the other updates but with Nordhaus’ baseline assumptions for the social discount rate left unchanged. This is well in line with the strong consensus that SCCs at the levels produced with the baseline assumptions in DICE ($39 per tonne) significantly underestimate the true social costs of carbon dioxide emissions.
  • Optimal climate policy according to this updated DICE model keeps equilibrium temperature below 2 °C in 2100 in three quarters of all model runs.

Despite these key updates to the DICE framework, there are still—as the authors also point out—additional enhancements that can be made to improve this type of climate economic analysis, which weighs the costs and benefits of climate action. Such enhancements include consideration of risk and uncertainty and the representation of so-called “tipping points” as well as taking into account that the value of environmental assets relative to other goods and services may increase as they suffer a larger share of the costly damages from climate change.

Overall, these new findings show that the temperature targets in the Paris agreement (where countries committed to limiting the global temperature rise to well below 2 °C and to actively pursue a 1.5 °C target) are also supported by climate economic analysis and that reaching the UN climate targets is a good investment for the planet.

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