Market Forces

The Silver Bullet Of Climate Change Policy

By / Bio / Published: January 24, 2014

From Forbes.com:

By Bob Litterman and Gernot Wagner

Whenever the conversation turns to climate change, someone is sure to opine that there’s no silver bullet. The issue is simply too complex to have one solution. When you focus on all the changes that need to occur to reduce greenhouse gas emissions globally it seems like a multifaceted approach is the only way forward.

Most of the world’s vexing problems share that feature. Mideast peace, nuclear non-proliferation, Eurozone stability, and plenty of other national security problems have no single right plan of attack. Some past plans might have brought us tantalizingly close to a seeming solution, but then reality started interfering once again, reconfirming the complexity of it all.

Climate change must surely be in that category. No single country, no single technology, no single approach can seemingly solve this one for us once and for all. Picking a single technology will almost inevitably end in some form of disappointment. Bureaucrats, the saying goes, ought not to try to pick winners. Leave that to venture capitalists for whom failure is a way of life. For every Apple and Facebook, there are dozens who never make it out of the garage. And clean technology doesn’t yet even have a single Apple and Facebook as the standout approach revolutionizing the field.

It turns out, though, that how you frame the issue is crucial. If you think like an engineer there are dozens of challenges. If you think like an economist, there is one. It’s guiding the ‘invisible hand’. How can you create the appropriate incentive to decrease the pollution that’s causing climate change? For that, the government need not be in the business of picking winners at all. What it should—and can—do is identify the loser that’s been clear for decades: greenhouse gas pollution. And the solution is equally clear: create incentives to reduce emissions by pricing it. If we make this one change, most other actions that are needed will follow.

That’s what the European Union has done by capping carbon emissions from its energy sector, including large industrials, covering almost half of total carbon emissions. That’s what California is doing with over 80 percent of its total global warming emissions. It’s what China is experimenting with in seven city and regional trials, including in Beijing and Shanghai. All these systems put a price on greenhouse gas pollution.

On the other side of the ledger, there are still much larger incentives to consume fossil fuels in many other countries. The International Energy Agency estimates that global subsidies are well over $500 billion. These subsidies, which incentivize emissions, sadly dwarf the paltry incentives to reduce them. Free marketeers, small government advocates, and others who dislike distorting government subsidies should be appalled at the tax money poured into fossil fuels.

There’s one simple principle that’s been around in economics for so long that no economist worth his or her degree would question the conclusion: increase the price, watch the quantity demanded go down. It’s such a universal truism that economists call it the “Law of Demand.” Generations of graduate students have estimated the effects of price on demand for anything from the generic widget to demand for car miles driven. People may be irrational at times, but one thing that we know for sure is that they respond to incentives.

Everything we know from decades of the study of human behavior would lead us to believe that carbon pollution will go down as the price on emissions increases. The only interesting question is by how much.

The prescription then for anyone seriously concerned about climate change is simple: price carbon to the point where its now unpriced damages are incorporated into the price, and get out of the way. It’s simple. It works. It’s conservative to the core.

It’s also a silver bullet solution if there ever was one.

Bob Litterman is a Partner at Kepos Capital, LP. Gernot Wagner is a senior economist at the Environmental Defense Fund.

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Why the cost of carbon pollution is both too high and too low

By / Bio / Published: January 23, 2014

From EDF Voices:

Tell someone you are a “climate economist,” and the first thing you hear after the slightly puzzled looks subside is, “How much?” Show me the money: “How much is climate change really costing us?”

Here it is: at least $40.

That, of course, isn’t the total cost, which is in the trillions of dollars. $40 is the cost per ton of carbon dioxide pollution emitted today, and represents the financial impacts of everything climate change wreaks: higher medical bills, lost productivity at work, rising seas, and more. Every American, all 300 million of us, emit around twenty of these $40-tons per year.

The number comes from none other than the U.S. government in an effort to uncover the true cost of carbon pollution. This exercise was first conducted in 2010. It involved a dozen government agencies and departments, several dozen experts, and a fifty-page, densely crafted “technical support document,” replete with some seventy, peer-reviewed references and an even more technical appendix.

Cass Sunstein, the Harvard legal scholar of Nudge fame, who was co-leading the process for the White House at the time, recently declared himself positively surprised how the usual interest-group politics were all-but absent from the discussions throughout that process. This is how science should be done to help guide public policy.

The cost of carbon pollution is too low

The number originally reached in 2010 wasn’t $40. It was a bit more than half as much. What happened? In short, the scientific understanding of the impacts of rising seas had advanced by so much, and the peer-reviewed, economic models had finally caught up to the scientific understanding circa 2007, that a routine update of the cost of carbon number resulted in the rather dramatic increase to near $40 per ton. (There are twenty pages of additional scientific prose, if you want to know the details.)

In other words, we had been seriously underestimating the cost of climate change all along. That’s the exact opposite of what you hear from those who want to ignore the problem, and the $40 itself is still woefully conservative. Some large companies, including the likes of Exxon, are voluntarily using a higher price internally for their capital investment decisions.

And everything we know about the science points to the fact that the $40 figure has nowhere to go but up. The more we know, the higher the costs. And even what we don’t knowpushes the costs higher still.

Howard Shelanski, Sunstein’s successor as the administrator of the Office of Information and Regulatory Affairs (OIRA, pronounced “oh-eye-ruh”), has since presided over a further update of the official number. In fact, this one didn’t incorporate any of the latest science. It was simply a minor technical correction of the prior update, resulting in a $1 revision downward. (The precise number is now $37, though I still say $40 at cocktail parties, to avoid a false sense of precision. Yes, that’s what a climate economist talks about at cocktail parties.)

And once again, it all demonstrated just how science ought to be done: Sometimes it advances because newer and better, peer-reviewed publications become available. Sometimes it advances because someone discovers and fixes a small mathematical error.

Your input is needed

While announcing the correction, Shelanski added another layer of transparency and an opportunity for further refinements of the numbers: a formal call for public comments on the way the cost of carbon figure is calculated, open through January 27 February 26.

We are taking this opportunity seriously. EDF, together with our partners at the Natural Resource Defense Council, New York University School of Law’s Institute for Policy Integrity, and the Union of Concerned Scientists, is submitting formal, technical comments in support of the administration’s use of the cost of carbon pollution number as well as recommending further revisions to reflect the latest science.

The bottom line, as economists like to put it, is that carbon pollution costs society a lot of money. So as the technical experts trade scientific papers, you can help by reminding our leaders in Washington that we need strong, science-based climate policies.

Update (on January 24): The official comment period just was extended for another month, through February 26. More time to show your support.

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Correcting the maths of the “50 to 1 Project”

By / Bio / Published: November 1, 2013

(This post first appeared on Climate 411.)

A nine-minute video, released earlier this fall, argues that climate mitigation is 50 times more expensive than adaptation. The claims are based on calculations done by Christopher Monckton. We analyzed the accompanying “sources and maths” document. In short, the author shows a disconcerting lack of understanding of climate science and economics:

  1. Fundamental misunderstanding of basic climate science: Pre-industrial levels of carbon dioxide (CO2) were at around 280 parts per million (ppm).[i] One of the most commonly stated climate policy goals is to keep concentrations below 450 ppm CO2. Monckton, oddly, adds 280 and 450 to get to 730 ppm as the goal of global stabilization efforts, making all the rest of his calculations wildly inaccurate.
  2. Prematurely cutting off analysis after ten years: Monckton calculates the benefits of the carbon tax over a ten-year time horizon. That is much too short to see the full effects of global warming or of the policy itself. Elevated carbon levels persist for hundreds to thousands of years.[ii]
  3. Erroneously applying Australian “cost-effectiveness” calculation to the world: This may be the most troubling aspect from an economist’s point of view. Monckton first calculates the effect of the Australia-only tax on global temperatures, which is unsurprisingly low, as Australia accounts for only 1.2% of world emissions. Next, he calculates the tax’s resulting “cost-effectiveness” — defined as the Australian tax influencing global temperatures. No surprise once again, that influence is there, but Australia alone can’t solve global warming for the rest of us. Then, Monckton takes the Australia-only number and scales it to mitigate 1ºC globally, resulting in a purported cost of “$3.2 quadrillion,” which he claims is the overall global “mitigation cost-effectiveness.” But this number simply represents the cost of avoiding 1ºC of warming by acting in Australia alone. Monckton has re-discovered the fact that global warming is a global problem! The correct calculation for a globally applied tax would be to calculate cost-effectiveness on a global level first. If Australia’s carbon price were to be applied globally, it would cut much more pollution at a much lower cost. And that, of course, is very much the hope. Australia, California, and the European Union are called “climate leaders” for a reason. Others must follow.

What’s the real cost of cutting carbon? The U.S. government’s estimate of the cost of one ton of CO2 pollution released today is about $40.[iii] That’s also the optimal price to make sure that each of us is paying for our own climate damages. Any policy with a lower (implied) carbon price—including the Australian tax—easily passes a benefit-cost test.

With all due respect Lord Monckton, 3rd Viscount of Brenchley, your maths are way off.

[i] “Summary for Policymakers,” IPCC Fifth Assessment Report, Working Group I (2013).

[ii] Results differ across scenarios, but a rough rule of thumb suggests that approximately 70% of the ‘peak enhancement level’ over the preindustrial level of 280 ppm perseveres after 100 years of zero emissions, while approximately 40% of the ‘peak enhancement level’ over the preindustrial level of 280 ppm persevered after 1,000 years of zero emissions (Solomon, Susan, Gian-Kasper Plattner, Reto Knutti and Pierre Friedlingstein, “Irreversible climate change due to carbon dioxide emissions” Proceedings of the National Academy of Sciences 106, no. 6 (2009): 1704-1709). Note that this refers to the net increase in carbon dioxide in the atmosphere, not the exact molecule. Archer, David, Michael Eby, Victor Brovkin, Andy Ridgwell, Long Cao, Uwe Mikolajewicz, Ken Caldeira et al. “Atmospheric lifetime of fossil fuel carbon dioxide.” Annual Review of Earth and Planetary Sciences 37 (2009): 117-134 discusses these two often confused definitions for carbon’s ‘lifetime,’ and concludes that 20-40% of excess carbon levels remain hundreds to thousands of years (“2-20 centuries”) after it is emitted. Each carbon dioxide molecule has a lifetime of anywhere between 50 to 200 years, according to the U.S. Environmental Protection Agency’s “Overview of Greenhouse Gases: Carbon Dioxide Emissions.” The precise number is under considerable scientific dispute and surprisingly poorly understood. (Inman, Mason, “Carbon is forever,” Nature Reports Climate Change 20 November 2008)

[iii] The precise value presented in Table 1 of the Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866 for a ton of carbon dioxide emitted in 2015, using a 3% social discount rate increased is $38. For 2020, the number is $43; for 2030, the number increases to $52. All values are in inflation-adjusted 2007 dollars. For a further exploration of this topic, see Nordhaus, William D. The Climate Casino: Risk, Uncertainty, and Economics for a Warming World. Yale University Press (2013) as only one of the latest examples summarizing this kind of analysis. Nordhaus concludes that the optimal policy, one that maximizes net benefits to the planet, would spend about 3% of global GDP.

Many thanks to Michelle Ho for excellent research assistance.

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New York Times op-ed: Inconvenient Uncertainties

By / Bio / Published: October 11, 2013

By Gernot Wagner & Martin L. Weitzman

The headline in The New York Times yesterday was succinct. “By 2047, Coldest Years May Be Warmer Than Hottest in Past, Scientists Say.” Not, say, “around 2050” or “within our lifetime.” The specificity makes the crisis feel real, imminent and terrible. Call it a convenient truth.

The story was about a new study published this week in the journal Nature that calculated that by 2047, the average temperature will be hotter across most parts of the planet than it had been at those locations in any year between 1860 and 2005.

In truth, attention to the year 2047 is misguided. Climate around the world has already changed to a point where we can perceive humanity’s fingerprint. Extreme weather events like the two hurricanes that hit New York City in the past two years are going to be only more intense in the future.

Continue reading at nytimes.com/opinion.

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World’s Carbon Markets: EDF, IETA launch online resource on emissions trading programs

By / Bio / Published: June 4, 2013

(This post first appeared on EDF Climate Talks.)

While Washington is stuck in gridlock, other jurisdictions around the world are moving forward on climate policy.

Market-based approaches to cutting carbon are in place in jurisdictions accounting for nearly 10% of the world’s population. Above: areas shaded blue have emissions trading programs that are already operating; areas in green have programs that are launching or being considered.

Market-based approaches to cutting carbon are already in place in jurisdictions accounting for nearly 10% of the world’s population and more than a third of its GDP. Many more jurisdictions are either moving ahead with market-based measures, or actively considering them.

As interest grows around the world, policymakers are increasingly seeking information about the range of existing and proposed initiatives.

In response, EDF has partnered with the International Emissions Trading Association (IETA), a trade association that represents businesses involved in carbon trading and climate finance, to launch The World’s Carbon Markets: A case study guide to emissions trading.

The online resource provides detailed information about key design elements and unique features of 18 emissions trading programs that are operating or launching around the world.

EDF has also put together a quick reference chart that makes comparing the 18 programs even faster and easier.

Growing interest in emissions trading

Market-based policies are a proven way to limit carbon pollution and channel capital and innovation into clean energy, helping to avert the catastrophic consequences of climate change.

While emissions trading programs around the world, like the ones we have looked at in detail, vary in their features, they all share the key insight that well-designed markets can be a powerful tool in achieving environmental and economic progress.

The countries, states, provinces and cities highlighted in this report, which are moving ahead with strong action on climate change, constitute a vital and dynamic world of “bottom-up” actions that complement multilateral efforts such as the ongoing United Nations climate negotiations.  Jurisdictions considering market-based approaches can use this new resource to learn from their growing number of peers already headed in that direction.

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Uncovering the Real Cost of Carbon

By / Bio / Published: June 3, 2013

(This post was co-authored by Thomas Sterner and appeared first on EDF Voices.)

Last week, the Obama administration released new energy efficiency standards for microwaves, along with an update to the government’s official Social Cost of Carbon (SCC) figure. What do those two things have to do with each other? Well, the efficiency standards will help the planet by cutting the energy needs of microwaves, which will in turn save consumers money. And the new SCC numbers show just how expensive our addiction to fossil fuels has become.

The SCC is used to estimate the damages from carbon emissions (and the benefits from reducing those emissions) for the purposes of regulatory benefit-cost analyses. The central estimate for the SCC is now around $35 per ton of carbon dioxide pollution emitted today.

That’s the administration’s estimate of the damage—to human health, ecosystems, and the economy—caused by every ton of carbon dioxide emitted into the atmosphere. The average American emits about 20 tons each year.

The new cost of carbon figure is a welcome step forward, reflecting the latest versions of the underlying models. The bad news is that the increased number also shows that our lack of a comprehensive climate policy is becoming ever more costly.

Moreover, this updated SCC number underestimates the true costs of carbon emissions. For example, the current SCC quickly rises to $55 per ton under a lower discount rate (that is, an estimate that doesn’t “discount” harms to the wealth and health of future generations by quite as much as the administration did in reaching its $35 per ton figure).

The value of one ton of carbon dioxide would rise higher still with a declining discount rate, something that, in line with the general consensus among economists, would more closely reflect the true costs of climate change. And none of that includes the cost of extreme climate events.

Basing Policy on Science

The good news: the administration’s latest numbers show exactly how policy analysis should be done—rigorously and consistent with the latest advances in science and economics. For example, instead of using older versions of three main SCC models to calculate its official number, the administration now uses the most recent peer-reviewed versions of each. That simple but important step helps to bring the new official SCC more in line with the latest academic literature.

In short, the administration’s economics are slowly and carefully catching up with what we all can see outside our windows. While atmospheric carbon dioxide levels have just passed the 400 parts per million threshold for the first time in over 3 million years, the real costs of climate change keep piling on.

What the country really needs, of course, is for Congress to pass a comprehensive climate policy. Only then will Americans stop living in a world where their personal behavior leads to socialized costs of at least $35 for each of the 20 tons of carbon dioxide we emit every year. Until then, the Obama administration is right to at least include these costs in its own regulatory impact assessments.

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