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The Social Costs of Carbon (SCC) Review – The Social Cost of Carbon The Social Costs of Carbon (SCC) Review – Methodological Approaches for Using SCC Estimates in Policy Assessment Final Report December 2005 Department for Environment, Food and Rural Affairs Nobel House 17 Smith Square London SW1P 3JR Telephone 020 7238 6000 Website: www.defra.gov.uk © Queen’s Printer and Controller of HMSO 2006 This document/publication is value added. If you wish to re-use, please apply for a Click-Use Licence for value added material at http://www.opsi.gov.uk/click-use/system/online/pLogin.asp. Alternatively applications can be sent to: Office of Public Sector Information Information Policy Team St Clements House 2-16 Colegate Norwich NR3 1BQ Fax: 01603 723000 e-mail: [email protected] Information about this publication and further copies are available from: Environment Policy Economics Defra Ashdown House 123 Victoria Street London SW1E 6DE Tel: 020 7082 8593 This document is also available on the Defra website. Published by the Department for Environment, Food and Rural Affairs Research on behalf of Defra With support from: DfID (Department for International Development) DfT (Department for Transport) DTI (Department of Trade and Industry) OfGEM (The Office of Gas and Electricity Markets) The Scottish Executive Welsh Assembly Government by AEA Technology Environment, Stockholm Environment Institute (Oxford Office), Metroeconomica, University of Hamburg, Judge Institute of Management - University of Cambridge and the University of Oxford Authors: Paul Watkiss with contributions from David Anthoff, Tom Downing, Cameron Hepburn, Chris Hope, Alistair Hunt, and Richard Tol. Contact Details: Paul Watkiss AEA Technology Environment UK Telephone +44 (0)870-190-6592 [email protected] Social Costs Carbon Review - Using Estimates in Policy Assessment – Final Report Executive Summary The effects of global climate change from greenhouse gas emissions (GHGs) are diverse and potentially very large. Traditionally the policy debate on climate change has tended to focus on the costs of mitigation, i.e. how much it will cost to reduce greenhouse gas emissions. This study focuses on the economic costs to society from climate change actually occurring, known as the Social Cost of Carbon (SCC). The SCC is usually estimated as the net present value of climate change impacts over the next 100 years (or longer) of one additional tonne of carbon emitted to the atmosphere today. It is the marginal global damage costs of carbon emissions. In 2002, the UK Government Economic Service (GES) recommended an illustrative estimate for the SCC of £70/tonne of carbon (tC), within a range of £35 to £140/tC, for use in policy appraisal across Government. The GES paper also recommended that this should be subject to periodic review. The current project, The Social Costs of Carbon (SCC) Review - Methodological Approaches for Using SCC Estimates in Policy Assessment, was commissioned by Defra as part of such a review. The aim of the project has been to inform Government on how best to incorporate SCC values in decision-making, given the uncertainty which will continue to surround monetisation of global climate change. Defra also commissioned a parallel project from the Oxford Office of the Stockholm Environment Institute. This second project, The Social Cost of Carbon (SCC) review – A Closer Look at Uncertainty, undertook a survey of expert opinion and new modelling work relevant to estimates of the SCC. Both projects will input to the review. The specific objectives of this policy project were to: • Review the previous use of the SCC values in policy assessment, and the possible approaches for future assessment, taking into account the factors that influence the values; • Undertake expert stakeholder consultation, to obtain their views on how such analysis should be undertaken, and on the uses of SCC estimates in policy assessment in the face of uncertainty; • Develop a series of case studies to demonstrate the various approaches for including SCC estimates in policy decision-making; and • Make recommendations. The study findings are set out below. Review of SCC use We found four potential applications for the use of the SCC across Government. These concern: • Project appraisal (project cost-benefit analysis); • Regulatory Impact Assessment (policy cost-benefit analysis); • Setting of economic instrument (input to the setting of taxes, charges, or subsidies); • Long-term (sustainability) 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 used has varied. For example, some applications have used the central illustrative value of £70/tC only, whilst some have used the full range £35 to £140/tC. Some applications have used one end of the range only. The review has also found a number of relevant policy appraisals or policy areas across Government where the SCC was not used at all, even though the policies involved changes in greenhouse gas emissions. AEA Technology Environment ii Social Costs Carbon Review - Using Estimates in Policy Assessment – Final Report The study also reviewed the use of SCC estimates in policy applications in other countries and organisations. We have found a general trend towards the use of marginal abatement cost estimates as a ‘shadow price’ of carbon emissions in project and policy appraisal, rather than a marginal damage cost estimate represented by the SCC. The UK government appears unique in its widespread adoption and implementation of a SCC estimate in policy assessment. However, we have also found a recent rise in interest in the economic benefits of climate change policy, as part of wider post-Kyoto considerations. Review of SCC Estimates The two projects have reviewed the SCC literature estimates. The review indicates that with typical assumptions about discounting and aggregation, some central estimates of the marginal damage cost of carbon dioxide emissions are lower than the current GES illustrative value of £70/tC. This reflects a trend in the literature towards lower SCC values in recent years. However, the literature studies do not cover all the impact categories of climate change, and most researchers consider the possibility of negative surprises to be more likely than positive ones. We have therefore assessed the coverage of the valuation studies to investigate the extent to which they may under-estimate the total SCC. The studies have been compared against a risk matrix, in relation to the uncertainty of climate change impacts and the uncertainty in valuation. Mapping the literature studies onto this matrix, we have found that very few studies cover any non-market damages, or the risk of potential extreme weather (floods, storms, etc). None cover socially contingent effects, or the potential for longer-term effects and catastrophic events. Therefore the uncertainty in the SCC value concerns not only the ‘true’ value of impacts that are covered by the models, but also uncertainty about impacts that have not yet been quantified and valued. Perhaps most importantly, it indicates that values in the literature are a sub- total of the full SCC, though we do not know by how much. We have also reviewed the key policy choices on parameters that affect the SCC. We have found that much of the variation in SCC estimates (for the sub-totals assessed so far) arise from a few key parameters in the choice of decision perspectives, most importantly: • Discount rate used; • Approach to weighting impacts in different regions (called equity weighting); The study has also reviewed potential approaches for using the SCC values in policy applications that take risk and uncertainty into account. The study has identified a number of options, including: • Use of an illustrative central value; • Use of a range; • Switching values; • Sequential sensitivity analysis; • Different values for different applications; • Marginal abatement costs • Multi-criteria analysis. • Other risk analysis techniques. We have assessed the advantages and disadvantages of each of these approaches. These findings above were used as the starting point for a stakeholder consultation. AEA Technology Environment iii Social Costs Carbon Review - Using Estimates in Policy Assessment – Final Report Stakeholder consultation The stakeholder consultation process focused on experts and users. The consultation process: • Identified stakeholders and provided a briefing paper on the review findings; • Undertook direct interviews with relevant experts and users; • Organised a follow-up seminar to the international social costs of carbon workshop, to present the initial findings from the study and obtain wider views. The consultation aimed to elicit views on the SCC, assess preferred approaches to deal with risk and uncertainty, and reveal views on the key parameters (discount rate, equity etc) appropriate for policy applications. Over 20 interviews were carried out. When views were collated, there were a number of key messages emerging: • All stakeholders saw the need for a shadow price of carbon in detailed appraisal. (i.e. for project appraisal and regulatory impact assessment). This involves appraisal at lower levels compared to strategic long-term objectives. • Nearly all stakeholders recognised the need for some form of benefits analysis for setting long- term targets, though views varied on the form this analysis should take; • All stakeholders agreed that once a long-term goal had
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