Common Tragedies

Thoughts on Environmental Economics

A cost for carbon

Posted by Daniel Hall on January 23, 2008

The UK government has begun requiring that government appraisals incorporate a cost for any greenhouse gas emissions associated with a project or policy. All cost-benefit analyses or environmental impact assessments must use this “shadow price of carbon” when evaluating policy or investment proposals. So, for example, as climate change minister Phil Woolas said,

“This will have huge implications for [the] government. If for instance a new power station is due to cost £1bn, but it will add £200m worth of carbon emissions, we will decide that the cost of the power station is £1.2bn, even though its cash price is £1bn.”

This shadow price for emissions is different than an actual market price such as that generated by the European cap-and-trade system, the Emissions Trading Scheme (EU ETS). While the market price is what actual emitters must pay in order to emit a unit of pollution, this shadow price is designed to represent the social cost of emissions, and requiring it to be used in appraisals allows this social cost to be accounted for when planning for any new projects.

This use of social costs, rather than market costs, has a long tradition in resource and management planning. For example, it is often used to put value on land in land planning regulations, or, like in this example, used to put a price on the pollution associated with a project.

Of course, with a market price already on carbon emissions, why the need for this social cost? Two primary reasons come to mind: 1) the policy covers sectors or activities not covered by the market price (i.e., the EU ETS), or 2) the social cost is higher than the market price.

In this case it looks like both reasons apply. While the ETS mainly covers electric generators and large industry, the UK government will broadly require a whole range of activities to incorporate this social cost: not only things like power plants, but transportation or housing planning as well. Second, the UK environment ministry has set the shadow price of carbon at £26 per tonne of CO2 in 2008, which is around €35 (or more than $50). The current price of allowances in the ETS is around €20 ($30). Further, the UK shadow price is set to rise at 2% (real) per annum to almost £60 per tCO2 in 2050.

Because the social cost is this high, it could have a significant impact on investment decisions in the UK, even in sectors already facing the price of ETS allowances. For example, experts seem to think that a carbon price somewhere between $30 and $50 per tonne CO2 would be sufficient to make new coal power plants with carbon, capture, and storage (CCS) cost-competitive with traditional coal power plants. Thus incorporating the shadow price could potentially mean that there is no new coal generation built in the UK without CCS.

H/T: Sustainablog via ClimateIntel.

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