Shadow Price of Carbon
30. In December 2007 the Government adopted a new
calculation of the costs of emitting carbon, to be known as the
Shadow Price of Carbon (SPC). The Government has announced that
it will incorporate the Shadow Price of Carbon, not just in its
appraisals of all new carbon reduction policies, but in its cost-benefit
analysis of all new policies and proposed construction projects.
This announcement gained some very favourable coverage in the
media, with one newspaper reporting it on its front page as: "Ministers
ordered to assess climate cost of all decisions—Government
says new 'carbon price' will favour eco-friendly policy choices".[44]
31. The reality is far more complex, and not necessarily
a step forward in terms of driving Government policy towards lower
emissions. To begin with, simply putting a price on carbon emissions
will not necessarily alter the economics of various policy decisions;
it all depends on what level the price is set at. Second, there
are intrinsic difficulties in assigning a single price to carbon,
which means that simply plugging such a figure into a spreadsheet
of costs and benefits, to work out whether a policy represents
value for money and should therefore go ahead, may in many cases
be inadequate to reflect its implications for the UK's overall
climate change goals. The overall risk is that the incorporation
of a Shadow Price of Carbon into all policy decisions may actually
lead to less thought being given to implications for climate
change strategy, while simultaneously giving a false sense of
assurance that the opposite is the case.
32. The details of the SPC, revealed in a paper published
by Defra,[45] give us
some cause for concern. The paper explains that the SPC is based
on a previously used concept, the Social Cost of Carbon, which
aims to reflect the cost in monetary terms of the damages arising
in the future from each tonne of carbon emitted today. We have
in previous reports subjected the Social Cost of Carbon to a great
deal of criticism. Major criticisms we have heard from witnesses
include the following:
- IT
IS IMPOSSIBLE
TO PUT
A MONETARY
COST ON
THE EFFECTS
OF CLIMATE
CHANGE: "many impacts are
too uncertain (will the Greenland ice shelf melt? How fast?),
unmonetised (what are the financial impacts of millions of environmental
refugees?) or unmonetisable (what is the value of a coral reef,
or the Amazon rainforest?)" (Friends of the Earth);[46]
- IT IS
IMPOSSIBLE TO
KNOW WHAT
LEVEL OF
CLIMATE CHANGE
WILL OCCUR
IN THE
FUTURE: "you can only calculate
the social cost of carbon once you have determined the carbon
trajectory that you are on, because the cost of a tonne of carbon
emitted today […] depends on how much carbon is emitted in
the future. […] As we know, the trajectory of climate change
is one of the most uncertain things in the lexicon, quite apart
from what the effects of any given trajectory of climate change
are likely to be" (Professor Paul Ekins).[47]
Indeed, in our 2007 inquiry into the Stern Review,
Professor Ekins told us
You will know that Defra and the Treasury had a joint
process and commissioned a couple of learned papers on the subject
which are on Defra's website and the Treasury's website. I was
a peer reviewer of those papers so I was quite closely involved
in it and I tried really to understand what was going on. Eventually
I came to the conclusion that [….] all attempts to put a
number, actually to arrive at a figure within which you could
locate the social costs of carbon, were so fraught and uncertain
as to be effectively useless as an instrument of policy.[48]
33. Defra's paper on the Shadow Price of Carbon is
completely silent on the first of the above points, that it is
impossible accurately to reflect the damages of climate change
in a monetary cost figure. We asked the Exchequer Secretary about
this, who replied:
The Green Book[49]
methodology is clear that all social costs and benefits should
be taken into account with the proviso that they should be monetised
wherever possible, and set out and explained clearly where they
can not be quantified. Work continues on a number of issues concerned
with appraising and pricing the effects of climate change.[50]
This reply does not inspire confidence. The strict
monetary value given for the SPC will undoubtedly be an undervaluation,
given that it explicitly excludes social costs such as those arising
from mass migrations and local wars due to increased flooding
and droughts. Meanwhile, given that the entire rationale behind
the new SPC is that it is meant to incorporate the costs of climate
change on a simple and universal basis, we have some doubts that
separately explaining the potential range of non-monetised costs
will in practice carry any weight in the cost-benefit analysis
process.
34. Even more worrying is the Defra paper's approach
to the other of the criticisms of the SCC we have highlighted
above, that in order to calculate the costs of climate change
you have to know in advance how much carbon will be emitted in
the future, and thus what level of climate change we might expect
the world to experience. The Defra paper deals with this problem
by assuming that greenhouse gas concentrations will be stabilised
at 550ppm CO2e (parts per million of carbon dioxide-equivalent).
Its rationale is as follows:
The Stern Review suggests that the optimum stabilisation
goal requires the world to aim for atmospheric concentration somewhere
in the range 450-550ppm CO2e to conclude that it is worth acting,
each country needs to be confident that enough other countries
are committed to a similar goal. Commitments under Kyoto and emerging
post-Kyoto consensus on emissions caps in the EU, combined with
emerging climate change policies in other countries abroad, mean
it is now much more likely that the world will do something significant
about global warming than that it will do nothing. Whether this
is consistent with the stabilisation goal advocated by Stern is
not yet clear, but for the purposes of decision making in the
UK this is the most reasonable assumption to make.[51]
35. As a result of this, the level at which the Shadow
Price of Carbon is set is considerably lower than the level which
Stern set for a 'business as usual' trajectory of emissions. In
other words, by assuming that action will be taken to ensure that
the effects of climate change will be relatively mild, the paper
concludes that the costs of climate change are relatively low.
In doing this, however, it is setting a relatively low carbon
price to be plugged into all Government decision-making today.
The risk is that this will fail to discourage the approval of
policies and projects that will lead to a growth in carbon emissions—and
thus help to make it more difficult to achieve the stabilisation
target that the paper assumes will be met. Friends of the Earth
commented on this:
I could give you what I find a shocking example,
from the Heathrow consultation that came out recently on this.
[…] In Heathrow they tot up that sum, the shadow cost of
carbon, against all the other costs and benefits, and that sum
is a net economic benefit to the economy so Heathrow gets green-lighted
using this lower cost of carbon. Effectively, Heathrow is getting
the go-ahead—which will massively increase carbon emissions:
180 million tonnes of carbon in total—because they have
used a lower [price] of carbon. […] They are using this lower
figure, which has the effect of making carbon emissions go up,
which means that they do not meet the targets that they are assuming
are being met through the use of the shadow price. […] It
is almost Orwellian in the way it uses carbon price to come up
with a policy result. It is just shocking.[52]
36. We asked the Exchequer Secretary about the circularity
in the way in which the Government had calculated a relatively
low level for the Shadow Price of Carbon. In response, she argued:
- that the Government was concerned
that by setting the SPC at a higher level, the costs of implementing
carbon reduction policies would begin to outweigh the future costs
of the climate change they were designed to mitigate;
- the Government is conducting further research
on what the costs of climate change are projected to be, with
the implication being that it would revise the SPC accordingly
in the light of new projections; and
- the Government will assess the case for changing
the basis of the SPC, so that it is reformed to reflect the global
carbon price deemed requisite to drive carbon reductions in line
with global targets.[53]
37. We do not feel these points address our concerns.
Most importantly, none of these points addresses the issue we
raised about the fatal circularity in the Shadow Price of Carbon,
that by assuming a relatively low level of climate change and
setting a relatively low carbon price as a result, the SPC may
fail to deter the approval of high-carbon developments. The first
point, that had the SPC been set at a higher level it might lead
to such an aggressive programme of emissions cuts in the UK that
this would outweigh the future costs of climate change, betrays
a short-termist view that fails properly to comprehend the risks
of failing to act in time. As for the third point, that the Government
will review the level at which the SPC is set at, the question
remains whether a single price figure will be enough to drive
the varied planning and investment decisions in different sectors
of the economy required to radically reduce UK emissions. We agree
with the comments of Simon Bullock of Friends of the Earth, who
argued that a better way of ensuring the right decisions were
taken at the right time would be for the Government:
[…] to set a strategy across the entire economy
and across all sectors for delivering the carbon budgets within
the Bill. It is a simpler business, although still complicated,
rather than to use carbon social cost price—basically the
damage cost—to say: "What is the most cost-effective
way of meeting this budget?" so for all sectors of the economy
we are going to meet it in this way. This sector will meet this
much, this sector will meet this amount, and in each sector we
do the most cost-effective policies and you look across sectors
to determine which sectors do most. That is a better way
of doing it. I think it is one that can be done with far less
confusion than exists at the moment.[54]
38. There appear to be serious flaws
in the thinking behind the new Shadow Price of Carbon. We recommend
that it be reformed, so that instead of assuming that global climate
change goals will be met, it is based on the costs of climate
change on a 'business as usual' trajectory of emissions. Furthermore,
given the inherent difficulties in putting a price on climate
change, the Government's first priority in deciding on the merits
of potential policies and construction projects ought to be deciding
how they affect UK carbon budgets, and only secondly on what the
monetary value of resulting carbon emissions would be. We may
choose to examine the Shadow Price of Carbon in more detail in
a future inquiry, looking in particular at how it is being used
in cost-benefit analyses and impact assessments throughout government.
44 "Ministers ordered
to assess climate cost of all decisions", The Guardian, 22
December 2007 Back
45
Defra, "The Social Cost of Carbon And The Shadow Price of
Carbon: What They Are And How To Use Them In Economic Appraisal
In The UK", December 2007, www.defra.gov.uk Back
46
Ev 9 Back
47
Environmental Audit Committee, Seventh Report of Session 2006-07,
Beyond Stern: From the Climate Change Programme Review to the
Draft Climate Change Bill, HC 460, Q226 Back
48
Environmental Audit Committee, Beyond Stern: From the Climate
Change Programme Review to the Draft Climate Change Bill, Q227 Back
49
The Green Book is a Treasury publication which provides guidance
to public sector bodies on the economic assessment of spending
and investment, including the preparation of business cases for
specific projects. The Treasury explains: "The Green Book
methodology should be used to make an economic assessment of the
social costs and benefits of all new policies projects and programmes
including the economic assessment of regulations under regulatory
impact analysis. As recommended by the Green Book all spending
proposals should be accompanied by a proportionate and well structured
business case." HM Treasury, "Green Book", www.hm-treasury.gov.uk
Back
50
Ev 70 Back
51
Defra, "The Social Cost of Carbon And The Shadow Price of
Carbon: What They Are And How To Use Them In Economic Appraisal
In The UK", p 4 Back
52
Q36 Back
53
Ev 68-9 Back
54
Qq 38-9 Back
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