Select Committee on Economic Affairs Second Report


Chapter 5: The Costs of Tackling Climate Change

73.  If the costs of tackling climate change are small, then a cautious approach to decision-making in the face of uncertainty would dictate that those costs should be incurred as an insurance against the chances of the worst effects of global warming occurring. But the costs of tackling global warming may be large. Moreover, those costs will largely be borne by the current generations, while the benefits will accrue to generations yet to come, who are projected to be significantly wealthier and technologically more advanced. Hence it is very important that a realistic picture of the likely costs be conveyed to, and understood by, people today who will have to pay them. We note the considerable efforts that the IPCC has made in constructing likely cost estimates for the world as a whole. We are far less satisfied with the data currently available on the costs to the United Kingdom, and we call for a significantly greater effort to clarify and estimate those costs.

74.  We heard evidence on costs and we were interested to note the different ways in which this cost information was conveyed. We therefore outline below our own understanding of the cost data.

Global costs

75.  We acknowledge that estimating abatement (or "mitigation") costs is very complex. First, costs are lower if the world in general adopts the lowest cost emission-reduction technologies first and the highest cost technologies last—but we have no guarantee the world will behave that way. Costs are estimated in different ways. Usually they are based on the direct costs of the technologies, e.g. the cost of building a nuclear power station. But many other kinds of costs are involved and technology costs do not necessarily correspond with the correct concept of cost which is measured by the "welfare" losses incurred to consumers and producers. Costs can vary considerably, depending on how compliance policies are introduced. For example, market-based instruments, such as carbon taxes and tradable permits, are thought to have lower compliance costs than simply telling emitters what technology to use ("command and control"). It is for this reason that so much emphasis is being placed on the newer policies such as permit trading systems. Many economists believe that costs will be lower than anticipated because emitters will find new technologies and the cheaper ways of overcoming compliance problems: climate regulation may "force" innovation[70]. But others believe that there are many hidden costs in regulation, so that actual costs may prove to be higher than estimated. For all these reasons, and others, we would expect wide variations in the estimates of the costs of control.

76.  Integrated Assessment Models (IAMs), in which simplified climate models are combined with economic models of the world economy, produce estimates of costs. As one would expect, as the target for atmospheric CO2-equivalent concentrations gets tougher and tougher, so not only the total costs of meeting those targets rise, but so do the incremental costs (the "marginal" cost). In a very interesting diagram, the IPCC Synthesis Report 2001 tries to bring together the cost estimates of several of the IAMs, and links them with emissions reductions and atmospheric concentrations. Table 6 shows the IPCC estimates converted to an "annual" form and with some adjustments to current year prices and using a lower discount rate than that used by IPCC.

TABLE 6

Costs to the world of achieving the 550 ppm target, expressed in annual terms, $2005 prices, per annum
Present value of cost $2005 prices, trillion Annual cost at 3%, borne in first 50 years, billion Annual cost at 3%, borne in first 20 years, billion
278 134
17661 1141

Notes: For 50 years at 3% divide the present value by 25.7. For 20 years, divide by 14.9. The above figures are therefore annuities derived from the present values. Present values taken from R. Watson et al. Climate Change 2001: Synthesis Report. Cambridge: Cambridge University Press. 2001. Figure 7.3

77.  Table 6 suggests that getting to the 550 ppm level may cost the equivalent of $2 trillion to $17 trillion in present value terms, i.e. equivalent of spending this sum of money once and for all today[71]. Expressed, more meaningfully, as an annual flow, the sums are $78 billion to $1141 billion per annum. To get some idea of these sums, the world's annual GNP is currently about $35 trillion. Annual expenditures would therefore be 0.2 to 3.2% of annual current income. Unless "Kyoto plus" agreements extend to developing countries, these costs would be borne by the richer nations of the world alone, suggesting that the burden would rise to 0.3 to 4.5% of their annual current income. However, in both cases, world income would be growing. For example, if the world economy grows at 2% per annum, then the "worst case" level of costs (assuming all costs are borne in the next 20 years) would fall to some 2.3% of world income in 2035. If the costs are spread out over 50 years, the fraction would fall to 1.3% of world income.

World costs per tonne carbon

78.  While Table 6 shows costs in formats that convey an overall picture of the likely cost burden to current generations, expressing these costs as an average cost of removing carbon is also useful. Indeed, we show in Chapter 6 why such figures are needed for a comparison with the damage done by carbon emissions in a cost-benefit framework. Table 7 shows our attempt to translate the figures into costs per tonne of carbon. While the IPCC Synthesis Report shows these costs as rising at an increasing rate per unit of change in CO2 concentrations, the resulting figures in terms of costs per tonne of carbon emissions reduced do not show this pattern[72].

TABLE 7

World costs expressed in $ per tonne carbon
Concentration target (ppm) Cumulative emissions, billion tC Incremental reduction in emissions billion tC Incremental cost at 3% discount rate $2005, trillion Incremental cost per tC $2005
MERGE FUNDMERGE FUND
7501348- 0.70.0- -
6501239109 2.08.718.3 79.8
5501043 1963.58.7 18.344.4
450714329 4.319.513.1 59.3

Column 1 shows the various concentration targets. Column 2 shows the cumulative emissions corresponding to those targets. Column 3 shows the change in emissions, i.e. the emission reductions, needed to secure targets of 650 ppm or less. Column 4 shows the total worldwide cost of achieving these reductions, according to two different Integrated Assessment Models - MERGE and FUND. The final column shows this cost expressed per tonne of carbon reduced.

79.  The "cost per tonne of carbon" for the 550 ppm target is thus embraced by figures like $18 to $80 tC, or about £10 to £44 tC.

Conclusions on world costs

80.  We conclude that there are several ways of presenting global costs of controlling emissions so as to achieve a long run goal of atmospheric concentrations of 550 ppm. In present value terms—akin to a "one off" payment—the sums are anything from $2 trillion to $17 trillion. In annuitised form—the present value expressed as an annual payment—the range is $80 billion to $1100 billion per annum, assuming these costs are borne in the first 20 to 50 years. In terms of cost per tonne of carbon removed or avoided, the figures range from $18 to $80 tC.

The technologies to tackle climate change

81.  A key issue is the range of the technologies that are available to tackle climate change. It is clear to us that there is no shortage of innovations available. The more important issue is their cost and the capacity to diffuse them at a rapid rate in the world economy. Professor Dennis Anderson of Imperial College London was especially helpful in providing cost information on the likely candidates[73]. His data are presented in Table 8.

TABLE 8

Illustrative costs of emissions-reducing technologies
Technology MarkerCost unit Cost of Marker
Cost of Substitute
Net cost
Near term estimate (10 years time)
NuclearNG/CCc/kWh
3.5
6.0
2.5
Hydrogen from coal or gas + CCSNG $/GJ
4.0
8.0
4.0
Electricity from fossil fuels + CCSNG/CC c/kWh
3.5
5.0
1.5
WindNG/CCc/kWh
3.5
5.0
1.5
Photovoltaic (solar input = 2000kWh/m2) Grid electy.c/kWh
10.0
15.0
5.0
BiofuelsPetrol$/GJ
12.0
15.0
3.0
Distributed generationGrid electy. c/kWh
10.0
15.0
5.0
Long term estimate:
NuclearNG/CCc/kWh
4.0
5.0
1.0
Hydrogen from coal or gas + CCSNG $/GJ
5.0
10.0
5.0
Electrolytic Hydrogen (onsite & distributed) NG (distributed)$/GJ
10.0
30.0
20.0
Electricity from fossil fuels + CCSNG/CC c/kWh
4.0
6.0
2.0
WindNG/CCc/kWh
4.0
6.0
2.0
Photovoltaic (solar input = 2000kWh/m2) b/ Grid electy.c/kWh
10.0
8.0
-2.0
BiofuelsPetrol$/GJ
12.0
15.0
3.0
Distributed generationGrid electy. c/kWh
10.0
10.0
0.0

Source: Professor Dennis Anderson, Imperial College London. Notes: NG = natural gas; NG/CC is natural gas - combined cycle power plant; CCS is carbon capture and geological storage; GJ = gigajoule; kWh = kilowatt hour; c = US cents

82.  Table 8 expresses the costs of carbon-reducing technologies relative to a "marker", i.e. the technology that would be displaced by the "new" technology. In the longer term, the costs remain above the marker technologies by the same margin other than for solar photovoltaic in regions where there is fairly high levels of sunlight. The fact that the costs of most of these technologies remain above the current technologies means that the present free (or, rather, quasi-regulated) market will not bring about their natural substitution. That substitution must be managed, first by judging whether the extra costs of these technologies is smaller or greater than the money value of the environmental benefits they bring, and second, by designing incentive systems to accelerate the diffusion of these technologies. The former is an exercise in cost-benefit analysis, the second is an exercise in designing market-based environmental policies such as carbon taxes and tradable permit schemes, or of government directly sponsoring the required R & D. Professor Anderson also argued that, once incentives are in place, they will in turn accelerate the process whereby unit costs are reduced[74].

83.  Given the wide array of potential technologies in Professor Anderson's list, we are surprised that the Government's Energy White Paper[75] should place such emphasis on just one technology, wind energy. (There is also a debatable assumption about the likelihood of pervasive energy efficiency gains.) It is one of the technologies with a low excess cost burden over the marker technologies. Also, Professor Anderson's table relates to the global picture, not just the United Kingdom. Nonetheless, we would have preferred a wider vision in the White Paper. Dr Dieter Helm of Oxford University noted that, whereas the R & D budget in the US embraced the "big" technologies such as linked coal and hydrogen, the UK research programme has been "captured" by certain renewable technology interests[76].

84.  Finally, we note the position of (conventional) nuclear power in Table 8. It is well known that nuclear power carries an excess cost penalty at the moment. Indeed, this is why British Energy has experienced such financial difficulties with the current electricity market. But Table 8 suggests that this excess penalty will be reduced significantly over time. In our view, it would be unwise to close the nuclear energy option. It is prudent to maintain as wide an energy portfolio as possible. We argue that the current capacity of nuclear power, before further decommissioning occurs, should be retained.

85.  Additionally, there are serious doubts about the extent to which energy efficiency and wind energy can get the country on to a trajectory of emissions consistent with the 60% target. As Dr Helm indicated to us, such a policy is heavily reliant on "picking winners" among the technology options. We are not confident that the Government, indeed any government, can be so sure of the effectiveness of the technologies they choose to back. It is far better that government sets the goal and the price signals to achieve that goal, leaving the market to select the technologies and their rate of diffusion through the economy.

Costs to the United Kingdom

86.  Estimating the costs to the United Kingdom for the UK's own programme is not straightforward. Indeed, this appears to us to be a point of criticism—government estimates of cost are unhelpfully vague for something as important as climate control. However, the Government's long run target of 60% reduction in CO2 emissions by 2050 is supposed to be geared to the 550 ppm target since it assumes that "others" act likewise. According to the Department of Trade and Industry, the cost of this target is assumed to be between £10 billion and £42 billion in 2050, with an assumption that costs up to 2020 are "negligible" because the emission reductions are secured by energy efficiency. The evidence presented to us by Dr Dieter Helm suggests that this latter assumption is wildly optimistic. Indeed, we detect signs that the Government is aware that its Energy White Paper embodies very optimistic assumptions about the exclusive roles afforded to energy efficiency and renewable energy to achieve this long run target[77]. In an effort to prompt better and clearer estimates from the Government, Table 9 below presents our best guesses of the costs to the UK.

87.  Figure 1 presents a very stylised picture of our assumptions. The dashed lines represent the DTI's assumption of zero cost to 2020 and rising costs thereafter. The continuous lines represent our assumption that costs begin now, as indeed they must have done through the current climate action programme.

FIGURE 1

Stylised cost trajectories for the UK

88.  The trajectories encompass the DTI's optimistic assumptions about energy efficiency and a more pessimistic scenario (not subscribed to by the Government) in which the costs are incurred immediately, i.e. before 2020 which is when the White Paper assumes costs begin to rise.

TABLE 9

Possible costs for UK 60% target, present values and annuities
End point costs in 2050 p.a. £ billion, 2005 prices Present value of costs at 3% discount rate, 2005 prices, £ billion
DTI path, positive costs starting in 2020 Pessimistic case, positive costs start in 2005
11.36394
47.5265398
Annualised costs 2005-2050 at 3% discount rate, 2005 prices, £ billion
11.32.63.8
47.510.816.2

Source: EAC estimates

89.  Table 9 suggests that the UK faces "one-off" costs equal to £60 to £400 billion, or an annual cost burden of £3 to £16 billion per year for nearly the next 50 years. This annual cost would be higher still if we assumed the cost burden has to be met in the next 20 years. In supplementary evidence, Defra advised us that the marginal control costs (the costs of reducing additional tonnes of greenhouse gases[78]) for the UK might lie in the range £25 - £150 tC in 2030, and £300 - £600 tC in 2050[79]. However, even the 2030 estimates could be understatements if energy efficiency does not progress as fast as assumed. Equally, widespread emissions trading schemes for greenhouse gases could lower these costs.

90.  We acknowledge the rough and ready nature of our cost estimates for the UK's long term target of 60% reduction in CO2 emissions by 2050, but the fact that we can only produce such figures arises from the poor information embodied in the Energy White Paper and elsewhere. We urge the DTI and the Treasury to produce more detailed estimates of these costs. Moreover, the cost trajectories should show sensitivity to the serious doubts over the White Paper assumptions about the roles of renewable energy and energy efficiency.

Costs of meeting UK goals as a percentage of GNP

91.  Several of our witnesses conveyed their view that the costs of control to the United Kingdom are trivial. They expressed costs as a fraction of anticipated GNP. For example, if GNP grows at 2% for the next 45 years, it would be 2.4 times the current GNP in 2050. Currently, UK GNP is £1.16 trillion. In 2050 it would therefore be £2.8 trillion. If we take the "high" DTI figure of £47.5 billion climate change control cost in 2050, this is 1.7% of GNP. If we take the low figure, it is 0.4% of 2050 GNP. We doubt if this way of expressing cost will convey information in a comprehensible manner to more than an expert audience, but we accept that "benchmarking" costs on GNP is useful. However, fractions like 0.4 to 1.7% of GNP are not trivial. If this benchmarking approach is to be used, it is appropriate to relate it to other costs. For example, even the lower end of the range exceeds the current international development budget in the UK.

92.  Other witnesses adopted a variant of the GNP benchmarking approach and asked what climate change controls will do by way of reducing UK economic growth rates. It was put to us that instead of growing at an average of 2% per annum for the next 45 years, the UK would grow at 1.95% to 1.99%, a barely perceptible difference. The temptation is to conclude that such changes in growth rates are trivial compared to the rewards of avoiding the worst impacts of climate change. But we regard this manner of presenting cost data as sleight of hand. It has to be recalled first that the UK climate target only has meaning if all other countries adopt the same course. If they do not, then the UK will have undertaken unilateral action to no purpose. Hence the "return" secured by the UK from pursuing its long run target is highly uncertain. But, in any case, no other item of government expenditure is treated this way. If it was, it would be easy to justify almost any large scale item of public expenditure. We were therefore surprised to see this approach being quoted by Defra in their supplementary evidence to us on costs. We think it important to avoid the deception embodied in the "change in the rate of growth" approach.

93.  Finally, we note that the Government uses the MARKAL model to estimate the costs of meeting various emission targets. The use of this model was noted approvingly by Professor Paul Ekins of the Policy Studies Institute[80]. But Dr Dieter Helm of Oxford University was scathing in his criticism of the model which he characterised as "garbage in, garbage out"[81]. Dr Helm's criticisms centre on both the nature of the model and the assumptions built into it about the costs of energy efficiency and the costs of renewable energy. He argued that both these costs are understated by the Government and hence MARKAL produces the answer that the costs to the UK of meeting the 60% target are similarly low. If Dr Helm is right, then even our estimates in Table 9 are likely to be understatements of the true cost.

94.  We are concerned that UK energy and climate policy appears to rest on a very debatable model of the energy-economic system and on dubious assumptions about the costs of meeting the long run 60% target. We call on DTI and the Treasury to improve substantially (a) the cost estimates being conveyed to the public and (b) the manner of their presentation. Without these improvements we do not see how the Government can argue that it has adequately appraised its long-term climate targets in terms of likely costs and benefits. Indeed, in our examination of the witness from the Treasury, it was clear to us that no such cost-benefit analysis exists in substantial form. We believe that the Treasury should be more active in scrutinising and publicising these costs and benefits, in association with Defra and DTI.


70   In the business literature this tends to be known as the "Porter hypothesis", after Professor Michael Porter.  Back

71   For comparison, Professor Nordhaus of Yale University has suggested that the cost of achieving the Kyoto Protocol targets (inclusive of US participation), and assuming the emissions levels in 2010 are sustained through 2100, would be some $3 trillion (in 2005 prices). See W. Nordhaus, Global warming economics. Science, 294, 9 November 2001, 1283-4 Back

72   This is rather counter-intuitive and we have been unable to determine why. There is a question arising as to why the incremental costs first go down and then up. Back

73   Supplementary evidence from D. Anderson (Vol II, pp 147-150) Back

74   Evidence from D. Anderson (Vol II, pp 137-150) Back

75   Our energy future-creating a low carbon economy, February 2003 Back

76   Evidence from D. Helm (Vol II, pp 87-95). In his evidence (Vol II, pp 96-106), Sir David King was particularly keen on the development of nuclear fusion. However, it seems to us that this technology remains a distant prospect and we have discounted it in our analysis. Back

77   Our energy future-creating a low carbon economy, February 2003 Back

78   The cost estimates in Table 9 are annual averages, not marginal costs. Back

79   Evidence from Defra (Vol II, pp 107-130) Back

80   Evidence from P. Ekins (Vol II, pp 178-196) Back

81   Evidence from D. Helm (Vol II, pp 87-95) Back


 
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