The Economics of Climate Change:

Reflections on the Stern Report

Dennis Anderson

Imperial College Centre for Energy Policy and Technology (ICEPT)

February 2007

Origins

1. Ministries of Finance Increasingly Engaged:

a) Intervening in newly liberalised energy markets

b) Taxing energy and pollution, financing R&D….

c) Effects on prices of Feed-in Tariffs, Obligations, Standards etc

d) Effects on economic growth………

2. Economists—many sceptical

3. Need to move beyond Kyoto—to involve US and developing countries especially

4. … and a sense that innovation offers a way forward

Scope (1)

1. Approach: assumptions of ‘traditional’ cost-benefit analysis questioned:

• ethical precepts; • limits of marginal analysis; • uncertainties and risks; • long-term nature of problem

2. Economic Impacts of Climate Change

3. Economics of Stabilization—benefits and costs

4. Policies for Mitigation

5. Policies for Adaptation

6. International collective action

Scope (2)

Benefits of Mitigation: (1) Temperature Rises

Benefits of Mitigation: (2) Human and Physical Impact

• Falling crop yields in Africa • Loss of glaciers and melt-water for irrigation in Asia• Increased rates of run-off and flooding• Extreme weather events• Loss of Greenland Ice-cap• Loss of Gulf Stream• Intensification of greenhouse effect through thawing of permafrost• ………

……thought possible for some time ( ~ 2% probability in 2000)

……now thought likely—such scenarios are no longer ‘alarmist’ (recent estimate is > 50% probability at 3 ˚C)

Benefits of Mitigation: (3) Raw Economic Effects

Mitigation: estimating the costs

1. Estimate two emission trajectories• Without policies in place (BAU)• Trajectory to stabilise accumulations at 450—550 ppm

2. Compare costs of alternatives with fossil fuels

3. Examine alternative portfolios, bearing in mind constraints and energy system requirements

4. Allow for changes in income elasticities of demand

5. Calculate costs per ton of abatement

6. Add up the costs statistically (all the above are uncertain)

Costs of Mitigation: (1) Emission Trajectories

(2) Incremental Costs of Low Carbon Options as % Costs of Fossil Fuels

(3) Portfolios considered. An example.

• Above include hydrogen production for transport and dCHP

• 20,000 ‘trials’ Using Monte Carlo Analysis

(4) Changes in Income Elasticity (energy efficiency)

Per Capita Income Elasticity of Energy Demand vs Per Capita Income

-0.5

0

0.5

1

1.5

0 2000 4000 6000 8000 10000

Per capita income (ppp, 1985 US$)

Elasticity

Is it moving downwards?

Source: Plotted from Judson, Schmalensee and Stoker (1999).

(5) Costs per ton of CO2 Abated

High oil and gas prices; higher rate of innovation

Low oil and gas prices; lower rate of innovation

(6) Costs as % of World Product

World product should grow by ~ 200% by 2050:

• 125% in the OECD economies

• 350% in the developing economies

Climate Change Mitigation Policies

1. Carbon pricing—carbon taxes or tradable permits

2. Double R&D effort, which declined by 50% since 1974

3. 3-5 fold increase in finance for innovation over the next 10 years, from $35 billion/year today. Instruments:

• Feed-in tariffs

• Renewables obligations (transport and power)

• Tax incentives, grants and credits …..

4. Address ‘barriers’ to uptake of efficiency

5. Take up ‘win-win’ opportunities---remove fossil fuel subsidies; congestion pricing…

6. Above as basis for international co-operation, supported by CDM and Clean Energy Investment Facility of World Bank

The Decline of the R&D Effort in the OECD 1974-present

-

5,000

10,000

15,000

20,000

25,000

1974 1979 1984 1989 1994 1999 2004

OECD: Million USD, 2004 prices and exchange rates

Other

Power & Storage technologies

Nuclear Fusion

Nuclear Fission

Renewable Energy

Fossil Fuels

Conservation

Stern Report: Constructive and Optimistic (?)

2007

Science established, and reasonably conclusive

Technological options proven and available—and not prohibitively expensive

Some policy experience over past 15 years

Development of national policies

New international framework—linked to national policies

10 million MW of investment in electricity

1000 EJ of output from ‘clean’ technologies

Economic growth

Industry increasingly engaged