8.3 The Financial Impact of Climate Change

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By the end of this lesson you will have learned about:

  1. The estimated damages related to climate change
  2. The Social Cost of Carbon
  3. A German example

 

We started this module by looking at the likely costs of retrofitting across a range of project types. Then we considered the decision making process of householders, landlords and governments.

Before we go on to look in more depth at financial appraisal methodologies, we are going to take a break and look at the bigger picture (globally in this lesson, and UK wide in the next).

If you are closely involved in the design and delivery of refurbished buildings, the chances are you don’t deal with macroeconomics and national/international policy on a day to day basis as well! However, many of you will want or need to understand the bigger picture.

1. Cost of action vs cost of damage

 

On a national and international scale….

the cost of actions which help reduce climate change are much lower than the cost of the damages.

 

1.1 Cost of Action. Various estimates are as follows:

  • the Stern Review (2006) estimated 1% of GDP by 2050, with a range of -2% to +5% of GDP to stay within 550ppm CO2 equivalent
  • The International Energy Agency (IEA) estimates 2% of current world GDP to stay within 450ppm CO2 equivalent
  • The Intergovernmental Panel on Climate Change (IPCC) AR5 estimates 1-4% by 2030 and 2-6% by 2050.

Stern compares this cost to reaching the same 2% growth target in 2051 instead of 2050.

Note: The Discount factor used is highly significant for results. Discount factors for projects are typically 5% or more. However, Stern suggests that when considering Climate Change a value of 1.5% is needed. Later lessons cover discount factors.

1.2 Compare these to the cost of damage which Stern estimated as:

  • If we can keep global temperatures within 2-3⁰C, temperature increase costs are relatively small, 0-3%, GDP/yr, which is similar to serving the National Debt.
  • If global temperatures slip to 5-6⁰C, temperature increase costs are 5% GDP/yr. (Extract from exec report, p.ix) and risks take it to 20%, now and for ever from
    1) environment and (non-market) human health impacts, which takes the 5% to 11% (conservative estimate)
    2) evidence that climate system may be more responsive from feedback, takes it from 11% to 14%
    3) disproportionate share falls on poor regions of world, if evenly distributed would be ¼ higher for 5-6°C.

1.3 International agreement

In Paris in 2015, 195 nations agreed to limit global warming to less than 2⁰C above pre-industrial levels and endeavour to limit it to 1.5 ⁰C.

 

However before and during the Paris conference, countries submitted comprehensive national climate action plans (INDCs).

These are not yet enough to keep global warming below 2°C, (Climate Tracker says 2.7°C) but the agreement traces the way to achieving this target.

 

If countries meet these targets, it looks as though Climate Change will not run out of control. This is just as well because in Stern’s work with Deitz he suggests the climate science suggests a risk losses could be up to 50% of GDP indefinitely into the future above the tipping point of 4⁰C.

http://climateactiontracker.org/news/224/indcs-lower-projected-warming-to-2.7c-significant-progress-but-still-above-2c-.html

1.4 EU Targets

EU member states have a binding target of 40% reduction by 2030 and the UK is currently meeting its first 3 carbon budgets on its way to reducing CO2 to 80% by 2050 relative to 1990 levels. The UK won’t currently meet its 4th carbon budget and has been exploring the options.

1.5 Individual projects

Economic models of individual projects usually ignore any climate related damage to society (in economic terms this is called an externality). Householders are charged no extra for CO2 they release in the atmosphere from heating1.

1 Though electricity generation companies, specific industries and aviation have to trade allowances through the EU trading scheme (http://ec.europa.eu/clima/policies/ets/faq_en.htm). Prices in Jul 2016 were €5/tonne CO2 which is no incentive, so many countries set a “floor price”, the UK’s for 2016 is £18/tonne CO2 , still not much incentive.

There is a cost to society; we are all polluters to a greater or lesser extent. Future generations and other countries (often those with less ability to pay) have not contributed to the problem, yet they will suffer a larger share of the consequences. Significant costs will arise through sea level rise affecting their ports and populations, rainfall patterns affecting crops, air pollution and so on. There is a substantial moral issue here.

2. The social cost of carbon

The social cost of carbon is essentially the carbon price required if a market mechanism was the only way we meet the 2°C target (i.e. without regulation, wide scale public campaigns etc). It isn’t the cost of the damage. It’s determined from a complex economic model developed by Stern and Deitz, published in 2014.

Stern and Deitz worked on several new versions of an economic and climate change model developed from the DICE model which has become very influential since the 1990’s. Stern and Deitz’s model is optimised and calculates the required tax on carbon (with no regulation to limit emissions) in order to bring about the necessary changes that we need in the time we have. As Nordhaus, original author of the DICE model, says in the manual to the 2013 revision “If the policy is optimized, then the carbon price is also the social cost of carbon”. Stern & Deitz’s models recognise that damaging effects from climate change will reduce output of CO2 “but the feedback is too small and too late for the system to self-regulate.”

Stern dismisses the standard and quadratic damages used in the DICE model, this leaves the 6 possibilities below. With current conversion rates to £, costs rise steeply from about £140/tonne of CO2 in 2015 to £770/tonne in 2095 and Stanford scientists estimate it could be $220/tonne CO2. (http://news.stanford.edu/2015/01/12/emissions-social-costs-011215/)

Graph of social cost of carbon
Graph of social cost of carbon

Remember, the Social Cost of Carbon is not the cost of damage – it is the cost to society of avoiding damage: this helps interpret these figures.

They SCC figures show that market prices would have to be extraordinarily high to bring about the changes we need. Carbon brief (https://www.carbonbrief.org/lord-stern-says-economic-models-of-climate-change-need-better-climate-science) writes “It is notable how the results differ to the model’s previous recommendation [the original DICE model developed by Nordhaus] and current carbon prices. Even in a best case scenario, the updated model’s carbon price is considerably more than the $12 that the standard model recommends. It is also much more than current carbon prices. The EU’s carbon market currently has a price of around $8, and two US markets have prices of $2 to $15.”

Many organisations favour regulation as being more effective:

  • IPCC: Tech summary (IPCC AR5 2013 Ch9) Strong barriers hinder the market uptake of these cost‐effective opportunities… Market forces alone are not likely to achieve the necessary transformation without external stimuli….Experience shows that pricing is less effective than programmes and regulation (medium agreement, medium evidence).
  • The Center for Climate Change and Sustainable Energy Policy (3CSEP): “In order to avoid the risk of the “lock-in effect” of the energy saving, governments are advised to first develop strategies to increase the minimum requirements of new construction and retrofit towards high energy performance levels. Only then is it recommended to introduce financial mechanisms or policies to accelerate retrofit rates (where applicable) supporting the deployment of advanced buildings on a large scale. “
  • The International Institute for Applied Systems Analysis (IIASA) in the ‘Global Energy Assessment’: “Standards for building codes, heating and cooling, appliances, fuel economy, and industrial energy management are one of the most effective policy tools for improving energy efficiency and should be adopted globally. “
  • IEA: “Market barriers in the buildings sector are complex and can be difficult to overcome, so successful implementation of public policy will be essential to achieving high levels of market diffusion.“

! Paragraph below added 30.09.16:

The AECB contacted Prof. Deitz asking how CLR modelling might include the cost of carbon given the existence of legally binding goals – notably the UK’s Climate Change Act. Deitz advised that these goals are informed by economic models, but also, quite legitimately, by other non-economic factors and that it is better to set the price of carbon equal to the marginal cost of abating emissions to reach the target. More surety in modelling is provided in this way. This now forms the official UK government approach to carbon pricing, which Deitz and colleagues played a role in formulating. He advises: “I believe the pragmatic purpose for which you want a carbon price falls squarely within this framework, therefore you could use the official UK government carbon prices/values.”
The UK carbon pricing figures Dietz refers to range from £6/tonne CO2 in 2015 and reaching a maximum of £47 in 2030 (central estimate, high estimate is £109 in 2030). CLR uses these figures to compare the relative financial performance of different depths of retrofit in section 8.9.

3. A German example

The German ‘Zukunft Haus Pilot Programme’ that ran from 2003 – 2005 illustrates quite a successful route forward. A pilot project showed how 80% reduction in energy consumption could be achieved. In 2007, the German Federal Government announced that all German pre1984 homes should reach this standard by 2020. Since 2006, Germany has created nearly 500,000 new jobs in renewable energy and nearly 900,000 jobs in retrofitting homes and public buildings. Green investment, green technology development and export are all major growth areas in Europe’s strongest economy.

Summary of German energy conservation and renewable programmes
Summary of German energy conservation and renewable programmes

There are three ‘pillars’ to the success of the programme include regulation, low cost loans, funding and major public campaigns:

http://sticerd.lse.ac.uk/dps/case/cp/CCCfull.pdf

 

 

Summary

This lesson has looked briefly at:

  1. The estimated damage of climate change
  2. The social cost of carbon
  3. A German example

 

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