Putting a Price on Climate Change
April 30, 2007
On 30 October 2006, the UK Government published the much anticipated report on the economics of climate change by Sir Nicholas Stern (the Stern Review), head of the UK Government Economics Service and former chief economist to the World Bank. More than 700 pages long, this report was the first fully comprehensive review of the global costs potentially created by an ever changing climate.
The past two decades have seen the science of climate change making headlines globally, with increasingly common studies and discussion regarding whether the continuing accumulation of greenhouse gases in the atmosphere is causing global temperatures to rise. The Stern Review presented a breakdown of what cost the world faces in acting to stop global warming, and what cost it faces in failing to act at all. Below we address its key findings and how the Stern Report might impact the climate change policies and activities of national governments, businesses and industry.
The Key Points of the Stern Review
The Dangers
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Average temperatures could rise by five degrees Celsius from pre-industrial levels if climate change goes unchecked.
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All countries will be affected by climate change, but the poorest countries will suffer earliest and the most.
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Warming of three degrees or four degrees Celsius will result in many millions more people being flooded. By the middle of the century, 200 million people may be permanently displaced due to rising sea levels, heavier floods and drought.
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Warming of four degrees Celsius or more is likely to seriously affect global food production.
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Warming of two degrees Celsius could leave 15 to 40 per cent of world species facing extinction.
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Before the industrial revolution, the level of greenhouse gases in the atmosphere was 280 parts per million (ppm) CO2 equivalent (CO2e); the current level is 430ppm CO2e. The level should be limited to 450 to 550ppm CO2e.
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Any higher CO2e would substantially increase risks of very harmful impacts. Any lower CO2e would impose very high adjustment costs in the near term and might not even be feasible.
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Deforestation is responsible for more emissions than the transport sector.
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Climate change is the widest-ranging market failure ever seen.
Recommended Actions
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The three elements of policy required for an effective response are carbon pricing, technology policy and energy efficiency.
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Carbon pricing, through taxation, emissions trading or regulation, will show people the full social costs of their actions. The aim should be a global carbon price across countries and sectors.
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Emissions trading schemes, like that operating across the European Union, should be expanded and linked.
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Technology pricing should drive the large-scale development and use of a range of low-carbon and high-efficiency products.
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Globally, support for energy research and development should at least double; support for the deployment of low-carbon technologies should be increased by up to five times.
Economic Impacts
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Unabated climate change could cost the world at least five per cent of GDP each year; if the more dramatic predictions materialise, then this figure could be as high as 20 per cent.
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The cost of reducing emissions could be limited to around one per cent of global GDP; people could be charged more for carbon-intensive goods.
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Each tonne of CO2 we emit causes damage worth at least US$85, but emissions can be cut at a cost of less than US$25 a tonne.
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Shifting the world onto a low-carbon path eventually could benefit the global economy by US$2.5 trillion a year.
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By 2050, markets for low-carbon technologies could be worth at least US$500 billion.
Ramifications
The Stern Review has highlighted the need for global co-operation amongst governments in tackling the problems of climate change. The official response from the United States is that the current administration considers climate change a matter of priority and that the Council for Environmental Quality is reviewing the findings of the Stern Review.
The UK Government, in contrast, has pledged to enact British climate change commitments in legislation through a Climate Change Bill, which includes a goal of reducing carbon dioxide emissions by 60 per cent by 2050, and strengthening official monitoring and reporting. Among other goals, the UK is aspiring to expand the EU carbon market to cover other sectors and greenhouse gas emissions beyond carbon dioxide, and link the EU carbon market with other markets, such as Australia, Switzerland, northeast America and California.
In discussions concerning the Stern Review, industry associations have highlighted business opportunities likely to arise as new markets emerge for low-carbon energy technologies and other low-carbon goods and services. In addition, they are petitioning the relevant governments to issue clear climate change policies, such as ensuring that mature low-carbon technologies, e.g., on-shore wind farms, are subject to an appropriate regulatory regime, and ensuring sufficient financial support for the development of emerging low-carbon technologies, e.g., tidal power.
Market participants are focused on the opportunities that will arise from the establishment and extension of carbon trading schemes and other market mechanisms recommended by the Stern Review. However, they have been quick to highlight the need for longer term policies to give certainty beyond the expiry of Phase II of the EU Emissions Trading Scheme in 2012, arguing that this is too short a period to maximise innovation. Market participants claim longer term certainty needs to be provided either by guaranteeing continuation of trading or otherwise setting a long-term price for carbon. Additionally, existing emission trading schemes must be extended to allow the maximum participation of other trading systems and mechanisms.
This view has been endorsed by the International Emissions Trading Association (IETA), which, although supporting the conclusions of the Stern Review on the benefits of a worldwide trading scheme, has emphasised again the need for clarity and predictability of future policies. IETA considers the unrestricted use of all approved Kyoto credits and the ability to link to other emissions trading systems essential in achieving an efficient and effective market. This also will help to deliver the required reductions in emissions at the lowest possible price.
Therefore, although the general reaction to the Stern Review is that a global system of emissions trading is needed urgently for there to be effective timely action against climate change, there are a number of issues that governments will need to address first to provide longer term policies and certainties. As Sir Nicholas Stern concludes, "…with the right incentives the private sector will respond and deliver solutions".
