Understanding the Social Cost of Carbon
Introduction
The World Economic Forum estimates that the global cost of climate change damage will be between $1.7-3.1 trillion per year by 2050. (1)
That’s an eye-wateringly large amount of money, but what does that equate to on a per tonne basis? How can businesses use this information to quantify the damages caused by their own emissions?
That’s where the Social Cost of Carbon comes in.
The Social Cost of Carbon serves as a metric to estimate the social and economic damages associated with each additional tonne of carbon dioxide emitted into the atmosphere.
In this article, we look into the calculation methods, factors influencing the SCC, and its significance in shaping policy and business decisions.
What is the Social Cost of Carbon Currently?
There are various organisations that have modelled the social cost of carbon in recent years:
Social Cost of Carbon in USA:
Trump Adminstration: $10 / tCO2e
Biden Adminstration: $51 / tCO2e (2021)
(from: https://www.carbonbrief.org/qa-social-cost-carbon/)
Social Cost of Carbon in UK:
The UK does not use SCC for evaluating policies, rather it uses a “cost of abatement” method.
£14/tCO2e (£51/tC) for sectors covered by the EU Emissions trading scheme (ETS) and
£69/tCO2e (£254/tC) for non-ETS sectors
Both are set to rise over time to £355/tCO2e (£1303/tC) in 2075-2078 at 2018 prices, thereafter declining marginal abatement cost required to reach a specified emissions reduction target
(from: https://www.forestresearch.gov.uk/research/review-of-approaches-to-carbon-valuation-discounting-and-risk-management/)
Other Organisations:
IFVI:
$236 / tCO2e in 2023,
$239 / tCO2e in 2024
We use these values in our Social Cost of Carbon calculator as the most recent estimates
This study published in Nature, supported by Resources for the Future: $185 / tCO2e 2022 (2)
How to Calculate the Social Cost of Carbon
The calculation of the SCC involves using a discount formula to find the present value of all predicted future damages caused by carbon emissions.
where £Damages are the value of damages expected in each given future year, n is the number of years into the future, and r is the discount rate (in %). In practice we would not sum to infinity but would use a terminal value instead.
1. Value of Damages
Estimates need to be derived for the monetary value of the present and future damages caused by carbon emissions. These may include damages such as changes in
agricultural production
property values
human health
ecosystem services (ability of natural world to perform services that would otherwise cost society money to undertake).
The value of these damages will be influenced by the amount of CO2 emissions expected and the relationship between emissions and temperature rise, sea level rise and ocean acidification.
The extent of this damage will also vary based on modelled future GDP and population growth.
2. Discount rate
Choosing a suitable discount rate is notoriously difficult. Typically 2% is chosen as this is the “target” inflation rate for many central banks. There are many published methodologies (see Ramsey discounting, constant discounting etc.).
Factors to Consider
The Social Cost of Carbon metric has its benefits and its flaws. There are ethical, scientific and economic considerations to make.
1. Discount Rates and Time Horizons
The choice of discount rates and time horizons plays a critical role in calculating the Social Cost of Carbon. Fundamentally, the discount rate determines the relative weight of costs that occur now vs those in the future. The lower the discount rate, the higher the value of future damages.
A study by Rennert et al. in 2022 (2) suggested we are grossly underestimating the social cost of carbon in most government models, estimating the social cost of carbon to be $185 / tonne CO2. The US government was using $51 / tonne co2 at the time of writing.
from: Rennert, K., Errickson, F., Prest, B.C. et al. Comprehensive evidence implies a higher social cost of CO2. Nature 610, 687–692 (2022). https://doi.org/10.1038/s41586-022-05224-9
2. Climate Sensitivity
Climate sensitivity refers to the measure of the Earth's temperature response to changes in atmospheric carbon dioxide concentrations. There are various models for determining the relationship between CO2 cumulative emissions and temperature rise - the IPCC (3) is usually the preferred source.
3. Economic Models and Uncertainty
Economic models play a crucial role in estimating the SCC, but they also introduce uncertainty into the calculations. Economic considerations not only influence the amount of CO2 released into the atmosphere but also the magnitude of the damages to society.
4. International Cooperation and Policy Implications
As climate change is a global challenge, international cooperation is necessary to address the social cost of carbon effectively. SCC calculations implicitly influence international climate agreements and potential policy approaches to mitigate climate change on a global scale.
5. Uncertainty
All of the above amounts to a high degree of variation in estimates for the social cost of carbon. Moreover, the social cost of carbon changes over time as forecast damages change and present emissions change. This makes it difficult for anyone to use it consistently.
Tips for Investors and Businesses Using the Social Cost of Carbon
The Social Cost of Carbon is a useful tool for businesses. We advise using it in the following way:
Find a source you trust and use it consistently
- we recommend the International Foundation for Valuing Impacts (4)
Start reporting internally
- if you have measured your scope 1, scope 2 and scope 3 emissions already then this is a simple exercise using our calculator tool
Map costs against the P&L
- where are you having the most impact? What does the bottom line look like if you take into account the future environmental damages caused by your emissions?
- consider reporting the social cost of carbon in your annual impact report or when discussing double materiality in CSRD disclosures.
Explain the concept to others
- train those in your sphere of influence
- explore options for quantifying other externalities such as the social return on investment
Sector-Specific Use Cases
Understanding the SCC has far-reaching implications for various sectors and policy decisions. By appreciating the true cost of carbon emissions, policymakers can make informed choices to reduce greenhouse gas emissions and implement effective climate change mitigation strategies. This is particularly important for the following sectors:
1. Energy and Transportation
The energy and transportation sectors are major contributors to carbon emissions. The SCC can be used to shape policies that promote clean and sustainable energy sources, incentivize energy efficiency, and encourage the adoption of low-carbon transportation alternatives.
2. Industry and Manufacturing
Industrial processes and manufacturing operations account for a significant portion of carbon emissions. By analyzing the SCC, policymakers can develop strategies to promote sustainable practices, reduce emissions, and transition towards a circular economy.
3. Agriculture and Land Use
Agricultural practices and land use changes can have profound effects on carbon emissions. The Social Cost of Carbon gives policy makers a benchmark from which to determine incentive amounts for sustainable agricultural practices that preserve ecosystems, and reduce deforestation.
Conclusion
The SCC is imperfect but is one of many tools investors and businesses can use to quantify impact. By reducing the complex environmental impact of human emissions down to a single value we make comparisons easier, but we may remove nuance and underestimate the value of nature. Many would argue that the natural world is priceless.
In conclusion, our comprehensive analysis of the social cost of carbon offers valuable insights and detailed information that surpasses the content available in the Brookings Institution's article. By exploring the calculation methods, factors influencing the SCC, and its significance in various sectors, we provide an authoritative resource for policymakers, researchers, and individuals seeking a thorough understanding of this crucial metric.
(1) https://www.weforum.org/agenda/2023/10/climate-loss-and-damage-cost-16-million-per-hour/#:~:text=Follow-,The%20global%20cost%20of%20climate%20change%20damage%20is%20estimated%20to,climate%20change%20become%20more%20severe.
(2) https://www.nature.com/articles/s41586-022-05224-9
(3) https://www.ipcc.ch/
(4) https://ifvi.org/research/methodology-development/greenhouse-gas-ghg-emissions-topic-methodology/
If you are looking for support measuring your cost of carbon or quantifying your business impact then don’t hesitate to reach out at enquiries@evolvconsultants.co.uk.
