Economics, Mitigation, and Adaptation: Decision-Making for

Climate Change and Sustainability

Susan M. Capalbo Professor and Head, Applied Economics

Oregon State UniversitySusan.capalbo@oregonstate.edu

November 2013ATS 320

Acknowledgements: support from USDA, NNF and REACCH

The history of life on earth has been a history of interaction between living things and their surroundings. To a large extent, the physical form and the habits of the earth’s vegetation and its animal life have been molded by the environment. … Considering the whole span of earthly time, the opposite effect, in which life actually modifies its surroundings, has been relatively slight. Only within the moment of Only within the moment of time represented by the present century has one species acquired time represented by the present century has one species acquired significant power to alter the nature of his world.significant power to alter the nature of his world.

from Rachael Carson’s Silent Spring, (1962)

• 25% of Earth’s lands are already degraded.

• More than ¾ of the 70% increase in global food production needed by 2050 will have to come from the ‘sustainable intensification’ of existing agricultural lands.

• A global issue, requiring responses internationally and nationally

Challenges Facing Agriculture in the 21st Century

Flow of presentation:

Nov 20134

Susan M. Capalbo

I. Defining Terms• Sustainability• Externalities• Examples with Climate Change

II. Tools of the Trade: Economic Framework for Decision-Making• Cost-benefit analysis• Discounting• An Efficient Climate Change policy

III. Different Approaches for Climate Policy

• Taxes, Permits, command and controlIV. Some Challenges: Dealing with Irreversibility, long time horizons

TAKE-HOME Messages

April 19, 20235

Susan M. Capalbo

(1) Economic forces, economic decisions are driving phenomena

such as global warming and biodiversity loss

(2) To change unsustainable behavior, need to develop economic environment within which they are no longer attractive– incentives matter

(3) Climate change is a global externality – very difficult to tackle from an economic point of view

Defining terms

6Susan M. Capalbo January 13, 2011

• Sustainability and Resilience• "Sustainable development is development that meets the needs of the present

without compromising the ability of future generations to meet their own needs.” World Commission on Environment and Development, 1987

• Essence of sustainability (three axioms):• (1) a treatment of the present and the future that places a positive value on the very

long run (discount issue)• (2) Recognition of all of the ways in which environmental assets contribute to economic

well-being (valuation issue) and how economic incentive and decisions impact global warming, biodiversity etc (economic issue)

• Recognition of externalities: spatial and temporal dimensions (economic issue)• (3) Recognition of the constraints implied by the dynamics of environmental assets

(science issue)

• Reference: Resilience Thinking by Brian Walker and David Salt (2006)

Defining terms

7Susan M. Capalbo

• Externality, spillover RESULTS WHEN THE ACTIONS OF ONE PERSON (OR FIRM) HAVE A DIRECT, UNINTENTIONAL, AND UNCOMPENSATED EFFECT ON THE WELL-BEING OF ANOTHER INDIVIDUAL OR THE PROFITS OF OTHER FIRMS.

• Examples (local and global) SECOND-HAND SMOKE

AIR POLLUTION FROM FACTORIESLOGGING IN FORESTED HEADWATERS (DEGRADES SPAWNING HABITATS)

R&D – PRODUCES KNOWLEDGE

GLOBAL EXTERNALITIES: Climate Change

Role of Economics in Climate Change Research

Susan M. Capalbo

• Mitigation: How to limit CO2 and GHG emissions 2 ways to think about Economic contributions:

(1) Set CO2 levels in atmosphere that minimize costs (SR and LR)(2) determine the least cost means to achieve (1)

7 ways to reduce carbon: http://www.youtube.com/watch?v=-wcDHZ7Z-hQ

• Adaptation: What are the economically feasible options? What are the economic costs of adaptation?

• My areas of research: agriculture and energy

Climate Change Policy

• International Policies addressing a Global Externality• United Nations Framework Convention on

Climate Change: Background• Europe Let’s Close the Gap

• National and State Policies: A Second-Best Approach

Take-home messages: Climate change is a global externality currently

beyond the scope of a comprehensive international policy

National and state level policies are a second-best solution to tackle a smaller piece of the global issue

April 19, 20239

• Economic concepts at play:• scarcity, discounting, tragedy of

the commons, intergenerational equity, opportunity cost

• Stern Review: Economics of Climate Change

• Economic Instruments• taxes• markets

• Financial Times Op-Ed• command and control/ best

management practices

Economics of Climate Change

April 19, 202310

Take-home message: Economics offers a framework to be used to solve the issues arising from climate change rather than a one-track solution

Cap and Trade (market)

• Modeled after SO2 program

• Create a ‘market’ (tradeable allowances)

• Advantages: cost effective way to reduce CO2 emissions (in theory)

• Leads to strong incentives to develop pollution control technologies

• Ag sector may be able to provide carbon offsets – next slide

Carbon Credits vs. Carbon Offsets

Carbon Credit Refers to any tradable certificate or permit representing the right to

emit one ton of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent of one ton of carbon dioxide

Carbon Offsets Refers to a ton of carbon dioxide equivalent. An offset negates the effects of carbon emitted in one place by avoiding the release of a ton of carbon elsewhere or absorbing/sequestering a ton of CO2 equivalent that would have otherwise remained in the atmosphere.

Carbon Markets

Carbon markets are based on a

CAP and TRADE Program (similar to the program enacted by the Clean Air Act of 1990, used to

reduce sulfur emissions)

• Government sets a yearly CAP on the amount of allowable greenhouse gases (in terms of carbon equivalences)

• Permits or allowances equal to the CAP are then allocated or auctioned off to each emitter

• Each emitters emissions are measured and at the end of the year each emitter must provide a permit for each ton of carbon emitted

• Emitters that don’t reduce emissions enough must buy credits (or offsets) and emitters that reduce emissions more than required can sell excess credits

Source:http://www.edf.org/sites/default/files/cap-and-trade-101_0.pdf

Carbon Prices Fluctuate (2013)

• January 14th California Carbon Allowances sold for about $15/ton

• Jan 24th Prices in the EU's Emissions Trading System dropped to €2.81/metric tonne and later climbed back above €4. ($4.18-$5.96/US ton)

• Feb 5th EU sold 3.47 million CO2 permits for € 4.10 each ($6.10/US ton)

• According to the Climate Exchange, prices for offsets are determined by the particular project and current market conditions. An important indicator of price is related to the type of standard the project meets. • Air Resources Board projects are going to take the highest prices (currently

around $8-11/ton)• Verified Carbon Standard (VCR) projects are generally taking the lowest prices

(currently around $0.25 - $1/ton). • There can also be a lot of variability based on project type, location, and various other features.

Keys to a Successful Cap and Trade Program

•Setting a realistic cap on CO2 emissions

•if set too low, CO2 allowances/credits will not be valuable

•if set too high, emitters will have to increase output prices significantly (causing unwanted ripple effects in the economy) or close down their operations

•Ability to measure and monitor emissions

•Ability to set up a relatively low cost means of trading allocations

•If offsets are used, these also need to be measured and monitored

Potential Sources of Carbon Offsets

“Studies in Canada and the United States have shown that increased amounts of atmospheric C02 can be sequestered

in soil by the use of agricultural conservation practices.”

•Retire land from agricultural production and replanting perennial cover (such as trees or perennial grasses)

•Eliminate bare fallowing and add cover crops to standard cropping systems

•Use of perennials in rotations

•Use of reduced/no tillage to increase the amount of soil organic matter and carbon sequestration in the soil

•Improved fertilizer management or use of composted animal manures which eliminates the emissions from the production and transportation of synthetic fertilizers

•Grazing land management

•Biofuel substitution (use of crop residues for biofuel)

Sources: Freedman et al. 2009. Credits and the conservation of natural areas. http://cfs.nrcan.gc.ca/pubwarehouse/pdfs/29788.pdf Schahczenski and Hill 2009. Agriculture, Climate Change and Carbon Sequestration http://www.fluxfarm.com/uploads/3/1/6/8/3168871/attracarbonsequestration.pdf

Potential Challenges to Agricultural Offsets:• Additionality: Is the offset truly an offset if the reduction would have happened anyway? For example, an emitter purchases an offset from a farmer which simply subsidizes a farmer to plant cover crops, when this is something they have been doing for a while anyways.

o Potential Remedy: Adjust credits so they are not 1-1.

• Leakage: carbon sequestration gains from offsets could be shifted to another source that results in increased emissions overall.

o Potential Remedy: Adjust credits so they are not 1-1.

• Permanence: When carbon is built up in the soil through reduced tillage or other practice, carbon can be released if the practice is not continued, making the GHG reductions only temporary.

o Potential Remedy: write a contract that address this problem.

• Measuring and Monitoring Costs: Difficult to measure accurately because GHG emissions from farm fields are a non point source of pollution.

oPotential Remedy: measure the amount of soil carbon sequestered by sampling and estimate the average carbon accumulation of each practice.

Or use remote sensing, aerial photography, or drive-by inspections to ensure that farmers are using an eligible practice.

Oregon Carbon Credits

Oregon has adopted power plant carbon dioxide (CO2) emission requirements that allow compliance through offsets.

The Climate Trust is the only qualified organization which manages funding from Oregon-based utilities with a statutory requirement to acquire carbon credits. This program currently has $6 million available to purchase carbon credits.

One of the areas the Oregon program is targeting is innovative sequestration projects like aggregation of small-scale forestry projects or soil carbon sequestration.

Climate Trust 5 SW Yamhill Street, Suite 400; Portland, Oregon 97204 503.238.1915

Soils provide the largest terrestrial store of carbon on Earth, with twice the carbon stored in shallow soil than in all the vegetation aboveground.

TRADEOFFS exist: the most financially viable use of land often favors increasing development, leading to loss of habitat for native species, valuable soil carbon and an estimated 35 M tons of greenhouse gas emissions annually in the U.S.

Climate Trust is currently collaborating with Ducks Unlimited to developand apply a new Avoided Grasslands Conversion methodology across the Northern Great Plains – an area where more than 770,000 acres of grasslands were converted to cropland between 1997 and 2007. Financial incentives will help preserve 50,000 acres of grasslands across the Prairie Pothole Region, and provide economic benefits to around 100 landowners.

Carbon Tax (another market-based policy)

How carbon is priced – directly, not thru marketsLess variability from year to yearReduces the uncertainty in pricing – tax sets a priceOptimal tax policies represent the lowest expected NPV of abatement across all policies considered for the given cumulative emissions goal.

Relevance for this discussion: taxes are a clear, consistent price for carbon

Command and Control

Performance standards or best practices

How carbon is priced: indirectly (shadow price on carbon)

This policy instrument makes it difficult to directly price carbon – one needs to know cost of alternative production process and the cost of the carbon constrained process

Let’s get real: Options for US Climate Policy

Absent from 2012 CampaignThree major tracks:• USE the Clean Air Act (Supreme Court Ruling: Mass vs EPA) – GHG covered

under Clean Air Act

• Carbon tax: way of of federal budget deficits• $20/t tax yields $100B annually • Issues: impacts on HH, economy? Competitiveness issues – trade impacts

• Clean Energy Standard (CES)(example: goal of 80% clean electricity by 2035)– sets minimum threshold on share of energy generation that must come from clean sources

• Source: RFF www.rff.org

Energy: A Technological Approach to Adaptation and Mitigation

• Technological approaches • carbon capture and storage, natural gas-shale

technology, combined heat, cooling, solar hot water heating, distributed solar photovoltaics, feed-in tariff, ethanol, nuclear power, LED lighting, batteries for electric vehicles, energy storage

• The Future of Coal, MIT Study

Take-home message: Energy technology can cross the line between adaptation and mitigation; economic feasibility is a key criteria for the success of new technologies

April 19, 202323

Current Dominance of Fossil Fuels

Source: EIA Energy Information Administration , 2001, 2005

Energy Consumption (USA, 2001) GHG Emission Sources (USA, 2003)

Data Source: Energy Information Administration; www.eia.doe.gov

Fossil Fuel Resources – Not Running Out

Source: BP, Stat. Review 2005bnboe = billion barrels of oil equivalent

•USA Total Oil Consumption: 7.5 billion barrels per year

Coal Drives CO2 Emissions

Source: International Energy Agency 2004

Kyototargetreductions

The CO2 Stabilization and Wedges Framework

Source: Princeton Carbon Mitigation Initiative

Seven possible wedges (these are the easy ones!)

• Replace 1400 coal-fired plants with gas-fired plants• Increase fuel economy of 2 billion cars (30-60mpg)• Add twice today’s nuclear power to displace coal• Drive2 billion cars on ethanol (1/6 cropland for fuel)• Increase solar power 700-fold• Cut electricity use in homes, offices, stores by 25%• Capture the CO2 at 800 large coal-fired plants

Tools of the Trade: Economic Framework for Decision-Making

30Susan M. Capalbo

• Cost-Benefit Analysis• Commons sense: Benefits/costs > 1 (good) Benefits-costs >0 (good)• Can be measured in dollars: compares the value of costs vs. value of

benefits and clarifies trade-offs• Attempts to incorporate future costs and future benefits -- now

controversy sets in! • Need to compare benefits and costs that occur in different time periods• Like comparing price of hotel room in US and price of hotel room in Canada –

need exchange rate!

• Measuring "value of benefits" in dollars has its challenges: • Can we quantify the value of saving the Northern Spotted Owl?• Use value vs. option value and nonuse value

January 13, 2011

Tools of the Trade: Economic Framework for Decision-Making

• Discounting: • Future value (FV) of $100 at an interest rate of 10% = $110 in 1 yr, $121 in 2 years, $1,745 after 30 yrs

• Present Value: amt today that is equivalent to given amt in the future

• Example: PV of a promise to pay $100 one year from now is worth only $90.91 when r=10%. PV=$82.64 in two years when r=10% (drops fast!)

• Net Present Value:

• Compares future vs. present costs and benefits: future B and C are given less weight than present B and C

31Susan M. Capalbo January 13, 2011

Today vs. Tomorrow: Dealing with Irreversibility

• Uniqueness—some stocks cannot be replenished or substituted (coal, petroleum, clean air, etc.)

• Permanent loss of a particular stock is considered regrettable

• “Sustainable usage”—may involve protecting some unique stocks at the expense of others

32Susan M. Capalbo January 13, 2011

Risks: Dealing with Uncertainty

• Uncertainty versus variability? • Climate change, pollution costs, health impacts

• We deal with uncertainty all the time? (2013 is year of statistics)

• What will the world look like in 100 years?• What technologies will we have? Can they compensate for

current damages?

33Susan M. Capalbo January 13, 2011

Challenges to supersizing CBA: Example from Climate Change• Large changes – can we use prices to approximate value of the changes• Large amounts of uncertainty that cascades

• GHG concentrations and temp and climate patterns – inherently stochastic

• Resulting economic and social impacts

• Three important complications:• Costs and benefits are highly nonlinear (thresholds, tipping points) (invoke precautionary principle)• Irreversibilities

• Policies impose costs on society (investments in capture) – should we wait for better info

• Environmental damage is irreversible – GHG accumulate – many years to undo

• Long time horizons: What discount rate to use