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Cost of Carbon

 

The Cost of Carbon
2.5.80In July 2009, the English Department of Energy and Climate Change (DECC) published a paper entitled "Carbon Valuation in UK Policy Appraisal: A Revised Approach".  This document supersedes DEFRA's 2007 guidance on "The Social Cost of Carbon and the Shadow Price of Carbon: What they are, How to Use Them in Economic Appraisal in the UK". (Responsibility for Climate Change Mitigation Policy moved to DECC from DEFRA when DECC was created in October 2008).
2.5.81This guidance sets out a new approach to carbon valuation, which moves away from a valuation based on the damage caused by carbon to a valuation based on the cost of mitigation.  More precisely, the new guidance aims to set a valuation of carbon which reflects the cost of meeting EU and UK reduction targets in both the short and long term.  The intention is to enable more accurate and informed policy appraisal by taking account of the cost of carbon in all policies which are likely to increase or decrease emissions levels.
2.5.82The document presents a number of carbon prices to be used in appraisal.  In particular, a clear distinction is made between the carbon price applied to the traded and non-traded sectors.  For appraising policies that affect emissions in energy intensive sectors covered by the EU Emissions Trading System (ETS), the 'traded price of carbon' should be used.  Those sectors outside of this scheme should use the 'non-traded price of carbon'.
2.5.83In 2009, for example, the traded price is estimated to be £21/tCO2e in the central scenario, while the non-traded price is estimated to be £51/tCO2e.  This large variation in prices suggests the existence of much more stringent abatement targets for the non-traded sector at a UK level. Between 2030 and 2050 it is assumed that a global market in carbon will be in place and therefore after this date one price applies to all sectors. A separate, albeit, interim approach has been taken to estimating carbon values post 2050 and DECC has published a separate paper outlining the methodology behind these interim calculations.
2.5.84

DECC has undertaken to update the short term traded carbon values on an annual basis. The first of such updates was completed in June 2010. This short paper revised the short-term values downwards due to changes in a number of factors:

  • Lower economic growth has led to lower demand for electricity and carbon intensive products, reducing the overall level of required abatement;
  • More detailed research has identified that there are many more abatement options than previously thought; and
  • A number of minor adjustments.
2.5.85NI Departments should consider applying the appropriate carbon price in appraisals where there is a significant carbon impact. A suggested approach is to conduct a sensitivity analysis in order to separate out the impact of allowing for the costs of carbon i.e. calculate NPVs with and without the inclusion of the appropriate carbon price. The role of sensitivity analysis is explained more fully at 2.8.21 below.
2.5.86A copy of the July 2009 DECC paper together with a summary document which sets out a brief guide to the new carbon values and their use in economic appraisal, and updated carbon values can be found on the DECC Carbon Valuation Page on the DECC website.

Valuation of Energy Use and Greenhouse Gases
2.5.87In January 2010, HM Treasury and DECC jointly published additional guidance on the "Valuation of energy use and greenhouse gas emissions for appraisal and evaluation".  This guidance makes a number of practical recommendations for how changes in energy use and emissions levels should be valued in appraisal.  The guidance also presents a number of spreadsheets which can assist in such calculations.
2.5.88HM Treasury recommends that this guidance is used to help assess proposals leading to an increase or a reduction in energy use or Greenhouse Gas emissions.  On a practical level NI Departments should consider following this guidance in cases where there is expected to be a "significant" change in energy use or the level of Greenhouse Gas emissions.  As with the guidance on the valuation of carbon a practical suggestion is to apply this guidance as a sensitivity scenario in order to separate out the effects of the emissions and energy use.
2.5.89A copy of the January 2010 paper can be found on HM Treasury's detailed guidance page on their website.

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