How do you put a price on carbon?

The Department for Transport’s NATA Refresh consultation document highlights a range of issues surrounding the incorporation of environmental impacts into transport appraisal. Going forward, one of the key elements of standard appraisal will be the valuation of changes in carbon emissions at the Shadow Price of Carbon (SPC).

This is intended to encourage transport policy makers and planners to implement the most cost effective measures for reducing such emissions, and the SPC will no doubt become a standard component of the appraisal tool kit.

Few economists would argue with the need to price carbon emissions in transport policy and project appraisals, but what price should be used? Following the Stern Review of the Economics of Climate Change, DEFRA has recently published guidance indicating a value of £25 per tonne of CO2 equivalent, and a means of up-rating this value over time. However, as both Stern and DEFRA have acknowledged, this single value is just one estimate within a very wide range – one study has estimated the value at more than 10 times the DEFRA guidance while others have concluded that the price should be zero!

Observers could be forgiven for thinking that this is another case of economists failing, quite spectacularly, to agree, and it certainly highlights the difficulties that they and others have in reaching a consensus about the future. Two questions are of particular importance – assumptions about the long term stable level of carbon in the atmosphere, and the weight we put on the impact of carbon emissions experienced by future generations.

The long term stable level of carbon concentration matters because an extra tonne of carbon does more damage when concentration levels are high. Taking the lead from Stern, DEFRA based the price of carbon on a concentration of 550 parts per million of CO2e, the upper end of a range thought to represent a reasonable global target. The difficulty is that the actual stabilisation level will depend on what the rest of the world does, and a different level could mean a very different SPC.

The weighting of future carbon impacts is at least as important and, if anything, subject to even more debate. Controversially, Stern argued that there is no ethical justification for discounting impacts experienced by generations as yet unborn, other than to take account of the possibility that the planet may not survive. He therefore used a relatively low discount rate in weighting the future costs of carbon emissions, well below the standard social time preference rate of 3.5 per cent recommended in The Green Book. DEFRA has sought to square the circle by advocating a carbon price based on Stern’s approach, coupled with discounting of carbon impacts at The Green Book rate, although this has led to charges of inconsistency from the economics community.

At one level all this may sound like another esoteric argument between economists and others involved in the climate change debate, but in practice there is much at stake in transport policy terms. Given the substantial changes in carbon emissions that transport interventions can bring about, the way in which these changes are valued in transport appraisal will potentially have a major impact on the choice of projects taken forward. DEFRA economists have recognised that the debate is not yet over and plan to review the SPC in a year. In the meantime, it will be interesting to see whether £25/t CO2e really does make a difference.