How should we calculate the cost of carbon?

14 January 2015

Will Evison and Jonathan Grant comment on the recent estimate by Stanford University that the social cost of carbon is $220 - six times higher than the figure currently used by the US Government. 

Will Evison, PwC Assistant Director, Environmental Economics commented: "Estimates of the cost of climate impacts form the basis for calculating the social cost of carbon. Assessing these costs is challenging and subject to a range of assumptions and as a result estimates in the academic literature range from below zero to over $1,000 per tonne. The true figure is unknown but the US Government number of $37 is almost certainly on the low side. The Stern review, an influential UK study published in 2006, estimated the social cost of carbon at $86, and with inflation that figure would be even higher today. Much of the variation between estimates is driven by the discount rate applied but other factors are relevant, such as the climate model used and the approach to valuing damages."

He added: "When we measure total impact, we use a social cost of carbon of $87 per tonne of CO2. Rather than undertake our own study of the social cost from first principles, we analysed over 60 recent papers to derive our estimate - selecting values that meet a number of criteria, and taking an average. Recent higher estimates like the ones in the Stanford paper could well push our central estimate upwards when we revise it later this year."

Jonathan Grant, PwC director of sustainability and climate change said: "Clearly this is a complex issue for companies to grapple with. When talking to companies about measuring the total impact of their carbon emissions, rather than discuss what the ‘right’ social cost is, we spend most of our time explaining why the social cost is so different from the prices of carbon credits which, in the EU, currently trade at around $8."

“In theory, the market price of an EU Allowance should reflect the marginal cost of mitigating a tonne of CO2 given the current emissions cap.  In practice, the EU Emissions Trading Scheme isn’t working optimally, which is why today’s price is so low and there are efforts to reform the market.  But the market price and the mitigation cost of a tonne of CO2 are both fundamentally different from the social cost, which aims to represent the actual impacts of emitting that tonne."