Considering Risk and Uncertainty
in Designing
Climate Change Policy
Beyond Science: The Economics and
Politics of Responding to Climate Change
James A. Baker III Institute for Public Policy
Rice University
February 9, 2008
Mort Webster
Massachusetts Institute of Technology
Outline
• Motivation:
– Three public policy questions
• Framework for analysis:
– The MIT integrated assessment model
• Three analyses of uncertainty
– Long-term greenhouse gas targets
– Near-term greenhouse gas targets
– Regulatory design and cost-containment
Policy Questions about Climate Change
• What should be the long-term global
concentration/temperature stabilization target?
• What should near-term global targets be?
– Emissions reductions in the next few decades
• How should greenhouse gas emissions
regulation be designed?
– Instruments for cost-containment
MIT
IGSM
Global CO2 Emissions
(Deterministic)
Global CO2 Emissions (GtC)
25
No Policy
CCSP 750
CCSP 650
CCSP 550
CCSP 450
20
15
10
5
0
2000
2020
2040
2060
Year
2080
2100
Global Mean Temperature Change
(Deterministic)
Global Mean Temperature Change from 2000
5
4
No Policy
Stabilize CO2 at 750ppm
Stabilize CO2 at 650ppm
Stabilize CO2 at 550ppm
3
Stabilize CO2 at 450ppm
2
1
0
2020
2040
2060
2080
Global Mean Temperature Change
Uncertainty Global Mean Surface Temperature Change
Uncertainty
2000-2100
1.2
No Policy
Probability Density
1.0
0.8
0.6
0.4
0.2
0.0
0
2
4
6
8
Decadal Average Surface Temperature Change
(2090-2100) - (2010-2000)
10
Global Mean Temperature Change
Uncertainty Global Mean Surface Temperature Change
Uncertainty
2000-2100
1.2
No Policy
CCSP 750 Stabilization
CCSP 650 Stabilization
CCSP 550 Stabilization
CCSP 450 Stabilization
Probability Density
1.0
0.8
0.6
0.4
0.2
0.0
0
2
4
6
8
Decadal Average Surface Temperature Change
(2090-2100) - (2010-2000)
10
How Much Would You Pay to Spin
the 750 or 550 Wheels?
o
5-6 C
o
<2 C
o
4-5 C
>7oC
o
2-3 C
750ppm
Stabilization
o
6-7 C
2-3oC
o
3-4 C
o
3-4 C
o
5-6 C
o
3-4 C
>4oC
o
4-5 C
No Climate Policy
550ppm
Stabilization
2-3oC
<2oC
BUT…
Not the right way to think about this problem
• Decisions about GHG reductions are not onceand-for-all for the next century
• More useful to ask:
What should we do for the next few decades if
1) we are uncertain today, and
2) we expect to reduce uncertainty, and
3) we can revise policies later?
• Related Question:
– How much might we learn in 20 years? 30? 40?
Decision Under Uncertainty
with Partial Learning
400
Perfect Information
after 2100
Carbon Tax ($/ton)
300
Revised policy after
reducing uncertainty
200
Near-term hedging
under uncertainty
100
0
2000
2020
2040
2060
2080
2100
2120
2140
Summary: Effect of Learning on Policy
(2oC Temperature Stabilization)
100
Optimal Tax in 2015
90
80
70
60
50
40
30
2020
2030
2040
2050
2060
never
Time When Learning Occurs
Source: Webster, M.D., L. Jakobovits, and J. Norton (2008).
"Learning about Climate Change and Implications for Near-term Policy."
Climatic Change (in press).
Current U.S. Climate Policy Debate
• America’s Climate Security Act of 2007
– Senators Lieberman, Warner
• Low Carbon Economy Act of 2007
– Senators Bingaman, Specter
Cost-Containment in
the Proposed Bills
• Both have banking provisions
– Reduce more in initial years - not controversial
• What do we do if it costs more than we expect?
• Bingaman-Specter Bill
– Technology Accelerator Payment (Safety Valve)
• Lieberman-Warner Bill
– Borrowing (with some limits)
– Carbon Market Efficiency Board
Research Question
• Allocate emissions permits for 2015-2050
• What if the costs in the first period (2015)
are more than expected?
• Is it better to have a:
– Safety Valve
– Borrowing
– [Intensity Target]
Study Design
•
•
•
•
Forward-looking MIT EPPA model
Hypothetical emissions reductions
Temporary shock to carbon price in 2015
Compare four alternatives
– No Cost-Containment
– Borrowing
– Safety Valve
– Safety Valve with cumulative cap enforced
Compensated Safety Valve
• Chief objection to Safety Valve:
– Cumulative cap not enforced
– If cumulative emissions matter, this is a
problem
• Possible solution:
– Have a Safety Valve with preset trigger price
– If original cap exceeded, use automatic
formula to distribute reductions in future
permits
Impact of Banking
• Typical proposed emissions caps
– Start gradual, decrease sharply later
– Would induce net banking
• If you expect net banking
– No need for Borrowing or Safety Valve
• This analysis:
– Hypothetical path of emissions caps
– No net banking
Hypothetical Policy
3500
Hypothetical Emissions Reductions
No Emissions Reductions
CO2 Emissions (mmt C)
3000
2500
2000
1500
1000
500
0
2010
2020
2030
2040
2050
“Borrowing” defined
In this analysis, Borrowing:
• Is unrestricted (any year 2015-2050)
• Has no penalty or interest
• Performed with perfect foresight
Safety Valve vs. Borrowing
Under Uncertainty
• Monte Carlo simulation
– Uncertain shock to carbon price in 2015
– 1000 random samples
• Safety Valve
– Trigger price is constant across all shocks
– Initial guess:
• Expected (non-shock) carbon price
Uncertainty in Carbon Price in 2015
0.04
Probability Density
0.03
0.02
0.01
0.00
30
40
50
60
70
Carbon Price ($/ton CO2)
80
90
Uncertainty in Carbon Price in 2015
0.04
Only Consider
Higher Cost
Outcomes
Probability Density
0.03
0.02
0.01
0.00
30
40
50
60
70
Carbon Price ($/ton CO2)
80
90
Carbon Price in 2015
1.0
Cumulative Probability
0.8
0.6
0.4
No Cost-Containment
NoCost-Containment
Cost-Containment
No
Borrowing
Borrowing
SafetyValve
Valve
Safety
Compensated Safety Valve
0.2
0.0
55
60
65
70
75
80
Carbon Price in 2015 ($/ton CO2)
85
90
Uncertainty in 2015 CO2 Emissions
(Year of Price Shock)
1.0
Cumulative Probability
0.8
Emissions
Cannot adjust
To shock
Emissions
adjust
optimally
to each shock
0.6
Emissions
Over-adjust
To shock
(fixed trigger price)
0.4
No Cost-Containment
Borrowing
Safety Valve
Compensated Safety Valve
0.2
0.0
1106
1108
1110
1112
1114
CO2 Emissions in 2015
1116
1118
Uncertainty in Policy Costs
(Cumulative over 2015-2050)
1.0
Cumulative Probability
0.8
0.6
0.4
No Cost-Containment
always has
highest costs
Safety Valve
always has
lowest costs
Borrowing
slightly better
than
Comp SV
No Cost-Containment
Borrowing
Safety Valve
Compensated Safety Valve
0.2
0.0
-1.50
-1.45
-1.40
-1.35
-1.30
-1.25
-1.20
Welfare Change from Abatement (%)
-1.15
-1.10
Effect of Different Trigger Prices
under Uncertainty
• “REF” trigger price
– Expected (no-shock) carbon price
• Alternative trigger prices (relative to ref):
+15%,
+30%,
-30%,
-70%
Carbon Prices with Different Trigger
Prices
1.0
1.0
1.0
1.0
Cumulative Probability
Cumulative
Probability
Cumulative Probability
0.8
0.8
0.8
0.6
0.6
0.6
0.4
0.4
0.4
Borrowing
Borrowing
Borrowing
Borrowing
Borrowing
SafetySafety
Valve
(REF)
Valve
(-70%)
Safety
Valve
(-70%)
Safety
Valve
(-70%)
Safety
Valve
(-70%)
Safety
Valve
(-30%)
Safety
Valve
(-30%)
Safety
Valve
(REF)
Safety
Valve
(-30%)
Safety
Valve
(REF)
Safety
Valve
Safety
Valve
(REF)(REF)
Safety
(+15%)
Safety
ValveValve
(+15%)
Safety Valve (+30%)
0.2
0.2
0.0
0.0
0.0
0.0
00 0
0
20
20
2020
40
40
4040
60
60
60
6060
80
80
80
8080
Carbon
Price
in
($/ton
CO
Carbon
Price
in
2015
($/ton
CO
CO
Carbon
Price
in
2015
($/ton
CO
Carbon
Price
in2015
2015
($/ton
CO
22)2)2)) 2)
100
100
100
100
100
Mean Welfare Impacts
Compensated Safety Valve
Mean Welfare Change from Abatement
Relative to "Borrowing" Case (%)
0.00
-0.02
-0.04
“Too Low”
a trigger price
is the most costly
-0.06
-0.08
-0.10
Borrowing
SV (ref)
SV (+15)
SV (+30)
SV (-30)
SV (-70)
Summary
• Emissions reductions
– Consider policy as risk management tool
– Decisions are not once-and-for-all
– Uncertainty is not a reason to delay
• Regulatory design
– Want some form of cost-containment
– Safety Valve: costs less, abates less
– Compensated Safety Valve
• Can simulate borrowing
• Important to get the trigger price right
• Too low is worse than too high