Thursday, June 26, 2008

Key Issues for Policies on Climate Change

This paper was prepared by the BIIE Climate Change Policy Group in May 2008 to summarise a number of general issues the group believes should be considered by the new Committee on Climate Change: use of cumulative targets, urgency and the need for an indicative framework, and reliance on markets to deliver CO2 reductions.

The BIIE Climate Change Policy Group is a group of senior professional economists with an extensive collective experience in energy policy and the energy industries.
Our antecedents pre-date the Stern report, when we called for much greater attention to be paid to climate issues. We have previously endorsed the general recommendations of the Stern report, without necessarily an unqualified acceptance of every feature of its detailed analysis. We believe coordinated international action is essential, and that UK action can have an important role to play within a global strategy of “contract and converge”. We have been advocates of unilateral UK action on both exemplary and self-interest grounds, and we welcomed the Climate Change Bill and the creation of the Climate Change Committee (CCC). We have in the past submitted evidence to the Environmental Audit Committee and to the Joint Parliamentary Committee considering the Climate Change Bill.

In this note we wish to focus on a small number of general issues to which we believe the CCC needs to give consideration at an early stage in its deliberations. We have selected particular issues which we believe are important, under-emphasised and on which we believe our group has developed a particular and distinctive view:
  • Defining the right basis for UK and international targets for CO2 reduction – as essentially cumulative. Doing this also reinforces the general case for urgency of action.
  • What we have described as a “time-critical” approach - the value of developing an indicative framework by sector.
  • The balance of instruments available to Government – concerns about the ability of the present market and institutional framework to provide the necessary incentives and momentum for change.


The clear implications of the best available evidence from the climate science are that CO2 policies need to align with the global objective of preventing concentrations from reaching dangerous levels. This implies a focus, at the level of global objectives, on keeping cumulative emissions within “safe” limits. Targets for annual emissions in particular years are useful indicators of progress, but are ultimately of secondary significance, since they should be determined by, and should not obscure, the primary objective. This implies, potentially, more pressure for more demanding reduction regimes in the early years. It reduces the very serious risk of postponing necessary policy actions by making the consequences of poor early performance more transparent. This is reinforced by further practical and economic considerations.

First, as a matter of simple arithmetic, the shape of the path from the baseline to a given 2050 annual emission level has a very large impact on cumulative emissions over 43 years. To illustrate the point, a 60% reduction over 45 years can be met by a steady 2% pa reduction. However a 3.5% pa reduction for 20 years followed by a 1% pa reduction for 25 years yields the same annual emissions after 45 years, but a cumulative emissions total that is lower by the equivalent of 9 years emissions at the end of the period, loosely speaking “gaining” an additional 9 years of time.

Second, the undeniable primacy of cumulative emissions, implied by the climate science, means that a rational approach to the design of any international regime and its associated market mechanisms is also more likely to be based on cumulative emissions from a baseline, or on some cumulative measure of emission costs. This would allow carryover of emission rights/savings between time periods, and would place less emphasis on rigid annual numbers. It is hard to see how international agreement could be obtained for a scheme that ignored the inequities of very different national pathways to a single year target. Aligning national targets consistently with the shape and structure of future international regimes, including the ETS, will be essential.

Third, and contrary to an impression created, unintentionally, by the recent DEFRA report on the social costs of carbon, the economic damage attributable to emissions[1] is higher the earlier they occur. It follows that the economic calculus should in principle be weighted even more towards a front end loading of reductions than would be implied by a pure cumulative target, and certainly more than would be implied solely by an “end year” annual rate. It also follows that the advantage of measures to sustain early reductions is twofold. Early reductions reduce CO2 at the time when that reduction is of most value (in terms of reduced damage); assuming they can be sustained they also reduce emission in all future years. Larger early reductions, if they can be achieved and sustained, are disproportionately beneficial in reducing cumulative emissions, and hence in delaying adverse climate impacts and/or easing the pace of transition to low carbon in later periods. This is one of the factors supporting greater urgency. This should be reflected in the value attaching to early reduction in emissions, and in more emphasis on cumulative emissions as the primary objective.

Fourth the above considerations will assume much greater significance if, as part of the review of the 2050 target, policy is to be based on a UK contribution to limiting CO2 concentration to 450 ppm (rather than the 550 ppm adopted since the 2003 White Paper). Not only would allowable cumulative emissions to 2050 be significantly lower, but also, because of lack of progress over the last decade, much larger reductions are required over a shorter period, further strengthening the case for urgency.


Our approach emphasises “time criticality”. We believe that a focus on timescales, once targets are settled and clearly linked to a science based limit for cumulative emissions, is a key to embedding urgency into climate change policy. By working back from the answer, establishing feasible trajectories would help to illustrate not only the scope for progress within the first three carbon budgets but also the rate of progress required after 2020 to stay within the cumulative limit. This would focus attention on the most critical and urgent issues. Simple illustrations indicate, inter alia, the central importance of the power sector, and the rates of change necessary in transport or in heating of buildings to recover to a cumulative target after failure to reach White Paper targets.[2]

Implementation, as distinct from budget setting, must also address the issue of lead-times. Although effective short term measures are vital and should be maximised, their scope is limited and over the whole period to 2050 realistic solutions will entail the often protracted lead-times involved in removing sources of inertia and “barriers” to change, and in introducing low carbon technologies and systems, with associated changes in infrastructure, institutions and financial and economic frameworks.

Accordingly the successful implementation of any path of UK CO2 reduction by 2050, consistent with keeping global concentration levels below 450 ppm, (or such other target as may be agreed) will require rigorous scheduling of measures from now on. Given the starting point there will be frequent tension between the urgent need to accelerate emissions reduction, and the lead-times involved in taking effective action. This tension gives rise to time critical issues. We have argued elsewhere that each of the main sectors (power generation, transport and heating of buildings) should be analysed by the relevant Government departments to identify these time critical issues and to indicate the timing of key decisions and commitments and the main agents of change. We cannot see how sustainable progress on CO2 reduction can be made without this kind of time critical analysis on a rolling basis endorsed by Government and conducted throughout with emphasis on urgency and lead times, with explicit timetables for action. Such an analysis needs to become an integral part of the accountability process associated with carbon budgets.


We have a fundamental concern that, even if government objectives and carbon budgets are clearly linked to the urgency of the science, and even if time-critical analysis is effectively incorporated into the carbon budgeting process, the present market and institutional framework will not provide the necessary incentives and momentum for the rate of change that is required.

This would require a comprehensive survey of existing incentives, regulations and market structures to determine the extent to which they assisted or impeded the rate of reduction of CO2 emissions. The BIEE group intend to carry out work in this area, initially concentrating on some of the issues that will need to be addressed in the crucially important power sector.

The context is defined by the existing market and regulatory structure; this includes large incumbent private sector firms and smaller potential new entrants, and a regulatory authority historically and statutorily focussed on competition issues, price control (of monopoly sectors) and consumer protection. The economic instruments currently perceived as available to government in pursuit of CO2 related objectives are limited to what can be applied within this liberalised market framework. Essentially this means reliance primarily on emissions trading (EU ETS), with some targeted support to renewables or other low carbon capacity.

Some features of these market and regulatory structures may create the potential for market failure, and for outcomes that impede or frustrate policies geared to achieving early and substantial CO2 emission reduction. Particular concerns include the following:

  • the White Paper placed considerable emphasis on carbon trading within the EU ETS. However a carbon price from this scheme may not only be volatile but may reflect only the market’s short term view of the cost of abatement, rather than the value of long-term low carbon investment.
  • asymmetry between incumbent fossil generation and low carbon new entry in terms of the commercial risk associated with new capacity investment (separately identified by Anderson and Newberry); it arises from the fact that fossil plant costs continue to be the price setter over an extended period.
  • potential conflict between the acceptability of instruments within a liberalised market framework and the achievement of optimal outcomes; for example undue reliance on market and trading solutions will fail if other political imperatives such as fuel poverty constrain prices.
  • theoretically at least, the adoption of intermediate targets could lead to outcomes that are perverse in relation to the “true” overarching objective of minimising cumulative emissions; this could occur for example if targets were too loose, delaying investment, or too tight, with shorter term trading signals adversely affecting necessary longer term technologies by inducing “quick fix” solutions.

  • since there is no certain long term carbon price and since the private sector uses a discount rate which is well above the social rate of time preference, the private sector cannot be expected to take socially optimal decisions about the time critical sequencing of low carbon power sector investments (ie there is a market failure).
  • while the twin objectives of low carbon and security of supply may, in the long-run, be wholly compatible, there are likely to be short-term conflicts which cannot always be resolved in favour of carbon; ie security is the more immediately binding constraint
  • general concerns for investors about regulatory risk, and certainty about policy and market frameworks
  • the main regulatory bodies relevant to the power sector have consumer protection and competition policy traditions that do not necessarily sit well with policies that attempt to attach primacy to climate policy
  • market participants do not need to design strategies to cover the risks of overall policy failure; governments do.

For these reasons it seems imperative that the Committee will need to focus on market and regulatory frameworks to make sure they are delivering not just on annual targets but also on future investment on a timescale compatible with overall objectives.


The group hopes the above observations will be useful to the Committee, particularly in:

  • the review of the 2050 targets and the effect on carbon budgets
  • linking the carbon budgeting process to the corpus of measures required to achieve sustainable momentum for CO2 reduction

    BIEE Climate Change Policy Group. List of Earlier Papers.

    1. Bringing Urgency Into UK Climate Change Policy. Paper by the BIEE Climate Change Policy Group. December 2006

    2. Time Critical Pathways For UK CO2 Reduction. Supplementary Note by the BIEE Climate Change Policy Group. 27 February 2007

    3. Draft Climate Change Bill. Response by the BIEE Climate Change Group. 24 May 2007.

    4. Shaping Carbon Budgets. Practical Application of an Approach Based on the Notion of Time Critical Pathways. Mike Parker, John Rhys and Gordon Mackerron on behalf of the BIEE Climate Change Policy Group. 3 January 2008

    5. Observations on the Time Profile for the Social Cost of Carbon. Technical Note by John Rhys. April 2008.

[1] The PAGE model results, which underpin both the Stern review and the DEFRA work, make it clear that a tonne of CO2 emitted in 2008 does c. 1.0 % more damage than the same emission in 2009. See also John Rhys note on this subject.
[2] Reference earlier paper on shaping carbon budgets