Guest post by David Middleton
Trump to Drop Climate Change From Environmental Reviews, Source Says
byMarch 14, 2017, 1:06 PM CDT
President Donald Trump is set to sign a sweeping directive to dramatically shrink the role climate change plays in decisions across the government, ranging from appliance standards to pipeline approvals, according to a person familiar with the administration’s plan.
The order, which could be signed this week, goes far beyond a targeted assault on Obama-era measures blocking coal leasing and throttling greenhouse gas emissions from power plants that has been discussed for weeks. Some of the changes could happen immediately; others could take years to implement.
It aims to reverse President Barack Obama’s broad approach for addressing climate change. One Obama-era policy instructed government agencies to factor climate change into formal environmental reviews, such as that for the Keystone XL pipeline. Trump’s order also will compel a reconsideration of the government’s use of a metricknown as the “social cost of carbon” that reflects the potential economic damage from climate change. It was used by the Obama administration to justify a suite of regulations.
Trump’s Secret Weapon Against Obama’s Climate Plans
Tom Pyle, president of the American Energy Alliance, a conservative, fossil fuel-oriented advocacy group, welcomed Trump’s comprehensive approach, calling it essential to undoing Obama-era climate policies that “permeated the entire administration.”
[…]
President Trump’s “secret weapon” is the discount rate…
How Climate Rules Might Fade Away
Obama used an arcane number to craft his regulations. Trump could use it to undo them.
by Matthew Philips , Mark Drajem , and Jennifer A Dlouhy
December 15, 2016, 3:30 AM CST
In February 2009, a month after Barack Obama took office, two academics sat across from each other in the White House mess hall. Over a club sandwich, Michael Greenstone, a White House economist, and Cass Sunstein, Obama’s top regulatory officer, decided that the executive branch needed to figure out how to estimate the economic damage from climate change. With the recession in full swing, they were rightly skeptical about the chances that Congress would pass a nationwide cap-and-trade bill. Greenstone and Sunstein knew they needed a Plan B: a way to regulate carbon emissions without going through Congress.
Over the next year, a team of economists, scientists, and lawyers from across the federal government convened to come up with a dollar amount for the economic cost of carbon emissions. Whatever value they hit upon would be used to determine the scope of regulations aimed at reducing the damage from climate change. The bigger the estimate, the more costly the rules meant to address it could be. After a year of modeling different scenarios, the team came up with a central estimate of $21 per metric ton, which is to say that by their calculations, every ton of carbon emitted into the atmosphere imposed $21 of economic cost. It has since been raised to around $40 a ton.
This calculation, known as the Social Cost of Carbon (SCC), serves as the linchpin for much of the climate-related rules imposed by the White House over the past eight years. From capping the carbon emissions of power plants to cutting down on the amount of electricity used by the digital clock on a microwave, the SCC has given the Obama administration the legal justification to argue that the benefits these rules provide to society outweigh the costs they impose on industry.
It turns out that the same calculation used to justify so much of Obama’s climate agenda could be used by President-elect Donald Trump to undo a significant portion of it. As Trump nominates people who favor fossil fuels and oppose climate regulation to top positions in his cabinet, including Oklahoma Attorney General Scott Pruitt to head the Environmental Protection Agency and former Texas Governor Rick Perry to lead the Department of Energy, it seems clear that one of his primary objectives will be to dismantle much of Obama’s climate and clean energy legacy. He already appears to be focusing on the SCC.
[…]
The SCC models rely on a “discount rate” to state the harm from global warming in today’s dollars. The higher the discount rate, the lower the estimate of harm. That’s because the costs incurred by burning carbon lie mostly in the distant future, while the benefits (heat, electricity, etc.) are enjoyed today. A high discount rate shrinks the estimates of future costs but doesn’t affect present-day benefits. The team put together by Greenstone and Sunstein used a discount rate of 3 percent to come up with its central estimate of $21 a ton for damage inflicted by carbon. But changing that discount just slightly produces big swings in the overall cost of carbon, turning a number that’s pushing broad changes in everything from appliances to coal leasing decisions into one that would have little or no impact on policy.
According to a 2013 government update on the SCC, by applying a discount rate of 5 percent, the cost of carbon in 2020 comes out to $12 a ton; using a 2.5 percent rate, it’s $65. A 7 percent discount rate, which has been used by the EPA for other regulatory analysis, could actually lead to a negative carbon cost, which would seem to imply that carbon emissions are beneficial. “Once you start to dig into how the numbers are constructed, I cannot fathom how anyone could think it has any basis in reality,” says Daniel Simmons, vice president for policy at the American Energy Alliance and a member of the Trump transition team focusing on the Energy Department. “Depending on what the discount rate is, you go from a large number to a negative number, with some very reasonable assumptions.”
[…]
This is worth repeating:
A 7 percent discount rate, which has been used by the EPA for other regulatory analysis, could actually lead to a negative carbon cost, which would seem to imply that carbon emissions are beneficial.
One of the most common ways of estimating the value of oil and gas revenue and reserves is called “PV10.”
PV10 is the current value of approximated oil and gas revenues in the future, minus anticipated expenses, discounted using a yearly discount rate of 10%. Used primarily in reference to the energy industry, PV10 is helpful in estimating the present value of a corporation’s proven oil and gas reserves.
Read more: PV10 Definition | Investopediahttp://www.investopedia.com/terms/p/pv10.asp#ixzz4bQb2uKyw
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We generally use a 10% discount rate when deciding how to allocate current capital.
A 3% discount rate, as used in the SCC calculation, essentially assumes that the time-value of money is insignificant. I suppose that since it’s OPM (other people’s money), the government doesn’t view the time-value of money as a particularly relevant thing.
OMB’s Whitewash on the Social Cost of Carbon
The “social cost of carbon” (SCC) is a key feature in the debate over climate change as well as the principal justification for costly regulations by the federal government. We here at IER and other critics have raised serious objections to the procedure by which the Obama Administration has produced estimates of the SCC.
Last summer I did a post on the GAO’s whitewash of our criticism, and now—just before the Independence Day holiday weekend—the Office of Management and Budget (OMB) has released its own whitewash.
There are several key points on which the Administration is obfuscating, but in this post I’ll focus just on the choice of discount rates. This one variable alone is sufficient to completely neuter the case for regulating carbon dioxide emissions using the social cost of carbon, so it is crucial to understand the controversy.
[…]
Why Do We Discount Future Damages?
Present dollars are more important than future dollars. If you have to suffer damage worth (say) $10,000, you will be relieved to learn that it will hit you in 20 years, rather than tomorrow. This preference isn’t simply a psychological one of wanting to defer pain. No: Because market interest rates are positive, it is cheaper for you to deal with a $10,000 damage that won’t hit for 20 years. That’s because you can set aside a smaller sum today and invest it (perhaps in safe bonds), so that the value of your side fund will grow to $10,000 in 20 years’ time.
In this framework, it is easy to see how crucial the interest rate is, on those safe bonds. If your side fund grows at 7% per year, then you need to set aside about $2,584 today in order to have $10,000 in 20 years. But if the interest rate is only 3%, then you need to put aside $5,537 today in order to have $10,000 to pay for the damage in 20 years.
An equivalent way of stating these facts is to say that the present-discounted value of the looming $10,000 in damages (which won’t hit for 20 years) is $2,584 using a 7% discount rate, but $5,537 using a 3% discount rate. The underlying assumption about the size and timing of the damage is the same—the only thing we changed is the discount rate used in our assessment of it.
Discount Rates in Climate Policy
Generally speaking, the climate damages that occur in computer simulations don’t begin to significantly affect human welfare in the aggregate until the second half of the 21st century. In other words, the computer-simulated damages need to be discounted over the course of decades and even centuries. (The Obama Administration Working Group used three computer models to calculate damages through the year 2300.) Thus we can see why the choice of discount rate is so crucial.
In its latest revision, the Working Group estimated that for an additional ton of carbon dioxide emitted in the year 2015, the present-value of future net damages would be $11 using a 5% discount rate, $36 using a 3% rate, and $56 using a 2.5% rate (see table on page 3 here). Yet when the media refer to these numbers as “the social cost of carbon,” it obscures how arbitrary the figures are. They can range from $11/ton to $56/ton just by adjusting the discount rate in a narrow band from 5% to 2.5%.
Violating OMB’s Clear Guidance
Fortunately, OMB provides explicit guidance (in the form of “OMB Circulars”) to federal agencies on how to select discount rates. Specifically, as we carefully explain on pages 12-17 of IER’s formal Comment, OMB Circular A-4 (relying in turn on Circular A-94) states that “a real discount rate of 7 percent should be used as a base-case for regulatory analysis,” as this is the average before-tax rate of return to private capital investment.
Now it’s true, Circular A-4 goes on to acknowledges that in some cases, the displacement of consumption is more relevant to assess the impact of the policy under consideration, in which case a real discount rate of 3 percent should be used. Thus it states: “For regulatory analysis, you should provide estimates of net benefits using both 3 percent and 7 percent” (bold added).
[…]
The current SCC is based on a moronically low discount rate of 3%. OMB guidance clearly states that “’a real discount rate of 7 percent should be used as a base-case for regulatory analysis,’ as this is the average before-tax rate of return to private capital investment.”
As 7% discount rate makes the SCC negative and would mean that carbon emissions are economically beneficial.
Conclusion
A “real world” discount rate zeroes out all of the economic benefits of carbon emission regulations. The simple application of a 7% discount rate to the social cost of carbon would falsify the EPA’s endangerment finding and obviate the agency’s court-imposed obligation to regulate CO2.
Reference
Nordhaus, William D.
Revisiting the social cost of carbon
PNAS 2017 114 (7) 1518-1523; published ahead of print January 31, 2017, doi:10.1073/pnas.1609244114
Addendum
As a default position, OMB Circular A-94 states that a real discount rate of 7 percent should be used as a base-case for regulatory analysis. The 7 percent rate is an estimate of the average before-tax rate of return to private capital in the U.S. economy…
https://www.transportation.gov/sites/dot.gov/files/docs/OMB%20Circular%20No.%20A-4.pdf
The whole notion of a social cost of carbon is a nonsense. For reasons peculiar to a US legal system it may be easier to tinker with parameters used than to discard the whole methodology. A potential damage from climate change? How much damage from climate change was there in any year in Obama years? The SCC has more to do with witchcraft than anything else.
Hey Seaice1,
It sounds like Stern wants to take known benefits away from future generations because he is afraid of unknown future risks associated with fossil fuels? No, thank you.
Similarly, the others you mentioned want slower growth for future generations because of unknown future risks?
Really, this analysis has faulty logic – begging the question. First, you assume low discount rate, then you deliver low growth rates because you enact policies based on that low discount rate. It’s a self fulfilling prophecy.
Idiocy!
Chris, you clearly have not understood. Even if you use the descriptive approach, which has no in-built ethical judgments, 7% is still too high. Nordhaus gets 4.4% using this approach.
Nordhaus’ Dec 2016 “PROJECTIONS AND UNCERTAINTIES ABOUT CLIMATE CHANGE
IN AN ERA OF MINIMAL CLIMATE POLICIES” uses two discount rates, 1.5% for welfare discount rate (intergenerational transfer) and 4.25% for goods discount rate.
The damage estimate is 0.236% loss in global income per °C squared with no linear term. That implies a tiny but negative impact from the ~1C warming we’ve already experienced. Show me the beef.
Dale S. the reason why the discount rate is important is because most of the damage is in the relatively far future. This is consistent with very little damage so far.
I never questioned the importance of the discount rate, just clarifying that Nordhaus used two different ones in his analysis.
The “where’s the beef” has to do with the damage estimate for warning-to-date. 0.236% per degree certain implies a net negative at +1C, but what I haven’t seen is anything resembling quality analysis that shows actual net negative impacts for +1C. CIA world factbook estimates 2015 was $75.73 trillion at the official exchange, if that’s 0.236% lower than it would be absent +1C warming, that’s a net negative of about $180 billion. I’d like to see a high quality paper quantifying the effects of the temperature and CO2 rise we’ve *already had*. I rather doubt it would demonstrate $180B in harm. Heck, even if you ignored the positive effects of warming and fertilization, I doubt $180B in damage could be demonstrated. (Unless you included the damages from money spent on climate change *policies*, in which case $180B is far too low.)
The illusion of technique….a book I read many years ago…
Is the discount rate they are using supposed to be real or nominal? In other words, are the future costs estimated in current dollars or in future dollars? It makes a big difference. Long term, real interest rates tend to be about one or two percent which justifies the sort of discount rate currently being used. Nominal interest rates are higher because they include an estimate of future inflation.
This is a hugely important issue. If the models to calculate future economic damage included some nominal inflation rate, then the discount rate should have added that in. SO if they assumed some cost inflation in the model the discount rate used should have been more like 9 and 5%.
The other thing to comment on is how to set the rate to use for discounting. In finance, there is the CAPM framework, which helps understand the value of an investment to a given firm. In social costs, there is not a solid theoretical framework for what the discount rate should be. It is pure seat of the pants, politically driven speculation. Sensitivity to discount rate is really important, but we shouldn’t pretend or assume accuracy or even relevance to any given number.
“’a real discount rate of 7 percent should be used as a base-case for regulatory analysis,’ as this is the average before-tax rate of return to private capital investment.”
David, I would say PV10 is being generous.
In general, when making project decisions, the greater the risks, the higher the discount rate you would apply.
In other words , for a sure thing / oil field investment, you might apply a PV10 . If there was risk associated with any aspect of the project, you would apply a higher discount rate, say PV12 or maybe PV15.
IF CAGW were an oil and gas deal & I was asked to do an economic analysis, I would apply something like a PV20, or even greater given the huge contradictions between the models and real world observation … which would say that the SCC is hugely negative / wildly uneconomic.
If CAGW were a prospect, I wouldn’t drill it even with your money because it would looks so risky & so uneconomic, given the facts at hand.
PV10 is generally used for revenue and proved reserves… P90 sort of numbers.
We are saying the same thing. CAGW & SCC by association are not “proved reserves” … more like a rank wildcat in an undrilled basin (by analogy) … thus not deserving even a PV10 assessment
David: Your post illustrates the importance of the discount rate to the social cost of carbon, but distorts and oversimplifies the problem.
Private business applies a discount rate of 10% to investment decisions because their cost of borrowed is far higher than for the government and because equity investors demand an even higher return to compensate for the risks they are running. The government can borrow money at a far lower rate which has historically averaged 3%. This is one of the Obama administration’s rationals for choosing 3%.
However, since most investments in energy infrastructure are made by private industry, the average citizen is charged far more than 3% (via a PUC, for example). If energy infrastructure were provided by the government, citizens would pay far more for the inefficiency of government operations.
The other factor that effects the discount rate is the wealth of our descendants who will suffer from the damage from warming. If we make the right choices today and grow our economy at even a modest rate, our descendants at the turn of the century are going to be far more wealthy than we are, especially in the developing world. They could be far more capable of adapting to climate change than we are of mitigating it today. The future economic growth rate enters in a formula called the Ramsey equation, used to calculate the discount rate in integrated assessment models like Nordhaus’s. The higher the economic growth rate, the higher the discount rate. Countries like India that are hoping to emulate China’s economic boom should use a higher discount rate. China horrendous pollution is a practical demonstration of thinking this way: The wealthy next generation can afford to clean up pollution that earlier generations were too poor to prevent.
Nordhaus discusses the discount factor and the Ramsey equation here:
http://www.econ.yale.edu/~nordhaus/homepage/stern_050307.pdf
The government isn’t borrowing money to pay for this. It would be imposing a cost on the private sector. This is why the OMB says…
They clearly say that this is not the appropriate measure for intergenerational transfers such as climate mitigation. You missed off the next bit:
”
“The 3 percent discount rate is based on a recognition that the effects of regulation do not always
fall exclusively or primarily on the allocation of capital. When regulation primarily and directly
affects private consumption, a lower discount rate is appropriate….
Discounting the welfare of future generations at 7 percent or even 3 percent could
create serious ethical problems.
An additional reason for discounting the benefits and costs accruing to future generations at a
lower rate is the longer the horizon for the analysis, the greater the uncertainty about the
appropriate value of the discount rate. Private market rates provide a reliable reference for
determining how society values time within a generation, but for extremely long time periods no
comparable private rates exist. As several economists (including Martin Weitzman9
) have explained, for the very distant future, the properly averaged discount factor corresponds to the
minimum discount rate having any substantial positive probability.
At the same time, some economists have cautioned that using a zero discount rate could raise
intractable analytical problems. They have argued that with zero discounting, even a small
improvement in welfare, if permanent, would justify imposing any cost on current generations
since the benefits would be infinite.
If the regulatory action will have important intergenerational benefits or costs, the agency might
consider a sensitivity analysis using a lower but positive discount rate, ranging from 1 to 3
percent, in addition to calculating net benefits using discount rates of 3 percent and 7 percent. ”
In other words, 3% would be appropriate, but even this misses out some important considerations, so maybe even lower than 3% is appropriate.
You have to read the whole thing to get the message, not just pick out the bit you like. It is quite clear that lower rates are favored for long term, intergenerational effects such as we are considering here.
It still says that 7% should be the base-case as the default position for regulatory analysis. The lower discount rates for “ethical” considerations are simply to see if the regulation can retain any positive NPV under those scenarios.
In the case of SCC, they never bothered to run the 7% case; much less use it as the base-case scenario.
and these economic models are superior to climate models in what way?
forget all that about the pinhead angels.
these are MODELS:
David: I did mentioned the cost of private capital as one possible discount rate. For a long time, I thought this was the most sensible discount rate. Unfortunately, OMB’s guidance is neither law nor the discount rate economists would recommend as optimal for the climate change issue (and inter-generational problem where future growth of the economy is a critical issue). I’m told the Ramsey equation has been proven mathematically to provide an optimum path for a given set of assumptions. Richard Tol, who criticizes the consensus more than he supports it, uses the Ramsey equation. The Nordhaus link has nice discussion of the issue and was written to criticize Stern’s arbitrary low discount rate.
What I personally find craziest is the hubris shown by people who think they know how to effectively spend money today to make the world a better place a century from now. Imagine someone in 1900 spending money in order to make our world today a better place. As the joke goes, an academic study of problem of horse manure predicted that major cities like New York City would be buried 10 feet deep in horse manure by 1925. The prediction turned out to be correct only for college campuses.
US Social Security will go broke about 2030, causing a 25% cut in benefits under current law. The rising cost of Medicare and Medicaid is a more intractable problem than SS. Unfunded pension liabilities drove Puerto Rico, Detroit and other cities into banruptcy and many other cities and states are vulnerable. Yet the Democrats believe poorly-understood climate change is THE critical issue that we must solve today, ignoring the intractable nature of global issues.
David: The worst problem in the Obama administration’s calculations is that they compare the worldwide benefit of US mitigation to the US cost of mitigation. This might make some sense if there were an effective world-wide binding agreement to mitigate and everyone made good on their commitments. Fat chance!
I vote 10% forever!
I know of no example of a regime that develops the country by accumulating money.
On the other hand, there are examples of development by realizing the opportunities / possibilities.
/ a country is supported by taxpayers able to pay taxes /
The science clearly shows that the earth is getting greener and that a major reason for this is increased CO2.
This represents a massive financial gain for the world. Can anyone estimate this gain in dollars?
This alone probably makes the ridiculous SCC negative.
Chris
Yes I can do that. At 200PPM vegetation is at stasis – that is there is zero net growth at 400 PPM we get 100% growth (as of today) so from that it follows that roughly 100%/200PPM = 0.5% of todays growth rate occurs for every PPM over 200PPM or stated otherwise 1% growth increase for every 2PPM, so one could say that yield improves around 1% for each 2PPM increase. Now CO2 is increasing at around 2PPM per annum yielding 1% per annum yield growth.in 2010 the World bank estimated Agricultural value at 2.81% of GDP $1.75T so combining these it follows that the increase in food yield is equal to 1% of that or 0.028 % of 2010 World GDP Per Annum. or That’s around 17.5B in 2010 to 122B (2010 dollars) per annum in 2016. An Expression for value in the year Y would be 17.5B x (Y-2009) or there about. This assumes that all the food can be consumed which is likely given the population is also increasing 1% per annum. The Total benefit from 2009 to 2016 of CO2 Enrichment is of the order $490 Billion.
I would like to comment david.
One of the biggest problems with the SCC is that it assumes that decarbonisation has no costs, that the alternative to fossil fuels has the same ongoing cost profile as fossil fuel. The problem is that this isn’t even remotely so. One could estimate the benefits fossil fuels by comparing the GDP of the world with the GDP of a theoretical world devoid of electricity, motor vehicles, electronics, modern communication. A world where ships still use sail and there is limited or no sewerage/ modern health care. This case is approximately the same as comparing GDP in 1850 with today (scaled for the extra people nowadays). Then there are the indirect costs of the mitigation – Lets assume mitigation is successful and CO2 is reduced to 350.orgs 350 PPM – this represents a loss of around 25% food yield that is being sustained by CO2 fertilisation. Take this away and not only do I lose 490B per annum in agricultural revenue but I drive the world into a famine – how is that risk of LOW CO2 Levels factored in?
There is no doubt that fossil fuels and therefore CO2 are extremely valuable to society and it is this inherrent value that must be exceeded by the alternatives. This is especially true given the state of much of the world is similar to Pre Industrial so much of the value from Fossil Fuels is yet to be earned. One has to assume that value will continue to be accumulated into the future.
I also have to point out that mitigation is a technological activity, activities based on technology do not follow the normal rules of inflation. For example an Airline flight from London to New York is significantly cheaper today (in real terms) than it was in 1970 simply because the technology improved. The Cost of Future mitigation is highly likely to be far less than the cost today. This suggests a higher discount rate is definitely required.
Finally mitigation costs are very likely to be inflated. In most cases they assume unmitigated damage rather than minimum cost mitigation. For example to deal with sea level rise it’s not appropriate to count the value of expensive coastal property that would be flooded rather I should estimate the cost to pile up dirt along the entire US coast which at $100000 a mile would cost only 8.8 Billion. That’s not counting discounts for cliff lines or uninhabited wetlands or uninhabited Alaskan coastline where no piles of dirt are required.
There is so much wrong with this metric but I think it’s worth it to calculate properly. A competent valuation of the total past/present/future societal benefit of fossil fuels against the total of minimum cost past/present/ future adaptation would be hugely positive, for thousands of years. It should be known because it would end the debate.
We should also consider land made more habitable from a more comfortable climate.
it’s clear from the comments above that this whole analysis needs re-examination, and some public comment on the results. A good task for the Pruitt administration – call a Conference on it, get both sides there, and issue majority and minority reports and whatever consensus can be hammered out. Make sure the (sometimes silly) assumptions in the current analysis are highlighted and countered as necessary. Also, make sure that realistic costs of implementation of the regulations, and costs to consumers in the future of these schemes are included in the analysis. Then let people decide.
Finally, in all of SeaIce’s arguments, he fails to acknowledge the meaning of “sensitivity analysis”. The reason 3% comes up as a counter to the standard 7% is that OMB is suggesting looking at various values, not to regulate based on them, but to see how much the calculations would vary at various rates. That’s what sensitivity analysis is all about – “how far off could my estimate be, and what would be the consequences if the central assumption is wrong?” It by no means excuses not doing the base (7% analysis) and pretending that 3% is the only reasonable solution. As SeaIce points out himself, 3% might not be an unreasonable number, but it’s clearly not the only number, and clearly not to be used in lieu of the standard number.
Taylor Pohlman. 3% is not the only number. There has been extensive debate about this and as yet no agreement on “the best” number, or even if there is a best number. Using a single number leads to contradictions, as described in the Arrow et al paper I posed earlier. In part it is because it is an ethical question about how we should value people not yet born, but even without that there is no agreement. However, those that think the value should be higher than 3% do not think those that think it should be 3% are moronic or fraudulent.
This is why I think your first point is a bit off. The debate has been and is sill going on. It does not so much need re-examination as it is being examined as we speak. However 7% is not the standard number for this sort of analysis . It is instead the upper bound of the social discount rate.
Longterm discounting is an ethical issue not yet resolved in public policy, and to pretend it is by dismissing the conclusions you don’t like as moronic or fraudulent is wrong.