Carbon Emissions
and Cost Benefit Analyses

32

Discussion Paper 2013 • 32
Svante Mandell

VTI Swedish National Road
and Transport Research Institute,
SwedenCarbon Emissions andCost Benefit Analyses
ITF/OECD 1st Session of the Working Group on

Assessment of Policies for Long-term Transition
to Sustainable Transport
Paris, 12-13 December 2013

Discussion Paper No. 2013-32

Svante MANDELLVTI Swedish National Road and Transport Research Institute
Linköping
SwedenNovember 2013

THE INTERNATIONAL TRANSPORT FORUM
The International Transport Forum at the OECD is an intergovernmental organisation
with 54 member countries. It acts as a strategic think-tank, with the objective of helping
shape the transport policy agenda on a global level and ensuring that it contributes toeconomic growth, environmental protection, social inclusion and the preservation ofhuman life and well-being. The International Transport Forum organises an annual
summit of Ministers along with leading representatives from industry, civil society andacademia.
The International Transport Forum was created under a Declaration issued by the Councilof Ministers of the ECMT (European Conference of Ministers of Transport) at its Ministerial
Session in May 2006 under the legal authority of the Protocol of the ECMT, signed in
Brussels on 17 October 1953, and legal instruments of the OECD.
The Members of the Forum are: Albania, Armenia, Australia, Austria, Azerbaijan, Belarus,
Belgium, Bosnia and Herzegovina, Bulgaria, Canada, Chile, People’s Republic of China,
Croatia, Czech Republic, Denmark, Estonia, Finland, France, Former Yugoslav Republic ofMacedonia, Georgia, Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Japan,
Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mexico, Republic of Moldova,
Montenegro, the Netherlands, New Zealand, Norway, Poland, Portugal, Romania, RussianFederation, Serbia, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey,
Ukraine, United Kingdom and United States.
The International Transport Forum’s Research Centre gathers statistics and conducts
co-operative research programmes addressing all modes of transport. Its findings arewidely disseminated and support policymaking in Member countries as well as
contributing to the annual summit.

Discussion Papers
The International Transport Forum’s Discussion Paper Series makes economic research,commissioned or carried out at its Research Centre, available to researchers andpractitioners. The aim is to contribute to the understanding of the transport sector and toprovide inputs to transport policy design.
ITF Discussion Papers should not be reported as representing the official views of the ITF
or of its member countries. The opinions expressed and arguments employed are thoseof the authors.
Discussion Papers describe preliminary results or research in progress by the author(s)and are published to stimulate discussion on a broad range of issues on which the ITF
works. Comments on Discussion Papers are welcomed, and may be sent to: International
Transport Forum/OECD, 2 rue André-Pascal, 75775 Paris Cedex 16, France.
For further information on the Discussion Papers and other JTRC activities, please email:itf.contact@oecd.org
The Discussion Papers can be downloaded from:www.internationaltransportforum.org/jtrc/DiscussionPapers/jtrcpapers.html
The International Transport Forum’s website is at: www.internationaltransportforum.org
This document and any map included herein are without prejudice to the status of or sovereignty over any
territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or
area.

CARBON EMISSIONS AND COST-BENEFIT ANALYSESTABLE OF CONTENTS

1. INTRODUCTION ................................................................................................. 5
2. POTENTIAL APPROACHES TO DERIVE THE CO2-VALUE ............................................ 6
2.1
2.2
2.3

Direct approaches ....................................................................................... 6
Indirect approach ........................................................................................ 7
Which approach to use? ............................................................................... 8

3. PRACTICAL IMPLICATIONS, PROBLEMS AND LIMITATIONS .................................... 11
3.1
3.2
3.3
3.4
3.5

Several policy goals are present at different levels ........................................ 11
Quasi-reductions occur over time ................................................................ 12
The interconnectivity between future permit prices and future climate policy .... 12
Several policy systems are present simultaneously ........................................ 13
Striving for transparency in the CBA ............................................................ 13

4. CONCLUDING REMARKS .................................................................................... 14
ACKNOWLEDGEMENT ........................................................................................... 15
REFERENCES ....................................................................................................... 18

Linköping, November 2013

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 20133

CARBON EMISSIONS AND COST-BENEFIT ANALYSESABSTRACTNew infrastructure projects may affect CO2 emissions and, thus, cost benefit analyses forthese projects require a value to apply for CO2. This may be based on the marginal social
cost of emissions or on the carbon price resulting from present and future policies. This
paper argues that both approaches are necessary, but for cost benefit analysis ofinfrastructure projects the latter should be the primary tool. A series of complications
arise when applying this principle in practice. These are discussed in the paper. Even if
the complications make the implementation of the approach difficult, we argue that it isstill preferable to a social cost approach.
JEL classifications; H54, Q51, R42
Keywords; Climate change, policy, cost-benefit analysis, carbon value

4

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

1. INTRODUCTION1

The issue of climate change has been high on the agenda for several years, and seems
likely to remain so for some time. Transportation is responsible for a large share of thegreenhouse gas emissions. In the EU almost 20% of the CO 2 emissions stem fromtransportation. The same is true for global emissions. In North America almost 30% of
the CO2 emissions originate from transportation, while the share is around 10% for Asia
(European Parliament, 2008). Investments in infrastructure projects, for example new
highways, high-speed railways, or airports, will potentially have an impact on thetransportation sector’s CO2 emissions. Investments like these are often preceded by costbenefit analyses (CBA). The present paper aims at discussing how expected changes in
CO2 emissions due to the investment in question are to be handled in the CBA. In
particular, the paper addresses principles behind what value to attach to a change in CO 2
emissions in a CBA framework. The discussion is primarily focused on CBAs in thetransportation sector but to a large extent it also applies to other sectors, e.g. energy orhealth.
In a guide on CBA prepared for the European commission, Florio et al. (2002, page 125)
defines CBA as a “conceptual framework applied to any systematic, quantitative appraisalof a public or private project to determine whether, or to what extent, that project isworthwhile from a public or social perspective. Cost-benefit analysis differs from astraightforward financial appraisal in that it considers all gains (benefits) and losses(costs) regardless of to whom they accrue.” Thus, CBAs need to consider factors that are
not dealt with – at all or in an incorrect way – by the market. CO2 emissions may serve
as a typical example to the extent that there, without any governmental intervention, will
not emerge a market for them. Such externalities are typically not addressed in afinancial appraisal, but should be addressed in a CBA as they constitute a loss (or a gain)
to people in the society.
The rest of the paper starts with a discussion of potential approaches to derive a CO 2
value applicable in a CBA. The two major options considered are a direct approach underwhich one tries to establish the social cost of emitting an extra tonne of CO2 and an
indirect approach where one derives the value through the (shadow) price necessary toreach the target underlying the CO2 policies. This discussion is brief as both approaches
have been addressed earlier, see for example Watkiss and Downing (2008), Pearce(2003) or Clarkson and Deyes (2002). Following the introduction of the approaches wewill argue that, given a set of assumptions, the latter is more suited for the purposes
addressed here, that is, to estimate a CO2 value for CBAs on infrastructure projects.
Having established this principle, and under which circumstances it is relevant, we turn insection 3 to a discussion about practical applicability, limitations and problems. Section 4
concludes.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 2013

5

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

2. POTENTIAL APPROACHES TO DERIVE THE CO2-VALUE

One can think of several ways to establish a CO2-value suited for use in a CBA. We focus
our attention on two distinctly different, though highly related, approaches; the social
cost of carbon and the induced price of carbon policy. These two approaches seem to be
the most widely discussed. The former may be viewed as a ‘direct approach’ and thelatter as an ‘indirect approach’. In this section, the background of these two approaches
will be given a brief presentation followed by a discussion on their applicability in a CBAsetting.
2.1

Direct approaches

The marginal social cost of carbon (SCC) is the cost one additional unit of carbon, in theform of CO2, into the atmosphere will cause the society as a whole. There are inparticular two complicating matters: First, it is not the flow, but the concentration of CO 2
in the atmosphere that affects the climate. Second, CO2 remains in the atmosphere forlong periods. To calculate the damage for each future period, one needs an assumption
regarding the path of future emissions, a baseline, to compare to. The SCC is the present
value of the monetized damage caused each period of emitting one extra tonne CO2
today as compared to the baseline. Calculating the SCC typically requires, so-called,
Integrated Assessment Models (IAMs). These models aim at combining theunderstanding we have about the natural mechanisms behind climate change with
monetized benefits and costs and thereby arrive at guidelines for optimal policy now andin the future.
In recent years, several studies reporting SCC estimates using different IAM:s andvarious settings have been published. Figure 1 exhibits a histogram constructed using
data from Tol (2008) which looks at 211 SCC estimates from 47 studies 2. The meanvalue is $104.80 per tonne C ( €19.70 per tonne CO2)3, but the distribution is skewed so
the median is considerably lower; $29 / tC ( €5.45 per tonne CO2). The estimates range
from -$6.60 per tonne C4 ( €-1.24 per tonne CO2) to $2400 per tonne C ( €451 per
tonne CO2). The middle 50 per cent of the estimates are found within the range of $10 to$90 / tC ( €1.88 to €16.92 per tonne CO2).

6S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

Figure 1. Histogram of 211 SCC estimates from 47 studies

Source: Based on data in Tol (2008).
The fact that the SCC is hard to estimate is in itself not a reason to dismiss these direct
approaches. Even less is it a reason to ignore the problem by applying a zero value. As
noted by Pearce (2003, p.3); “If there is uncertainty about a social cost estimate, that
uncertainty does not magically disappear by not adopting the social cost estimate”. Evenso, the large spread in estimates serves as an illustration of the difficulties in finding theCO2 value to apply in a CBA.
2.2

Indirect approach

The indirect approach takes its starting point in that existing policies create a cost perunit of emission for the regulated agents. This cost may be more or less difficult toobserve. In some cases it is a rather straightforward exercise to at least arrive at areasonably precise (marginal) cost estimate. In particular this is the case when theregulation is either by the means of an emissions tax or a by a tradable permits schemethat establishes a market clearing price for the permits. Both in the case with an(homogeneous) emissions tax and a well-designed emissions trading scheme5, the tax or
the resulting permit price will be a good measure of the marginal abatement cost in theeconomy. This follows from the fact that the agents have incentives to reduce theiremissions up to a point where additional reductions would cost more than paying the tax
or covering the emissions with permits.
As noted, for instance, by Clarkson and Deyes (2002) and Pearce (2003), to use thepermit price as a proxy for the social cost of an additional unit of CO 2 emissions is notwithout problems. In particular, this is due to the circularity in that the approach relies
on political decisions which put a price on emissions, but information regarding the
expected social costs is required for the policy maker to make the decisions.
To some extent, the circularity may be avoided by studying marginal abatement costs
associated with reaching a given target. This approach is, for instance, used by the UK
Department for Energy and Climate Change, DECC (2009). It takes its starting point inranking potential measures according to their (marginal) costs and then derives the CO2value from the last measure required to reach a given target. For our purposes, there is
S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 2013

7

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

no need to make a strong distinction between these two approaches. In the former, thepolicy will induce a price that is high enough to reach the given target. In the latter, thegiven target requires a certain series of measures to be taken – the cost of the last ofthese establishes the induced price. These two prices would, under standard assumption,
be the same.
The indirect approach is also associated with large uncertainties, even though thesearguably are substantially smaller than those surrounding the direct approach; see Dietz
and Frankhauser (2010).
2.3

Which approach to use?

That it is not obvious which approach to use is illustrated by the diversity of ways inwhich different countries handle the problem. Oddgard et al. (2005) provide an overview
of practices in the EU’s Member States. Since 2005 a series of important policy changes
has been implemented, most notably the EU ETS is now up and running, which
presumably has led to some Member States changing their approach6. In 2005, only athird of the EU’s Member States stated that they included greenhouse gas emissions in
the CBA. Finland, The Netherlands and Italy used a damage cost approach, i.e. somekind of direct approach. Austria, Germany, Sweden and Switzerland used the cost of
avoiding emissions, i.e. an indirect approach. Even though the authors note thedifficulties in comparing values between nations, it is apparent that the values differ
significantly. Germany applied the highest value per tonne CO2, more than six times
higher than the value applied in Denmark, which is the lowest (205 and 32 €/tonne CO2,
respectively).
The UK is an interesting example. According to Oddgard et al. (2005) they did notinclude climate change in their CBAs in 2005. Clarkson and Deyes (2002) argue that the
UK should use a direct approach. The UK Department for Energy and Climate Change(DECC) (2009), however, proposes a revised approach which takes it stand in calculating
the marginal abatement cost for reaching a given target, i.e. an indirect approach. The
latter approach has been adopted in the UK and is now used in practice.
It is worth noting that for countries that do not have a climate policy with quantitative
targets as the EU, the indirect approach becomes less useful. The US, for example,
adopts a SCC approached based on series of IAM studies, Greenstone et al. (2011).
The principle behind CBA is that all resources required for a project should be accounted
for in the analysis. This includes resources for which there is no market. This seems tofavour the direct approach; the value to be attached to CO2 reductions (or increases) in a
CBA is the social cost of carbon because it would provide a direct estimate of themonetized damage. This is also a conclusion drawn in some other studies, for instance
Clarkson and Deyes (2002). There are two major problems with this approach. First, as
noted above, there are huge uncertainties in several dimensions involved partly due to aseries of scientific issues that are yet to be resolved. Second, the social cost of carbon
approach does not take the existence of policy measures into consideration, which we
subsequently argue that a valid approach should.
The first is in itself not a reason to discard the social cost of carbon approach. As a CBAof the kind we are interested in here is forward-looking, basically all values in it will be
subject to uncertainty. The value attached to CO2 may be more uncertain than manyother values. This does not imply that the social cost of carbon approach is wrong, onlythat it is harder – from the great range of estimates conducted – to decide on which
8

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

value(s) to use in the analysis and that the uncertainties must be dealt with in theanalysis. There are several ways, from the range of estimates, to derive a single value,
or at least a small number of values.
Ultimately, we expect the policymakers, at least partially based on the scientific findingsin the field, to weigh different interests towards each other to arrive at a policy, forexample an emissions tax system or a tradable permit approach, which incorporates the‘political’ social cost of carbon. This includes taking future generations’ wellbeing into
consideration, weighing the utility of different groups towards each other, forming a
judgement on the impact from low probability/high cost events to name but a few of awhole list of highly complex issues calling for attention.
A consequence of this view is that both approaches are necessary. The direct approach –the social cost of carbon estimates – is an input to a policy process which, as an output,
will result in a policy and consequently a (shadow) price, i.e. a marginal cost associatedwith meeting the policy target. This marginal cost may be interpreted as a manifestation
about the political cost of carbon. Once the policy maker has established a policy, thismust be taken into consideration when deciding on the value for the CBA. Thus, the factthat there currently – and probably also in the future – exists policies geared towards
CO2-emissions will influence the CO2 value applicable in a CBA. In practice, these policies
often contain numerous different and interdependent instruments. We will return to thisin the next section.
To frame the discussion, we start by considering two stylized cases. Either a majority of
the global CO2-emissions are covered by a homogenous emissions tax or by a cap-andtrade regime. In the former case, using some other valuation than the tax would lead toefficiency losses due to a lack of cost effectiveness. If the value applied in the CBA islarger than the tax, the resulting reductions in emissions could have been achieved at alower cost somewhere else in the economy 7. Even if an internationally harmonizedcarbon tax has several appealing features, it is associated with a series of problems
making it a less likely candidate for future policies, see Pearce (1991), Pizer (2002) andBohm (1997).8
The latter stylized case entails an agreement specifying an upper limit of emissions fromthe participating parties. To facilitate cost effectiveness, parties may trade in emission
permits. What would then be the implications of an investment in infrastructure that,say, results in that people commute by train rather than by cars? The most important
thing to note is that total emissions are not affected as these are fixed through thepermit trading scheme. The main consequence of the investment lies in that otheremitters do not have to reduce their emissions to the same extent as without the
project9. That is, what in the absence of a trading scheme would have been emission
reductions is now rather a reallocation of abatement efforts in the economy. Let us referto reductions in emissions that are caused by the project, but countered through thetrading scheme, as ‘quasi-reductions’. As reducing emissions is costly, the quasireductions are associated with a value corresponding to the costs other emitters would
have had in the absence of the project. That is, if emissions are covered by a tradable
permit scheme, any quasi-reductions in CO2 emissions generated by a project should bevalued at the market price for emission permits, since the permit price reflects themarginal cost of abatements which now are avoided. Thus, in order to correctly capture
the effects of the project, the CO2 value used in the CBA should be equal the (shadow)
price generated by climate policy.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 2013

9

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

Implicitly, this assumes a hierarchy in policy decisions in that the CBA, and thus thedecision regarding investing in the particular infrastructure project, depends on the
climate policy decision. It is important to note that this discussion relates to what CO 2
value to apply for CBAs of measures not directly related to climate policy, but rather
measures like investments in new infrastructure. Pearce (2013) makes the point that if
one derives the value from a policy measure and then uses that value to evaluate thesame measure, this will always justify the policy. Thus, the indirect approach to derive aCO2-value is clearly not a good approach to evaluate climate policy. However, a crucial
circumstance here is that we do not want to evaluate, say, an infrastructure investment
as a climate policy measure. What is important, to avoid cost ineffectiveness, is toevaluate the investment given the climate policy already in place.
As an example, Ortega et al. (2013) assesses the benefits and costs associated withinvestments in Spain. They conclude that on-shore wind and small hydro, but not solar
technologies, typically generate benefits in excess of the costs. When assessing themonetary benefits associated with reduced CO2 emissions they use a SCC approach(using values from Tol (2012)). In the light of the discussion above, this may result inincorrect conclusions. The reason is that Spain’s electricity sector is a part of the EU ETS,
so any reduction in CO2 emissions from investing in Spanish renewable electricity will
reallocate the abatement burdens – i.e. someone else in the system may now abate less.
The value of this does not depend on the SCC, but on the costs saved by those otheremitters. The value of these costs on the margin is given by the EU ETS-price, i.e. theprice induced by the climate policy.10

10

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

3. PRACTICAL IMPLICATIONS, PROBLEMS AND LIMITATIONSGiven a tradable permit scheme, the discussion above suggests that the problem israther straight-forward; the permit price should be used in the CBA as it reflects thevalue of the reallocation of abatement efforts following from the project. Applying thissimple principle to a real life situation is not without problems. In the following we willaddress some of these.
3.1

Several policy goals are present at different levels

It is currently the case that there are several different CO2 related policies working atdifferent levels of the society. Climate change is a global problem, and the localisation of
CO2 emissions is not important for its impact on the climate. Thus, at the top of thehierarchy would be a global agreement and the targets specified therein. The closest we
currently have to a global agreement is the Kyoto protocol. At a level below this there are
multinational agreements such as the EU’s climate policy. At the time of writing, thefuture for a global climate policy is uncertain. The EU has declared that their target willremain. Below these there are national policies. Currently, all of the above are based on
quantity targets, even though there is room for flexibility, e.g. through trade in emission
permits11.
There are often different goals for different sectors on a given level. For instance, thehousehold and transport sector within a given nation may face different CO 2 targets. For
each of these levels and targets we may, at least in theory, derive a shadow price. Most
likely these shadow prices will differ between the different levels. So, which value should
be used in the CBA? A starting point is to use the ‘closest’ binding target. That is, if the
project affects transportation and there is a specific binding CO2 target for the transport
sector, disregarding what policy instrument is used to reach it, the shadow pricefollowing from the target is the relevant one if it binds. However, if the target in thetransport sector is not stringent enough to fulfil the national target the latter must be
associated with a higher shadow price. We may view the different levels as a chain oftargets. If different targets apply at different levels, so will the resulting shadow prices.
By choosing a CO2 value which answers to the highest shadow price of the chain, no
target will be violated.
There is currently no tradable permit scheme in operation that directly targets
transportation and thus no permit price directly paid by participants in the transportation
sector. Rather, CO2-emissions from the transportation sector are primarily regulated
through taxes, if at all. The discussion above implies that what is crucial is that there is aquantitative overarching (binding) target, e.g. the Kyoto protocol or the EU’s climate
policy. If emissions from transportation are too large, i.e. larger than the sector’s target,some other sector must decrease their emissions or additional permits must bepurchased in order to meet the overarching target. In either case, this incurs a cost,which should be considered in the CBA.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 201311

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

3.2

Quasi-reductions occur over time

Project such as the ones discussed here are long-lasting. As a consequence, they will
have an impact on CO2 emissions for many years to come. Thus, we need to estimate theCO2 values valid in the future. That is, the values created by future (quasi-)reductions.
For infrastructure projects, the relevant values are future shadow prices in thetransportation sector. Even if this sector will not be subject to a trading scheme, we haveargued that the overarching target, which probably will remain being expressed inquantity terms, is important. Thus, the future permit prices carry some information about
the induced prices in the transportation sector, as these will reflect the then prevailing
marginal abatement cost in the overarching economy.
A starting point for estimating these prices would be to look at the futures market for
permits. Most likely this will not reveal the prices actually valid in the future – but, aslong as the market is functional, it provides information about the market’s ‘best guess’.
The futures market for EU ETS permits shows that prices are rather volatile and that
contracts valid further into the future cost more. The latter indicates that the market
believes that the European climate policy will remain and perhaps even be more stringent
in the future12. One needs to keep in mind that many of these markets are currently notvery transparent.
Thus, the values used in CBA should change over time in accordance to what the policy
induced price is believed to be at different points in the future. A good illustration of how
difficult this is may be found in the current situation on the EU ETS-market. The EUcommission (2012) noted in their report “The State of the European Carbon Market in2012” that there is a substantial surplus of allowances on the market. Furthermore, thesurplus is growing and is estimated to peak under 2014 at volume of ~2700 Mt CO2,
(Neuhoff et al., 2012). The commission has suggested potential measures to tackle theproblem, e.g. implementing a stricter target, incorporate additional sectors in the ETS
etc. It is however far from clear which measures, if any, will be implemented. Obviously,
the future price will depend on what will happen and, thus, so should – according to thediscussion above – the CO2-value used in the CBAs. The market’s beliefs about theoutcome are already capitalized into the market prices. However, if the EU reaches adecision on how to handle the problem (if at all) this will likely have a strong and rather
immediate impact on the EU ETS-price13. Even if it is clearly difficult to handle such priceshifts in the CBA-process, this is not an argument to adopt the SCC-approach. A practicalway forward may be the approach the UK uses which specifies an increasing path overtime for the CO2-value, DECC (2009). The path may be calibrated with some interval if
new information becomes available.
3.3 The interconnectivity between future permit prices and future climate policy
A complicating matter from a CO2 value perspective lies in the interconnectivity between
future permit prices and future climate policy. A policy maker concerned with efficiency
would allocate a number of emission permits to the market such that the expectedmarginal abatement costs, which corresponds to the expected price, equals the expectedmarginal benefit from abatement. If the marginal abatement costs are reduced, thepolicy maker would typically reduce the number of permits thereby making the(overarching) system more stringent. Thus, even if the emissions are fixed through thetrading scheme in the shorter run, in the longer run the scheme will be calibrated and the
project may influence this calibration.

12

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

Even if a single project has negligible impact on future climate policy, there is an
important observation to be made in that future calibrations of the trading scheme
probably will dampen the fluctuations in permit prices. If, for instance, a new technologythat makes abatement much cheaper is introduced, permit prices will drop ceterisparibus. As the optimal response from the policy maker then is to set a more stringent
target (than if the new technology had not been introduced) the price drop will at least
partly be countered. Note that this applies to innovations in the transport sector as well,even when it is handled through taxes. A decrease in transport sector emissions, given atax, creates room for further emissions from other sectors without violating theoverarching target and, hence, there are incentives to make the target more stringent.
3.4

Several policy systems are present simultaneously

Most of the discussion above relies on a setting in which emissions from any given
sector, e.g., transportation, are regulated through one single mechanism. However, in
real life there are often multiple instruments in use simultaneously. There may becircumstances under which this is justified, Bennear and Stavins (2007) and Mandell(2008).
The large number of different instruments makes it particularly difficult to achieve an
overview of the system. Thus, deriving a CO2 value for CBAs becomes even more
complicated. With respect to the discussion above, there is a particular problem present
in the different tradable permits and taxes being in place in that they point towards
different values. To an extent this is a similar problem as the vertical levels discussed
above, and the guidelines are the same – one needs to consider what the value of aquasireduction is in the particular setting. This value may differ between if the project
influences emitters subject to, say, EU-ETS as compared to a non-trading EU sector astransportation14.
3.5

Striving for transparency in the CBA

The CO2 value applied in the CBA should capture the value of changes in (quasi-)
reductions of CO2, nothing else. This is of particular importance, because the sole
purpose of a CBA is to provide transparent information regarding whether or not to
conduct the project in question. As a consequence, it is desirable that CO 2 policies thatare partly motivated by, say, increasing the incentives for technological progress, arelabelled as such in the CBA and not as general CO2 policies. Of course, this applies to thepolicies as such – but given their existence, it may prove useful trying to disentangle thepure CO2 emissions motivated part from other “hidden” motives, as to protect thecompetiveness of domestic industry, to induce further technological progress, toinfluence emissions that covary with CO2 emissions, or to provide an example for othernations to follow, to name but a few. All such other effects may be important, but hidingthem in a CO2 price fits badly with the primary purpose of conducting a CBA.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 201313

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

4. CONCLUDING REMARKSThis paper contains a discussion about underlying principles of importance when deciding
on a value to apply on CO2 emissions in CBAs. Even though the discussion has been
focused on CBAs for infrastructural investment it is applicable on projects in othersectors, but not on CBAs on climate policies. The first question addressed is whether thevalue should be based on the social cost of carbon, being the discounted social damage
caused by a unit of emissions, or on a shadow price created by present and future
policies.
The discussion may be summarized in two claims. Firstly, as long as science can only
provide a range of estimates of the (marginal) social cost of CO 2 emissions, choosing
which value to apply is ultimately a task for politicians/policy makers. This is not an
uncontroversial claim as one may argue that, say, a group of scientists are more likely toarrive at a value close to some true – but unobservable – value. Secondly, the choice ofvalue to put into the CBA should not ignore existing and future policies. Given the type of
CBA we address, the second claim would seem to be less controversial than the first.
From this we conclude that the question is not which approach, direct or indirect, should
be applied. Rather, both approaches are required, but at different stages of the process.
The social cost of carbon is necessary to provide input to the political process. This
process will, as an output, provide a set of policies and this set is what generates theinduced prices, which provides the base for the CO2 value in the CBA. This conclusion
stands in contrast to some earlier studies, for instance Clarkson and Deyes (2002).
However, it is in line with HEATCO’s (2005)15 recommendations but, interestingly, fordifferent reasons. In HEATCO it is argued that the induced price is a second best
approach as the social cost of carbon – which would be the first best – is not observable.
We argue that the CO2 value shall be derived from existing and future policies,
disregarding whether or not the social cost of carbon is observable. To a large extent ourconclusions are also in line with those of the UK’s department of energy and climatechange, DECC (2009). The main difference is that DECC uses the marginal abatement
cost resulting from a given target, i.e. not directly the resulting price from a given policy.
The advantage with that approach is that it avoids the circularity inherent in using theCO2 value when evaluating climate policy. For project CBAs this is not a problem. Rather,
directly using the prices induced by the policy assures that the evaluation is aligned withthe overarching climate policy. However, the two approaches (abatement cost or induced
policy price) should result in the same value, at least as long as the standard
assumptions for a functional market apply.
We have also argued that under an overarching quantitative target, in contrast to anemissions tax approach, the first, and more controversial, claim is basically not required
to arrive at the conclusion above. The reason is that quantitative target keeps theaggregate emission level fixed. Consequently, also the aggregate damage will be fixed
and whether or not the regime is designed using the ‘correct’ social cost of carbon or not
has no impact on the CBA’s CO2 value. Transportation emissions (not international air or
maritime) are covered by the EU’s climate target and, thus, subject to an overarching
14

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

quantitative constraint, as is the case in other countries with binding Kyoto obligations.
However, there is currently no transportation sector directly regulated through a tradable
permit scheme and, hence, no permit prices that directly reveals the carbon price in thetransportation sector. Thus, the relevant price must be derived from the policies aimed
towards the sector’s CO2 emissions.
Having established a principle applicable in a stylized setting, we devote the remaining
paper to problems and limitations when applying the principle in practice. We conclude
that there is a whole series of complications that may occur, including permit markets
that are far from transparent, several different instruments that capture different aspectsof a CO2-value, multiple policies present simultaneously.
One main conclusion from this second part of the paper is that it is difficult to establish a
CO2-value to apply in CBAs for infrastructure projects. However, this should not be taken
as a reason to abandon this approach in favour of a social cost of carbon approach. The
principles put forward are still relevant, even if they are hard to apply.

ACKNOWLEDGEMENT

Financial support from the Swedish Road Administration is gratefully acknowledged. The
paper has benefitted from suggestions by Fredrik Hansen, Elisabet Idar-Angelov,
Roger Pyddoke, Björn Carlén, Jan-Eric Nilsson, and two anonymous referees.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 201315

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

NOTES

1.

This discussion paper is an updated version of Mandell (2011).

2.

Tol (2005, 2008) examines these studies in more detail, for example by comparing
peer-reviewed with non-peer-reviewed studies, and more recent studies with older
ones.

3.

The conversion uses $1 = €0.69 and that one unit CO2 weighs 3.67 times one
unit C.

4.

Negative values are due to an initial positive impact on crops etc. For higher
concentrations this is reversed.

5.

That is, one which keeps transaction costs low, does not result in that any agentsreceive market power, and provides transparent information to the market etc.

6.

To the best of my knowledge, there is no more recent review of current practices
published.

7.

Consider a project with one single effect; to decrease emissions by one unit and that
this project just passes a CBA test when evaluated using a CO2 value larger than theCO2 tax. It would then have been less costly to decrease emissions by one unit
somewhere else in the economy (the cost for this equals the tax). Thus, using avalue for evaluating the project that differs from the marginal cost induced by thepolicy leads to investments that are not cost effective.

8.

Noteworthy, there are recent studies that argue the problems with international andharmonized taxes may be avoided, see Nordhaus (2007) and Cooper (2008).

9.

If the project is large enough, permit prices will decrease. In practice, it is hard to
think of a project of such a large scale that it has anything but a negligible impact on
the permit price.

10. In this particular case, the SCC chosen is close to the EU ETS price, and thus thequalitative results would still hold.
11. For instance, the EU-15 reduced its greenhouse gas emissions by 8%, compared to1990, in the period 2008-12. Sweden has a national target of reducing emissions by
4%. In both cases, some of the reductions may be achieved by purchasing emission
permits or conducting projects outside the EU.
12. The latter observation is not necessarily the case as higher prices in the future may,for instance, be due to the discount rate, cf. Hotelling’s rule.

16

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

13. That the market reacts strongly when uncertainties are resolved may be illustrated
by the way EU ETS prices dropped from around €4.50 to around €3 when theEuropean Parliament voted against backloading on April 16, 2013.
14. It is worth repeating that this may be an indication of a sub-optimal policy mix, butthat there may also be reasons, e.g. differences between the sectors’ risk for carbon
leakage, that may justify price differences. See, e.g. Mandell (2010).
15. HEATCO strived to develop Harmonised European Approaches for Transport Costing
and Project Assessment and was financed by the 6th Framework Programme.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 2013

17

SUMMARY & CONCLUSIONS: RECENT TRENDS IN CAR USAGE IN ADVANCED ECONOMIESREFERENCES

Bennear, Lori Snyder and Robert N. Stavins (2007), Second-best theory and the use ofmultiple policy instruments, Environmental Resource Economics, 31, 111-129.
Bohm, Peter (1997), Designing Efficient Treaties to Protect the Global Environment, in:
Claude Jeanrenaud (Ed.), Environmental Policy Between Regulation and Market,
Birkhäuser Verlag, Basel, pp. 155-170.
Clarkson, Richard and Kathryn Deyes (2002), Estimating the Social Cost of Carbon
Emissions, DEFRA, Government Economic Service Working Paper 140.
Cooper, Richard N. (2008), The case for charges on greenhouse gas emissions,
Discussion paper 2008-10, Harvard Project on International Climate Agreements,
Cambridge, Mass.
DECC (2009), Carbon valuation in UK policy appraisal: A revised approach, Climate
Change Economics, Department of Energy and Climate Change, July.
Dietz, S. and S. Frankhauser (2010), Environmental prices, uncertainty, and learning,
Oxford Review of Economic Policy, 26(2), pp. 270-284.
European Parliament (2008), An overview of global greenhouse gas emissions andemissions reduction scenarios for the future, Note, IP/A/CLIM/NT/2007-7, PE
400.994.
Florio, M., U. Finzi, M. Genco, F. Levarlet, S. Maffii, A. Tracogna and S. Vignetti (2002),
Guide to cost-benefit analysis of investment projects, Prepared for the European
Commission.
Greenstone, M., E. Kopits and A. Wolverton (2011), Estimating the social cost of carbon
for use in US federal rulemakings: A summary and interpretation, NBER Working
Paper 16913.
HEATCO (2005), Deliverable 5, Proposal for Harmonised Guidelines, Second revision,
heatco.ier.uni-stuttgart.de
Mandell, S. (2008) Optimal Mix of Emissions Taxes and Cap-and-Trade, Journal ofEnvironmental Economics and Management, 56, 131-140
Mandell, S. (2010), “Steering the European transport greenhouse gas emissions under
uncertainty”, Journal of Transport Economics and Policy, 44(1), 1-16.
Mandell, S. (2011), “Carbon Emission Values in Cost Benefit Analyses”, Transport
Policy,18(6), 888-892.
Nordhaus, William D. (2007), To tax or not to tax: alternative approaches to slowing
global warming, Review of Environmental Economics and Policy, 1, pp. 26-44.
18

S. Mandell — Discussion Paper 2013-32 — © OECD/ITF 2013

CARBON EMISSIONS AND COST-BENEFIT ANALYSES

Oddgard, Thomas, Charlotte Kelly and James Laird (2005), Deliverable 1, HEATCO Work
Package 3: Current practice in project appraisal in Europe, www.heatco.ier.unistuttgart.de
Ortega, M., P. del Río and E.A. Montero (2013), Assessing the benefits and costs ofrenewable electricity. The Spanish case, Renewable and Sustainable Energy
Reviews, 27, pp. 294-304.
Pearce, David (1991), The role of carbon taxes in adjusting to global warming, The
Economic Journal, 101, pp. 938-948.
Pearce, David (2003), The social cost of carbon and its policy implications, Oxford Review
of Economic Policy, 19(3), 362-384.
Pizer, William A. (2002), Combining price and quantity control to mitigate global climatechange, Journal of Public Economics, 85, pp. 409-434.
Tol, R.S.J. (2005), The marginal damage costs of carbon dioxide emissions; anassessment of the uncertainties, Energy Policy, 33, 2064-2074.
Tol, R.S.J. (2008), The social cost of carbon: Trends, outliers and catastrophes.
Economics, The Open-Access, Open-Assessment E-Journal, 2, 1-24.
Tol, R.S.J. (2012), A cost-benefit analysis of the EU20/20/2020 package, Energy Policy,
49, pp. 288-95.
Watkiss, P. and T.E. Downing (2008), The social cost of carbon: Valuation estimates andtheir use in UK policy, The Integrated Assessment Journal, 8(1), 85-105.

S. Mandell, Discussion Paper 2013-32 — © OECD/ITF 201319

International Transport Forum
2 rue André Pascal
75775 Paris Cedex 16
itf.contact@oecd.org
www.internationaltransportforum.org