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Lehman: climate change policy risks pricing carbon reduction too high

Lehman: excessive cost of carbon reduction will distort markets

21/09/07 – Climate change policy risks driving up costs of CO2 emission reductions by up to 130 times its optimal value if it does not use a price mechanism, according to the study “The Business of Climate Change II” by the investment bank Lehman Brothers, a follow up to a report published in February.

Dr Llewellyn, senior economic policy adviser and main author of the study, affirmed that “where the implicit cost of carbon is excessive, it is going to distort markets. This distortion will harm some companies, for example the car industry”, adding that “history teaches us that centrally planned economies tend to fail and that is why for regulation to produce the best results for society at the least cost, climate change policy will have to place the price mechanism at its core”.

The proposal by the European Commission to reduce new car CO2 emissions from the present level of around 160g to 120g of CO2 per kilometres prices carbon at up to $620 per tonne, the study found. Lehman values the reasonable societal costs of reducing CO2 today at $14 per tonne.

An earlier study from the research institute TNO, conducted for the European Climate Change Programme came to similar conclusions. Taking into account the price of technology and the fuel savings for consumers, the TNO institute set the societal costs of emission cuts through vehicle technology at between €132 and €233 per reduced tonne of CO2. This is up to ten times more expensive than similar or even more effective measures such as an increased use of biofuels and adopting an economic driving style.

Lehman Brothers add that their $620 per tonne figure represents the development costs of the technology required and is an up front figure on the cost of a new car. The study notes that many technologies are still under development, whose costs are uncertain and which value can so far only be guessed. According to TNO, the price of an average car will increase by around Euro 3600 when CO2 emissions from cars have to be brought down by 2012 to 120 gCO2/km, using vehicle technology only.

The Lehman study states that only price-based policies stand to direct resources efficiently to the reduction of greenhouse gases. Whereas policies that do not make use of the price mechanism generally do succeed in restricting carbon emissions, there is no guarantee that the cost of so doing will be anywhere near the ‘social’ cost. Not infrequently, the cost is much higher – sometimes by an order of magnitude or more. Calculation of the price of carbon implied by regulation-based policies should therefore be made systematic to avoid imposing an unnecessarily high burden on society.

The study also underlines that automobiles in Europe account for only 1.5% of global emissions and are the lowest-emitting in the world.  The industry has reduced European fleet average emissions from 186g CO2/km in 1995 to 160g CO2/km in 2006, and the sector must also comply with Euro 4 and 5 regulations with respect to toxic CO2, NOx and HC emissions (which increase CO2 emissions) and meet EuroNCAP safety standards, which include an increase in cars’ weight and, therefore, in their CO2 emissions.

Although, as claimed by the European Commission, increase in transport emissions (including trucks) rose by 32% from 1995 to 2005, this is primarily the result of a 2% per year growth in the number of automobiles in Europe; a 2% per year increase in miles traveled per car; and lower average driving speeds as a result of congestion, which exacerbates CO2 emissions. At the same time, the auto sector is important in the European economy, with the jobs of an estimated 12m employees depending on auto manufacture. The auto sector is also the largest investor in R&D in the European Union, spending €20bn per year.

http://www.lehman.com

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