September 16, 2013 U.S.

Department of Energy, Building Technologies Program Mailstop EE-2J, Room 1J-018 1000 Independence Avenue SW Washington, DC 20585-0121 EERE-BT-PET-0043 Re: The Social Cost of Carbon Kathleen B. Hogan, Deputy Assistant Secretary for Energy Efficiency, Energy Efficiency and Renewable Energy. Dear Ms. Hogan: The Social Cost of Carbon (SCC) is used by the Environmental Protection Agency (EPA) and other federal agencies to quantify the economic damages associated with a small increase in carbon dioxide (CO2) emissions over the course of a particular year.1 At Heritage, we believe that the calculations of SCC deserve thorough vetting, as they can have a significant impact on many environmental regulations. The integrated assessment models (IAMs) used for estimating SCC have several serious shortcomings. In particular, the loss functions of these models are often arbitrarily chosen, and we have yet to see any legitimate justification of these functions themselves. As the statistics estimated from these models are dependent on the models’ loss functions, such justification is important, as different loss functions will almost surely yield different results. There are also several other assumptions in these IAMs that demand rigorous examination: • Discount rates. From a theoretical perspective, the discount rate quantifies how much a society is willing to pay to prevent future damages. Thus, lower discount rates signify that future damages become more costly. The Office of Management and Budget (OMB) stipulates that any analysis should use a 7 percent discount rate as a base case, and a 3 percent discount rate could be used to show sensitivity to results.2 The Obama Administration, however, computed SCC based on 2.5 percent, 3 percent, and 5 percent

1

The official definition of the Social Cost of Carbon (SCC) is “an estimate of the economic damages associated with a small increase in carbon dioxide (CO2) emissions, conventionally one metric ton, in a given year,” and is discussed further in U.S. Environmental Protection Agency, “The Social Cost of Carbon,” http://www.epa.gov/climatechange/EPAactivities/economics/scc.html (accessed September 16, 2013).
2

U.S. Office of Management and Budget, “Circular A4,” September 17, 2003, http://www.whitehouse.gov/omb/circulars_a004_a-4/ (accessed September 16, 2013); Paul C. Knappenberger, “An Example of the Abuse of the Social Cost of Carbon,” Cato Institute, August 23, 2013, http://www.cato.org/blog/example-abuse-social-cost-carbon (accessed September 16, 2013).

discount rates. We believe that it would be worthwhile to estimate SCC assuming a 7 percent discount rate as well. Time horizon. The time horizon on which these IAMs are based is also an issue. Right now, SCC is calculated summing up damages up to the year 2300. Projecting accurate economic impacts decades into the future is difficult enough; it is sheer hubris to purport that the government can make meaningful projections centuries into the future. We therefore believe it would be far more realistic to estimate the model over a significantly shorter time horizon. Equilibrium climate sensitivity. Finally, although the Administration has updated its underlying economic/climate change models, it has not included any updates regarding the characteristics of equilibrium climate sensitivity (ECS). ECS is an important driver in determining the amount of climate change that will result from a particular amount of anthropogenic carbon dioxide emissions. Recent research has provided new distributional estimates of ECS that are important to use in IAMs.

We have begun to analyze the sensitivity of IAMs to the aforementioned assumptions by using the DICE model used by the U.S. Government Interagency Working Group to compute SCC in February 2013.3 Below are some preliminary results from one of five scenarios based on certain forecasts regarding economic growth, population growth, CO2 emissions, and non-CO2 forcings. A more comprehensive statistical analysis will be published shortly. [1] Discount Rates We estimated SCC using the DICE model. We re-estimated SCC for the 2.5 percent, 3 percent, and 5 percent rates the EPA has reported, as well as for the 7 percent discount rate suggested by OMB. Our results are below: Average SCC: Baseline, End Year 2300 Discount Rate: Discount Rate: 3% 5% $37.74 $10.60 $43.18 $12.79 $47.78 $14.66 $52.37 $16.53 $57.52 $18.71 $62.67 $20.88 $68.48 $23.42 $74.28 $25.96 $80.47 $28.78

Year 2010 2015 2020 2025 2030 2035 2040 2045 2050
3

Discount Rate: 2.50% $58.85 $66.23 $72.34 $78.44 $85.16 $91.89 $99.36 $106.84 $114.84

Discount Rate: 7% $4.79 $6.01 $7.04 $8.06 $9.28 $10.50 $11.94 $13.39 $15.03

W. Nordhaus, “The ‘DICE’ Model: Background and Structure of a Dynamic Integrated Climate-Economy Model of the Economics of Global Warming,” Cowles Foundation for Research in Economics, 1992. The EPA provided us with the MATLAB code to run the recent version of DICE used in this analysis but is not responsible for our results.

Not surprisingly, we see a markedly lower estimate of SCC assuming a 7 percent discount rate. [2] Time Horizon We also altered the end year of the DICE model in computing SCC. SCC calculations are based on summing damages over a particular time horizon. In particular, the EPA’s estimates are based on summing damages up to the year 2300. Below is our estimation of SCC based on summing damages up to 2150 instead of 2300: Average SCC: End Year 2150 Year Discount Rate: Discount Rate: Discount Rate: 2.50% 3% 5% $45.16 $32.02 $10.39 2010 $50.73 $36.56 $12.52 2015 $54.86 $40.10 $14.30 2020 $58.98 $43.64 $16.09 2025 $63.21 $47.39 $18.13 2030 $67.45 $51.15 $20.18 2035 $71.70 $55.05 $22.50 2040 $75.95 $58.96 $24.82 2045 $79.85 $62.66 $27.29 2050 And below are the resulting percent changes:

Discount Rate: 7% $4.78 $6.00 $7.01 $8.03 $9.24 $10.44 $11.86 $13.28 $14.86

Year 2010 2015 2020 2025 2030 2035 2040 2045 2050

SCC Percentage Changes as a Result of Changing End Year from 2300 to 2150 Discount Rate: Discount Rate: Discount Rate: Discount Rate: 2.50% 3% 5% 7% –23.26% –15.16% –1.98% –0.21% –23.40% –15.33% –2.11% –0.17% –24.16% –16.07% –2.46% –0.43% –24.81% –16.67% –2.66% –0.37% –25.78% –17.61% –3.10% –0.43% –26.60% –18.38% –3.35% –0.57% –27.84% –19.61% –3.93% –0.67% –28.91% –20.62% –4.39% –0.82% –30.47% –22.13% –5.18% –1.13%

As the above results indicate, changing the end year results in lower estimates of SCC, especially for lower discount rates.

[3] Equilibrium Climate Sensitivity We also changed the distributional assumptions of ECS. There are a number of recent studies offering more updated ECS distributions.4,5,6 We chose the distribution from the Otto et al (2013) study because it is closest in distribution to the ECS distribution that the DICE model currently uses. Additionally, 14 of the 17 authors of the study have been involved with the recent Intergovernmental Panel on Climate Change’s Fifth Assessment Report.7 Below are our results using their distributional assumptions: Average SCC: ECS Distribution Updated in Accordance with Otto et al 2013, End Year 2300 Year Discount Rate: Discount Rate: 3% Discount Rate: 5% Discount Rate: 7% 2.50% $22.42 $6.92 $3.34 2010 $34.10 $25.64 $8.31 $4.17 2015 $38.38 $28.42 $9.51 $4.86 2020 $42.02 $31.20 $10.71 $5.54 2025 $45.66 $34.37 $12.12 $6.36 2030 $49.76 $37.54 $13.53 $7.19 2035 $53.86 $41.11 $15.17 $8.15 2040 $58.41 $44.67 $16.80 $9.12 2045 $62.96 $48.63 $18.67 $10.24 2050 $67.94 The following are our percentage changes as a result of changing the ECS distribution: SCC Percentage Changes as a Result of Updating ECS Distribution in Accordance with Otto et al 2013, End Year 2300 Discount Rate: Discount Rate: Discount Rate: Discount Rate: 2.50% 3% 5% 7% –42.06% –40.59% –34.72% –30.27% –42.05% –40.62% –35.03% –30.62% –41.91% –40.52% –35.13% –30.97% –41.79% –40.42% –35.21% –31.27% –41.57% –40.25% –35.22% –31.47% –41.39% –40.10% –35.20% –31.52%

Year 2010 2015 2020 2025 2030 2035
4

M. Aldrin et al., “Bayesian Estimation of Climate Sensitivity Based on a Simple Climate Model Fitted to Observations of Hemispheric Temperatures and Global Ocean Heat Content,” Environmetrics, Vol. 23, No. 3 (2012), pp. 253–271.

5

N. Lewis, “An Objective Bayesian, Improved Approach for Applying Optimal Fingerprint Techniques to Estimate Climate Sensitivity,” Journal of Climate, 10.1175/JCLI-D-12-00473.1. A. Otto et al., “Energy Budget Constraints on Climate Response,” Nature Geoscience, Vol. 6 (2013), pp. 415–416.

6 7

Intergovernmental Panel on Climate Change, “IPCC Fifth Assessment Report (AR5) Authors and Review Editors,” July 23, 2013, http://www.ipcc.ch/pdf/ar5/ar5_authors_review_editors_updated.pdf (accessed September 16, 2013).

2040 2045 2050

–41.21% –41.07% –40.84%

–39.97% –39.86% –39.57%

–35.23% –35.29% –35.13%

–31.74% –31.89% –31.87%

These results indicate that changing distributional assumptions in accordance with Otto et al (2013) again results in a lower SCC estimate than initially believed. [4] Combining Different Changes to assumptions. The analysis in [3] was based on an end year of 2300 that we had previously suggested was unrealistic. Coupling changes to the ECS distributional assumptions with a more humble time horizon provides SCC estimates even further away from the EPAs original projections: Average SCC: ECS Distribution updated in accordance with Otto et al 2013, End Year 2150 Year Discount Rate: Discount Rate: 3% Discount Rate: 5% Discount Rate: 7% 2.50% $19.38 $6.80 $3.34 2010 $26.79 $22.12 $8.17 $4.16 2015 $30.10 $24.34 $9.32 $4.84 2020 $32.69 $26.56 $10.48 $5.53 2025 $35.28 $28.98 $11.82 $6.34 2030 $38.03 $31.39 $13.16 $7.16 2035 $40.77 $33.94 $14.68 $8.11 2040 $43.58 $36.48 $16.20 $9.06 2045 $46.38 $39.05 $17.88 $10.15 2050 $49.10 And once again, below are the percentage changes: SCC Percentage Changes as a Result of Updating ECS Distribution in Accordance with Otto et al 2013, End Year 2150 Discount Rate: Discount Rate: Discount Rate: Discount Rate: 2.50% 3% 5% 7% –54.48% –48.65% –35.85% –30.27% –54.55% –48.77% –36.12% –30.78% –54.81% –49.06% –36.43% –31.25% –55.02% –49.28% –36.60% –31.39% –55.34% –49.62% –36.83% –31.68% –55.63% –49.91% –36.97% –31.81% –56.14% –50.44% –37.32% –32.08% –56.59% –50.89% –37.60% –32.34% –57.24% –51.47% –37.87% –32.47%

Year 2010 2015 2020 2025 2030 2035 2040 2045 2050

These results are significantly lower than any of the results reported by the EPA. Our analysis here is only a subset of work conducted at The Heritage Foundation. More comprehensive analysis with other changes in assumptions will be published shortly. Regardless, our results suggest a significant amount of uncertainty in SCC computations due to sensitivity of assumptions, particularly the model’s time horizon, discount rate, and ECS distribution. Additionally, the FUND model shows net gains from global warming below three degrees, and the newer estimates of ECS project a warming level that has a high chance of falling in the range where warming has net benefits. We believe that these uncertainties, coupled with other issues (such as the sensitivity of the loss function) render SCC estimates virtually meaningless. As a result, the SCC estimates are unsuitable for regulatory cost-benefit analysis. Given these serious concerns, we request that the determination of values for the Social Cost of Carbon be revisited and reopened for public comment.

Sincerely,

Kevin Dayaratna and David Kreutzer, Ph.D.

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