The visible hand in economics

Cost of carbon

Posted on: September 5, 2007

No right turn has a good point about what the market price of carbon will be versus what the government is pricing it at.

As of May, the government is financing based on a carbon price of $13.21 per carbon ton (update CO2). This is ridiculous, when we see other New Zealand prices set between $33.75 and $70. In European market pricing carbon dioxide futures at over 20 euros.

Update: As carbon dioxide is only 27% carbon (thankyou wikipedia), in carbon terms the European futures price is approximately 74 euros per ton. However, I suspect that the govt. and market prices are for CO2 as well, implying that the price per carbon ton is $49 in Treasury estimates.

Whether you agree with the Kyoto protocol or not, we have to pay our Kyoto liability. What good is lying to ourselves about what the size of it will be. Hopefully government environmental policy uses the world price for carbon to make policy, instead of the Treasury price.

18 Responses to "Cost of carbon"

Why not assume the NZ trading prices are the silly ones? Treasury’s methodology is available at:

On the face of it it seems reasonable enough.

Note that:

Because New Zealand is not bound by the EU emissions caps (EU countries have their own emissions caps but are dealing with them in a single EU-wide ‘bubble’), the EU price is not appropriate for New Zealand – particularly because the EUA price is considerably more than what other Kyoto-compliant credits can be bought for. Simply using the EUA price as a proxy for the assumed price in the Crown’s carbon liability would therefore significantly over-estimate the cost of Kyoto compliance to New Zealand.

CPW, that is a fair point about the European price.

But if NZ businesses are pricing carbon at over $30 per carbon ton, why is the government pricing it so much lower? I would like to know where the government is going to buy carbon credits for $13.21 per ton, and what factors provide this low price. I suspect there is some significant upside risk to government forecasts.

The Treasury estimate is for 2007 emissions and is based on the EU emissions trading scheme (which New Zealand is not a part of). It is calculated purely for the purposes of calculating the Crowns future Kyoto liability. It takes the mid-point of three EU point prices, and is US$11.90 for 2007. It was about US$10.60 for 2006.

Estimates of future emissions unit prices vary wildly. The 20 Euro figure was the forward price at August for EU units in Decemeber 2008, and therefore is just as open to the criticisms Matt has of Treasury’s figure.

Estimating long-term GHG prices is an extremely difficult task because of uncertainty about the future. The value of future emissions units is a function of the future supply and demand for emission units in some future global market. The major future uncertainties are:
– The policy and regulatory framework for future global GHG emissions
– The level of a future emissions cap and where and when it applies
– The rate of technological progress and its diffusion and uptake across nations
– The global population and GDP growth and distribution.

Looking out to, say, 2030, estimates of the price vary between $1 and $1000. This exposes the problem with any price on emissions – with a tax the level of emissions reductions is uncertain, with cap and trade the price of emissions is uncertain.

I wouldn’t trust treasury as far as I could throw it

“As a result, an estimate of the cost of carbon credits is determined by a simple average of the World Bank midpoint point of USD 7.20 and the Point Carbon midpoint of USD 12.07 per tonne of CO2-equivalent. It is therefore an implicit assumption of this estimate that the Crown will purchase a portfolio of carbon credits, some cheap with high delivery risk and some expensive with low delivery risk”

By taking a simple average we are going to be right smack bang in the middle of the distribution. I don’t know about you guys, but given how small we are compared to the rest of the world it seams to me that the big players with more money will pick up the good credits before us, so we are more likely to be in the upper quartile of the distribution. Thus it would be prudent use a higher a price

I accept everything DT said about uncertainty, but given all the uncertainty wouldn’t we be better off overestimating the price the underestimating it?

I made a mistake in the Euro price by not reading the methodology. The European price is per carbon dioxide ton while the Treasury price is per carbon ton. The update has been put in the short blog post as Update.

I agree that there is significant uncertainty over the price of carbon, and I also agree with William that we should be over-estimating instead of under-estimating the price. Ultimately I think the price NZ businesses are charging is indicative of the sort of price that might be set up when we have a NZ trading market. The gap between the Meridian price and the price Treasury is estimating makes me a little nervous.

Been reading the Allen report which the carbon price is based on, and I think the Treasury price is for CO2 as well, I suspect that the Meridian price will be the same deal.

Why should we bias all our cost forecasts upwards? I don’t see this as an efficient practice in general, as it would mean that many socially desirable projects wouldn’t pass a cost benefit test.

If you want to make the case for the government running a surplus as a precautionary measure then fine, but this should be done by planning for a surplus with unbiased forecasts, not by high-balling all your cost estimates just in case.

Can we have biased forecasts for other policies we like? I predict tax cuts increase revenue! Whoopee.

I am a little busy to check, but most of these things are for CO2 equivelant. This means covering all greenhouse gases, the harm of which is expressed in terms of tonnes of CO2 emitted. Without getting too technical, methane (CH4) is about 21 times worse (for instance) per volume than CO2, so one tonne of methane is expressed as 21 tonnes CO2 equivelant. I would be surprised if a different methodology is used since Kyoto covers multi-gases.

In terms of trademe, that price means nothing. That is currently not trading on market fundamentals – like the Tana handbag, people are buying for symbolic reasons.

Ahh, my comment was stupid. I meant to say that it would be better to have an over-estimate than an under-estimate, not that we should blatantly over-estimate the value of carbon, sorry.

However, I’m still not sure that $13.21 will turn out to be the market price for carbon. Regulatory risk from countries allowing important industries to over-run carbon quotas will surely increase the demand for carbon once the government gets into trading. Why does Treasury use a point estimate instead of trying to work out underlying demand under different potential world regulatory environments.

I agree that the Trademe price is more symbolic than real, after all with a week to go they are at $100 a credit (for the 20 credit package). But there is some leeway between the two prices, and I’m not convinced that this mid-point valuation accurately represents what carbon prices will be.

I guess my primary note of difference is that I have a subjective belief that the carbon price will be higher than $13.21 when carbon trading is in full swing. I would welcome any information regarding the validity of this belief 😉

As an aside, if you think the NZ government (or world markets) are chronically underestimating the cost of reducing carbon emissions, this implies, all else equal, that we should be less willing to undertake emission reduction projects.

Yes, relative to the socially optimal price. However, we are still more willing to undertake emission reduction projects than we would if there was no price for carbon.

I wish we just had a carbon tax 😉

I wasn’t in anyway trying to say that in general we should bias ALL cost estimates upwards, I just think in this case taking the simple average would bias the estimated carbon price for new zealand down.

If we bias all costs down then socially undesirable projects would be undertaken…..


Agreed that it would probably go up. This of course is dependent on a number of factors – for instance we don’t even have a post CP1 (2013-) agreement, so there may be no cost of carbon from then on. This is the problem – we don’t even know what the system is going to look like beyond Kyoto, which is currently for 2008-2012.

If you are interested, the Stanford Energy Modelling Forum (probably the best modellers in this area) did examine this out to 2050 under some assumptions. The results were examined in a special issue of The Energy Journal which I can give to you to borrow. The figures vary wildly between the 19 models looked at, but the averages are rising well above the 2007 figure, but do so over time.

Ultimately the determinant of price will be affected by what national governments and international organisations deem that people will bear as a ceiling price. If it is $000’s then all of a sudden I think you will see targets revised.

The Treasury price is per ton of CO2. This is easily determinable as the quantum – 41.2 MT – is the amount of CO2-equivalent we are expected to exceed our Kyoto agreed allocation by.

EU prices are also per ton of CO2. Everyone uses it because its the agreed measure under the UNFCCC and Kyoto.

(And at this stage, I should also point out that I buggered up my maths, and that while householders seem willing to pay upwards of $80 / ton for offsets, bidding on the business package is only $10 / ton. Clearly, not enough NZ businesses feel they need to offset yet. I’m also suspicious that Meridian is double-dipping on its reductions; they were awarded Kyoto credits equal to their entire CP1 reductions by the government, and have sold them; these credits aren’t proper Kyoto credits, so are they for Cp1, pre-CP1, or what?)

The US sulphur dioxide market springs to mind as an anecdotal example where reducing emissions was ultimately far less costly than early forecasts and market pricing suggested. I’m loath to argue that the futures prices are likely wrong in one way or another, obviously there’s a pretty big profit to be made if you really believe that.

However if I had to take a punt I would cast this as a “peso problem” type situation. There is a non-negligible chance that carbon-trading regimes will collapse making your carbon credits worthless (I think the price already dived once when the EU gave out to many credits). Hence the market price may tend to track below the observed ex-post price if carbon trading regimes hold together.

Thats an interesting point Chris.

I always felt that when there is uncertainty, risk averse individuals require a greater return to make up for this uncertainty. As the return on carbon credits would be the capital gain in their value, I thought that the current price would be lower. Also the time value of money, when will carbon credits actually be required, if it is a fair way away then the current price would also be below the future liability.

I’m just not sure if taking a mid-point is the appropriate way to value a future liability. Then again, the scenario you have put forward is very convincing.

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