A recent NBER working paper authored by Adrien Bilal of Harvard and Diego Känzig of Northwestern suggests that the “social cost of carbon” (SCC) is much higher than previously estimated. The new estimate of over $1,000 per metric ton indicates that carbon credits traded on Europe’s ETS market are undervalued by an astonishing 1347 percent. This article explains the difference between carbon price and carbon cost and emphasizes the importance of the SCC in the continued survival of our civilization.
Carbon dioxide is a chemical compound with indistinguishable molecules. The prices paid on carbon markets vary widely, depending on the market. There are two approaches to pricing carbon: “sticks” and “carrots.” Cap-and-trade systems are examples of “sticks” where regulators create mandates related to greenhouse gas emissions for large industries. Voluntary markets allow companies to pay for emissions above a self-imposed target. However, using carbon prices in these markets to determine the value of carbon can be confusing due to the differing prices.
Some carbon prices are set by government fiat as part of the “carrots” approach. The U.S. government offers tax rebates for carbon capture, with different values per ton depending on how the captured carbon is used. However, these prices do not reflect the true social cost of carbon, which represents the future damage to society caused by releasing CO2 into the atmosphere. The SCC is economists’ best estimate of this damage, discounted to the present value.
William Nordhaus, a renowned economist who won the Nobel Prize for Economics in 2018, estimated the SCC at around $47 per metric ton based on his DICE model. However, his model has been criticized for its assumptions and lack of consideration for potential tipping points and catastrophic outcomes of climate change. Bilal and Känzig developed a new model that estimates the real cost of each ton of CO2 emitted at $1,056 and suggests that society would be 37% better off without 50 years of warming.
Although Bilal and Känzig’s model has its limitations, it is seen as a more accurate estimate of the SCC compared to Nordhaus’ model. The potential consequences of a significant increase in global temperatures, such as mass extinctions and disruptions to food systems, highlight the need for a realistic cost of carbon that reflects the damage to society. Investors are encouraged to consider the true social cost of carbon, rather than relying on current market prices, which may not accurately reflect the risks associated with carbon emissions. Ultimately, understanding the difference between price and cost can have significant implications for the future of our civilization and the planet.
