When Starting with the Most Expensive Option Makes Sense: Optimal Timing, Cost and Sectoral Allocation of Abatement Investment

Abstract

This paper finds that it is optimal to start a long-term emission-reduction strategy with significant short-term abatement investment, even if the optimal carbon price starts low and grows progressively over time. Moreover, optimal marginal abatement investment costs differ across sectors of the economy. It may be preferable to spend $25 to avoid the marginal ton of carbon in a sector where abatement capital is expensive, such as public transportation, or in a sector with large abatement potential, such as the power sector, than $15 for the marginal ton in a sector with lower cost or lower abatement potential. The reason, distinct from learning spillovers, is that reducing greenhouse gas emissions requires investment in long-lived abatement capital such as clean power plants or public transport infrastructure. The value of abatement investment comes from avoided emissions, but also from the value of abatement capital in the future. The optimal levelized cost of conserved carbon can thus be higher than the optimal carbon price. It is higher in sectors with higher investment needs: those where abatement capital is more expensive or sectors with larger abatement potential. We compare our approach to the traditional abatement-cost-curve model and discuss implications for policy design. HighlightsThe same carbon price translates into different abatement investment costs in different sectors Sectors with higher emissions and more expensive abatement capital should invest more dollars per abated ton Abatement cost curves cannot be used to model abatement options that require investment in low-carbon capital * Corresponding author: Adrien Vogt-Schilb, avogtschilb@iadb.org, +1 202 623 2564Email addresses: avogtschilb@iadb.org (Adrien Vogt-Schilb), guy.meunier@ivry.inra.fr (Guy Meunier), shallegatte@worldbank.org (Stéphane Hallegatte) Preprint submitted to ElsevierNovember 10, 2017Keywords: climate change mitigation, transition to clean capital, path dependence, social cost of carbon, marginal abatement cost, timing JEL classification: Q54, Q52, Q58National governments committed to stabilize climate change to mitigate subsequent damages (G7, 2015; UNFCCC, 2016). This will require transitioning from an economy based on polluting capital, such as inefficient buildings and polluting cars, to an economy based on clean capital, such as retrofitted buildings or electric vehicles. A critical question for public policy is to determine the optimal cost and timing of such abatement investment. Is action as urgent as frequently advocated? A second important issue is the optimal allocation of abatement. There are many options to reduce greenhouse gas (GHG) emissions, from renewable power plants to improved building insulation and more efficient cars. Each of these options has a cost, and would reduce emissions by a certain amount. Should mitigation start with the least expensive options and progressively clean the economy by ascending cost order?To shed light on these questions, we study the optimal timing, cost, and sectoral...

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