Dual discounting in forest sector climate change mitigation Hanne K. Sjølie Greg Latta Birger Solberg Forest sector modeling workshop Nancy, France May 31, 2012

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Outline  Discounting in climate policy analyses / forest sector  Hypothesis  Model  Results  Discussion 2 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Basis for discounting  Social opportunity costs (SOC): Costs of capital  Social time preference (STP): –per capita economic growth (g), –the elasticity of marginal utility of consumption (η) and –pure time preference (“impatience” of individuals) (p) –STP = g×η + p  ”Should be” the same, but differ due to i.a. taxes, externalities, information 3 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Discounting in climate policy analyses  The discount rate is very important in climate policy analyses  However, among scientists there are large disagreements regarding the magnitude of the discount rate as well as the rationale of the appropiate rate  Ex. Stern Review and the following debate:  The Review advocates for strong, rapid mitigation action as the benefits of action greatly exceed the costs  The conclusions diverge from many other economic assessment of climate policies  Moreover, “the difference stems almost entirely from its technique for calculating discount rates and only marginally on new science or economics” (Nordhaus, 2007, p. 201).  The Review used a discount rate of 1.4% 4 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Low and dual discount rate  Stern (and many others) use arguments as ethics / intergenerational equity as arguments for using a low discount rate  Discounting environmental and non-environmental goods likewise is based on the assumption of perfect substitutability  Kula and Evans (Kula, E., Evans, D., Dual discounting in cost- benefit analysis for environmental impacts. Environmental Impact Assessment Review 31, 180–186) argues for the use of dual discount rate: One for monetary values and a lower for carbon  Their argument being as the scarcity of environmental values increases with economic growth, such values should not be included in the economic growth part of the STP 5 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Dual discounting in forestry  Kula and Evans compare the NPV of a forestation project in Nothern Ireland using hyperbolic discount rate starting at 3.5% for all values with a dual discounting scheme where monetary values discount rate starts at 3.5% and carbon at 1.5%  The NPV of the project is negative with the single discount scheme and positive with the dual 6 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Hypothesis Do the results of Kula and Evans hold in all kinds of carbon mitigation projects in forestry? More specifically, do the results hold in projects with an initial carbon stock? Or could a low discount rate lead to initial harvests being offset by later carbon sequestration to a higher degree, thereby leading to less short-term carbon sequestration? Hypothesis: When having initial carbon stocks, a lower discount rate on carbon yields less CO 2 emission reductions in the short run 7 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Analysis 8 Dual discounting in forest sector climate change mitigation Using a partial equilibrium model of the Norwegian forest sector Carbon discount rates: 0%, 2%, 4%, 6% and 8% Monetary discount rate: 4% Carbon price: 12.5 €/ton CO 2 eq Discount rate and carbon price are constant over the horizon

NORWEGIAN UNIVERSITY OF LIFE SCIENCES 9 The forest sector model for Norway NorFor Demand for final products (county) Forest growth, management: Biomass supply (9000 NFI plots) Forest industry Sawnwood (county) Pulp, paper and boards (mill) Bioenergy (county) Trade (counties + 2 foreign regions) Decay, machines Growth Transport Substitution, storage Combustion Processing Demand GHG Forest growth, management: Biomass supply Forest growth, management: Biomass supply Demand Forest industry Trade Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES NorFor  Perfect foresight  Rational agents: consumers, industry, forest owners  Elasticity of foreign supply: 0.8 (logs), 5 (products)  Elasticity of foreign demand: -0.8 (logs), -5 (products)  20 5-year periods run, 19 analyzed 10 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Impacts on harvest 11 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Investment in forestry 12 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Industrial production 13 Dual discounting in forest sector climate change mitigation Decline in the long run Increase in the long run Only marginal impacts with discount rate >= 4%

NORWEGIAN UNIVERSITY OF LIFE SCIENCES GHG fluxes 14 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES GHG fluxes 15 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Discussion  Not discounting carbon yields lower GHG emission reductions in the short term but considerably higher in the long term  Carbon price harvest is below Base levels for all periods with a single discount scheme  Short-term harvests are higher with zero carbon discount rate than in both Base and 4% carbon disccount rate but considerably lower in the long run  Future carbon sequestration offsets early harvest to a higher extent with low carbon discount rate  Much more investments in forestry with low discount rate  Large shifts in industry with low carbon discount rate as NPV of substitution effects becomes relatively larger than producer surplus  Leakage is substantial particularly under low carbon discount rate but direction of results still hold with fixes trade levels 16 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES Discussion  Discounting carbon less with the aim to allocate more resources to climate change mitigation does not necessiraly yield the desired results  Main difference from the Kula and Evans study is the initial carbon stock  Important to test a new scheme on a varity of assumptions  Basic assumption of dual discounting: non-substitutable goods  Instead of dual discounting, future scarcity of environmental goods can be reflected in increasing prices – but prices can be difficult to assess due to lack of markets  Discounting in models: Market observations or policies or ethical judgements? Versus other parameters in the models 17 Dual discounting in forest sector climate change mitigation

NORWEGIAN UNIVERSITY OF LIFE SCIENCES 18 Thank you!