Time for All Hands on Deck

“The power of the price system to change behavior is incredibly effective, so when we impose a significant price on carbon emissions they will decline dramatically.”

Bob Litterman, a recognized expert on risk management, expressed strong confidence in the power of pricing carbon to reduce carbon emissions – but we need to get price incentives now.

The forum for Litterman’s presentation was an August 28 webinar on “Managing Risk by Pricing Carbon” sponsored by PriceonCarbon.org and the League of Women Voters.

Litterman described four lessons from risk management: 1) We have to think about worse case scenarios*. 2)  Time is a scarce resource – and we don’t know how much time we have. With climate change, every year that passes without a price on carbon the problem grows and there is a deadweight loss to society. 3) We need to find the appropriate pricing of risk.  Investments in the energy sector’s future require confidence that we’ll price climate risk appropriately. 4) There is a difference between managing uncertainty and measuring risk.

We are actually managing the uncertainty of the effects of climate change. We measure risk as the Social Cost of Carbon (SCC); estimates for SCC range from about $40 to over $200 per ton of CO2e. With poor confidence in risk measures, we must err on the side of caution, which means a high price. “It’s hard to justify a price lower than $100/ton,” Litterman cautioned.

“We have to worry about worse case scenarios,” Litterman said, “We’re taking risks here that we shouldn’t be taking, there is no advantage to taking these risks. It just doesn’t make sense. It’s not rational. We have to price emissions immediately, at a high level.”

Get Price Incentives First

We may be nearing a “tipping” point where Congress could accept a carbon tax as part of a tax reform package. Of paramount importance is to get the price incentives quickly. There are varying proposals for how to use the revenue, ranging from dividends to households, to decreasing corporate income taxes, and several other options and combinations. Litterman stressed that how revenue is used should not get in the way of establishing the price incentive of a carbon tax; compromises on revenue use will likely be necessary to get votes. But getting incentives to lower emissions must be done now.

When asked, Litterman said he believes that at this point the momentum seems to be behind a carbon tax. But that either cap and trade or a carbon tax can create appropriate incentives – if they do, then from an environmental perspective they are essentially equivalent.

We’re Already on the Path

The world and U.S. are already moving fairly quickly toward a low carbon economy even without incentives. When we add incentives, it will be imbedded in the cost of nearly everything, and behavior will change. The market has already recognized that stranded assets, such as coal and oil sands, will lose value, and the equity prices have dropped accordingly.

All Hands on Deck

We now have the opportunity to pass a carbon tax, but we need a strong grassroots effort to convince our elected representatives that we want it. That’s something the League is good at. Litterman counseled us to “ask especially Congressmen and Senators, ‘Do you agree that we should be pricing climate risk appropriately? Let’s start talking about what the price should be.’”

“We all have to do everything we can,” Litterman concluded. “I’m doing my best and I hope you will as well.”

* Description of some of the worse case scenarios are described in The Uninhabitable Earth.


For links to a recording of the webinar, Dr. Litterman’s slides, and handouts go here