The Time Value of Carbon
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Estimated reading time ~ 6 mins
The Time Value of Carbon (TVC) is the concept that emission cuts today are worth more than those carried out in the future.
The term ‘Time Value of Carbon’ was first used in relation to climate change by Larry Strain in a 2017 white paper for the Climate Leadership Forum. Although there is one earlier mention of the term, Larry Strain appears to have been the first to connect it with climate change:1
When we evaluate emission reduction strategies, there are two things to keep in mind: the amount of reduction, and when it happens. Because emissions are cumulative and because we have a limited amount of time to reduce them, carbon reductions now have more value than carbon reductions in the future.
The reason why the TVC arises is because climate change is a ‘stock-flow’ problem. The stock refers to the total concentration of GHG’s in the atmosphere. The net flow refers to the difference between man-made GHG emissions (⬆️the stock of CO2e), and their removal (⬇️ the stock of CO2e), through natural processes or via engineered carbon dioxide removal (CDR).
The science of climate change argues that there is a limit to how much additional CO2e that can be pumped into the atmosphere - known as the carbon budget. If the stock of CO2e goes over this limit then the negative impacts from climate change are likely to accelerate, with each additional threshold leading to non-linear impacts.
The IPCC estimated that the global carbon budget at the start of 2020 consistent with limiting warming to 1.5°C and a likelihood of 50% was 500 Gt CO2. An updated estimate, published last year in the journal Nature, concluded that the carbon budget had halved to around 250 Gt CO2, equal to around six years of current CO2 emissions.2
It’s important to note that estimating the carbon budget involves a great deal of uncertainty, and one of the largest sources involves the contribution of non-CO2 emissions. As the updated study highlights, the size and timing in which non-CO2 GHG emissions “depends on socioeconomic projections as much as on geophysical uncertainty, and potential warming after net zero CO2.” A single point estimate for the carbon budget gives a false impression. In reality the carbon budget could be significantly higher, much smaller, or indeed, already in negative territory.
Uncertainty over the size of the carbon budget shouldn’t be a reason to postpone putting climate mitigation actions even further. Indeed, the Precautionary Principle (PP) suggests that where there are threats of serious or irreversible climate change, a lack of full scientific certainty should not be used as a reason for postponing cost-effective mitigation measures.
The chart below illustrates the emission trajectories required to limit warming to below 1.5C, in the absence of net-negative emissions, based on a starting point of 2000, and every year subsequently through to 2019. If emissions had peaked and begun to decline after the year 2000, the 1.5C target would have only required emission reductions of around 3% per year.3
Alas, rather than cutting emissions, global GHG’s pumped into the atmosphere rose by over 40% over the subsequent two decades. Fast forward to 2019 and the analysis suggests that meeting 1.5C would now require cuts of 15% each year through to 2040, without net-negative emissions. Every year that goes by where the world is not on a 1.5C pathway increases the need for even larger emission cuts.
Unfortunately, as the chart above illustrates, our collective decision to postpone emission cuts in the past means there must either be severe year-on-year declines in GHG emissions, an increased focus on carbon removal, or some combination of the two.
This is despite the uncertainties over the carbon removal properties of natural systems (i.e., the degree to which the climate system responds to emission cuts and removal is symmetrical), and the potential technological progress we make towards gigatonne scalable engineered CDR (See Why CDR regulation could deter climate mitigation: The risk of 'moral hazard' tends to increase when governments intervene).
On a societal level the benefit of an individual firm cutting emissions or removing carbon today clearly outweighs putting it off for 10 years. Companies that only begin to make an impact in 2034 will have added to the stock of CO2e in the meantime, and hence drawn down the carbon budget. The likelihood that the carbon budget will be breached goes up the longer that mitigation efforts are put off.
What are the implications for investors and policymakers of the current TVC undervaluation? Well they may need to start thinking in terms of a ‘discounted carbon flow’ (DCF). Marc Guilbert, managing partner of BXV Capital developed a DCF model based on the carbon discount rates implied by the IPCC’s RCP scenarios.4
DCF’s could be a way for climate tech investors to compare different large-scale projects with very different carbon profiles. As Guilbert highlights, “solutions of varying maturity and emission reduction profiles will be needed to abate global emissions.” Overlaying the DCF onto impact models such as the IPCC’s could become a useful diversification tool in which to reduce carbon risk (see A 'green' unicorn: What the cleantech boom and bust tells us about the future of climate tech).
What about policymakers, and carbon markets in particular? Well, the TVC undervaluation suggests that policymaker should use a more dynamic means of targeting emission cuts and carbon removals. The DCF approach could be a more effective way of managing the risk associated with exceeding the carbon budget, and would likely imply much more ambitious targets (and hence higher carbon prices) than are currently in place.
To paraphrase a Chinese proverb, the best time to have begun to cut emissions, planted a forest, or invested in engineered CDR, was twenty years ago. The second best time is now.
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https://carbonleadershipforum.org/the-time-value-of-carbon/
https://www.carbonbrief.org/unep-1-5c-climate-target-slipping-out-of-reach/
https://www.nature.com/articles/s41558-023-01848-5#Sec2
https://www.linkedin.com/pulse/time-value-carbon-discounted-flow-dcf-marc-guilbert-ph-d-/