UQx Carbon101x 4.2.1.3 Marginal abatement cost curves

UQx Carbon101x 4.2.1.3 Marginal abatement cost curves


In
managing the carbon footprint of an organisation, it makes sense to implement the lowest cost
abatement options first… But what does this mean? And, how do you work this out? In this video, we’re going to investigate
“marginal abatement cost curves”, which are a useful tool for comparing and prioritising
different abatement options. Consider this scenario:
Your company wants to reduce its carbon footprint, and it has two low-emissions technologies
to choose from. The first is a vehicle fleet upgrade, with
a net present value, or NPV, of negative 200,000 dollars. The second is a fuel switching project, with
a net present value of negative 100,000 dollars. Assuming you have capital constraints and
can only implement one of these projects, which abatement option would you choose? Now, if you recall from the previous video,
a negative net present value represents a net financial cost over the project lifetime. Therefore, in our example, the project with
the lower NPV is more appealing. That means you’d choose the fuel switching
option, right? Well, not necessarily, if we’re considering
carbon management as a driver. Net present value gets us halfway to identifying
the lowest cost abatement options. It helps us understand which projects have
the highest financial benefits, but it does not tell us about a project’s relative greenhouse
gas reduction benefits. Let’s assume the vehicle fleet upgrade has
the potential to reduce the company’s carbon footprint by 20,000 tonnes of CO2 equivalent,
and the fuel switching project will avoid only 5,000 tonnes. Now which option will you choose? From a carbon management perspective, your
company is likely to want the most “bang for buck” – that is, the most carbon
abatement for the least cost. Therefore, we need a way of relating NPV to
carbon abatement, in order to know which projects are most beneficial in terms of both their
financial and greenhouse gas reduction performance. And there’s a nice, simple metric for this:
“Marginal Abatement Cost”. This is defined as “the average cost of
reducing one tonne of carbon dioxide equivalent”. It is expressed in dollars per tonne of CO2
equivalent. Importantly, when the marginal cost is positive,
then the cost to the company will be that amount per tonne of CO2 e reduced. When marginal cost is negative, however, it
means the company is saving that amount per tonne of CO2 e reduced. A negative marginal abatement cost is therefore
considered a cost saving. This may sound confusing and counterintuitive,
but it will become more clear shortly. The cost per tonne of CO2 equivalent reduced
is found by taking the net present value – NPV (which you should have already derived from your financial analysis), dividing it by the total volume of abatement the project will achieve over its lifetime and then multiplying
this number by negative one. This last part of the equation is important,
as it translates a positive NPV into a negative abatement cost saving figure, and vice-versa. Going back to our example, this means the
fleet upgrade has a marginal abatement cost of 10 dollars per tonne of CO2 e, while the
fuel switching project will cost 20 dollars per tonne of CO2 e. Now which project would you choose? Well, now that we’ve factored in the projects’
respective abatement potential, the fleet upgrade is the better option. To visualise this, we can go one step further
and develop a marginal abatement cost curve, or “MACC”, which looks like this. Each box on the MACC curve represents a different
project option to reduce greenhouse gas emissions. Essentially, a MACC is a visual, economic
decision-making tool that assists managers to identify, rank and prioritise emissions
abatement projects. Let’s focus our attention on this biogas
to energy project. As you can see, a MACC presents two important
indicators. The X-axis gives us the volume of abatement
that each project can deliver over our evaluation timeframe. Here, we can see that a biogas project will
reduce the organisation’s emissions by 20,000 tonnes over the evaluation timeframe. The Y-axis gives the marginal abatement cost. In the case of the biogas project, the marginal
cost is $16 per tonne of CO2 equivalent. Once we’ve added all of the organisation’s
project options to the MACC, these are ranked from lowest (most desirable) to highest abatement
cost per tonne of CO2 equivalent. This produces the characteristic fan pattern
that you see here. Importantly, projects that present savings
(that is, negative abatement costs) are positioned below the horizontal axis, and should be prioritised
for implementation. Those that appear above the horizontal axis
should, however, be evaluated carefully against the marginal cost of other compliance options,
such as buying allowances or offsets on the carbon market. For example, our biogas project has a marginal
cost of $16 per tonne. However, if offsets are cheaper at say $10
per tonne, then the organisation would first choose to buy offsets, as they will save $6
for every tonne of CO2 equivalent when compared to the biogas project. So, in a nutshell, a MACC is a useful way
to visualise and understand the internal abatement options for an organisation, and compare their
relative cost and climate mitigation performance against other compliance options. We will expand on this further in Part 4’s
practical activity, where you will apply this new understanding to build a MACC for your
Tasland company.

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