A global study of the size and cost of measures to reduce greenhouse gas emissions yields important insights for businesses and policy makers.

The debate about greenhouse gases is heating up. Across a wide spectrum, some voices argue that emissions and climate aren’t linked, while others urge immediate concerted global action to reduce the flow of emissions into the atmosphere. Even the advocates of action disagree about timing, goals, and means. Despite the controversy, one thing is certain: any form of intensified regulation would have profound implications for business.

• A study of the relative economics of different approaches to reducing greenhouse gas emissions offers surprising insights for policy makers and business leaders.
• For starters, in a 25-year perspective, power generation and manufacturing industry offer less than half of the potential for reducing emissions.
• Almost a quarter of possible emission reductions would result from measures (such as better insulation in buildings) that carry no net life cycle cost—in effect, they come free of charge.
• The study finds that a substantial share of the overall opportunities, including a large potential to reduce emissions by protecting and replanting forests, lies in developing economies.

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Our contribution on this topic is not to evaluate the science of climate change or to address the question of whether and how countries around the world should act to reduce emissions.

In this article we aim instead to give policy makers, if they choose to act, an understanding of the significance and cost of each possible method of reducing emissions and of the relative importance of different regions and sectors.

The supply of abatement approaches

Our analysis offers some noteworthy insights. It would be technically possible, for one thing, to capture 26.7 gigatons of abatement by addressing only measures costing no more than 40 euros a ton. But because these lower-cost possibilities are highly fragmented across sectors and regions—for instance, more than half of the potential abatements with a cost of 40 euros a ton or less are located in developing economies—an effective global abatement system would be needed to do so. Politically, this may be very challenging.

What’s more, power generation and manufacturing industry, so often the primary focus of the climate change debate, account for less than half of the relatively low-cost potential (at a cost of up to 40 euros a ton) for reducing emissions

The implication is that if policy makers want to realize abatement measures in order of increasing cost, they must also find ways to effectively address opportunities in transportation, buildings, forestry, and agriculture. This potential is more difficult to capture, as it involves billions of small emitters— often consumers—rather than a limited number of big companies already subject to heavy regulation. Looking at specific measures, nearly one-quarter of the abatement potential at a cost of up to 40 euros a ton involves efficiency-enhancing measures (mainly in the buildings and transportation sectors) that would reduce demand for energy and carry no net cost. The measures we include in this category do not require changes in lifestyle or reduced levels of comfort but would force policy makers to address existing market imperfections by aligning the incentives of companies and consumers.

Further, we found a strong correlation between economic growth and the ability to implement low- cost measures to reduce emissions, for it is cheaper to apply clean or energy-efficient technologies when building a new power plant, house, or car than to retrofit an old one. Finally, in a 2030 perspective, almost three-quarters of the potential to reduce emissions comes from measures that are either independent of technology or rely on mature rather than new technologies.

The role of developing economies

Even though developed economies emit substantially more greenhouse gases relative to the population than developing ones, we found that the latter account for more than half of the total abatement potential at a cost of no more than 40 euros a ton. Developing economies have such a high share for three reasons: their large populations, the lower cost of abating new growth as opposed to reducing existing emissions (especially in manufacturing industry and power generation of high- cost developed markets), and the fact that tropical countries have much of the potential to avoid emissions in forestry for 40 euros a ton or less.

Forestry measures—protecting, planting, and replanting forests—make up 6.7 gigatons of the overall 26.7 gigatons of the potential abatement at a cost up to 40 euros per ton.7 We estimate that for no more than 40 euros a ton, tropical deforestation rates could be reduced by 50 percent in Africa and by 75 percent in Latin America, for example, and that this effort could generate nearly 3 gigatons of annual abatement by 2030. Major abatements in Asia’s forests would cost more, since land is scarce and commercial logging has a higher opportunity cost than subsistence farming in Africa and commercial agriculture in Latin America.

In agriculture and waste disposal, which produce greenhouse gases such as methane and nitrous oxide, developing economies also represent more than half of the 1.5 gigatons of possible abatements costing no more than 40 euros a ton.

Abatement measures in this sector would include shifting to fertilization and tillage techniques that generate fewer emissions and capturing methane from landfills.

Reducing growth in energy demand

An additional 6 gigatons—almost a quarter of the total abatement potential at a cost of 40 euros a ton or less—could be gained through measures with a zero or negative net life cycle cost. This potential appears mainly in transportation and in buildings. Improving the insulation of new ones, for example, would lower demand for energy to heat them and thus reduce emissions. Lower energy bills would more than compensate for the additional insulation costs. According to our model, measures like these, as well as some in manufacturing industry, hold the potential to almost halve future growth in global electricity demand, to approximately 1.3 percent a year, from 2.5 percent.

As for measures that would have a net cost, we found that around 35 percent of all potential abatements with a net cost of up to 40 euros a ton involve forestry; 28 percent, manufacturing industry; 25 percent, the power sector; 6 percent, agriculture; and 6 percent, transportation.

A power perspective

The power sector represented 9.4 gigatons, or 24 percent, of global greenhouse gas emissions in 2002, the latest year that consistent global figures are available across all sectors. In the IEA’s business- as-usual scenario, emissions from power generation will increase to 16.8 gigatons a year in 2030 as a result of a doubling of global electricity demand. Five key groups of abatement measures costing 40 euros a ton or less are relevant to the power sector: reducing demand, carbon capture and storage, renewables, nuclear power, and improving the greenhouse gas efficiency of fossil fuel plants. Com- bined, these measures hold the potential to reduce the power sector’s total emissions to 7.2 gigatons by 2030.

Among power generation technologies, nuclear (at 0 to 5 euros a ton for avoided emissions) is the cheapest source of abatement and nearly cost competitive with power generated by fossil fuels. We estimate that abatements from carbon capture and storage could cost 20 to 30 euros a ton by 2030; those from wind power could average around 20 euros a ton, with a wide cost range depending on the location and on the previous penetration of weather-dependent electricity sources. In our model, the overall additional cost to the power sector of achieving the target of 450 parts per million, compared with the business-as-usual scenario, would be around 120 billion euros annually in 2030. This figure illustrates the very significant potential implications, for companies in the power sector, of any further actions that regulators may take to reduce greenhouse gas emissions.

Addressing the abatement potential described above would likely create a major shift from traditional coal and gas power generation to coal plants with carbon capture and storage, to renewables, and to nuclear power. In our model, coal- fired plants using carbon capture and storage would increase their share of the world’s power generation capacity from nothing in 2002 to 17 percent by 2030; renewables (including a big but slow-growing share for large-scale hydropower), to 32 percent, from 18 percent; and nuclear power, to 21 percent, from 17 percent. Fossil fuel power generated without carbon capture and storage would decrease to 30 percent, from 65 percent.

Low-tech abatement

The role of technology in reducing emissions is much debated. We found that some 70 percent of the possible abatements at a cost below or equal to 40 euros a ton would not depend on any major technological developments. These measures either involve very little technology (for example, those in forestry or agriculture) or rely primarily on mature technologies, such as nuclear power, small-scale hydropower, and energy-efficient lighting. The remaining 30 percent of abatements depend on new technologies or significantly lower costs for existing ones, such as carbon capture and storage, biofuels, wind power, and solar panels. The point is not that technological R&D has no importance for abatement but rather that low-tech abatement is important in a 2030 perspective.

What are the implications?

Our analysis has revealed a number of important implications for each sector and region, should regulators choose to reduce emissions. We summarize the primary overall conclusions below.

Costs for reducing emissions

For the global economy, the cost of the 450- parts-per-million scenario described in this article would depend on the ability to capture all of the available abatement potential that costs up to 40 euros a ton. If that happens, our cost curve indicates that the annual worldwide cost could be around 500 billion euros in 2030, 0.6 percent of that year’s projected GDP. However, should more expensive approaches be required to reach the abatement goal, the cost could be as high as 1,100 billion euros, 1.4 percent of global GDP.

If, as some participants in the climate debate argue, the cost of reducing emissions could be an insurance policy against the potentially severe consequences of unchecked emissions in the future, it might be relevant to compare the costs with the global insurance industry’s turnover (excluding life insurance)—some 3.3 percent of global GDP in 2005.

Cost-conscious regulation

Should regulators choose to step up current programs to reduce greenhouse gas emissions, they should bear in mind four types of measures to restrain costs:

1. . Ensuring strict technical standards and rules for the energy efficiency of buildings and vehicles
2. . Establishing stable long-term incentives to encourage power producers and industrial companies to develop and deploy greenhouse gas-efficient technologies
3. . Providing sufficient incentives and support to improve the cost efficiency of selected key technologies, including carbon capture and storage
4. . Ensuring that the potential in forestry and agriculture is addressed effectively, primarily in developing countries; such a system would need to be closely linked to their overall development agenda.

Shifting business environment

For companies in the power sector and energy- intensive industries, heightened greenhouse gas regulation would mean a shift in the global business environment on the same order of magnitude as the one launched by the oil crisis of the 1970s. It would have a fundamental impact on key issues of business strategy, such as production economics, cost competitiveness, investment decisions, and the value of different types of assets. Companies in these industries would therefore be wise to think through the effects of different types of greenhouse gas regulation, strive to shape it, and position themselves accordingly.

No matter whether, how, or when countries around the globe act to reduce greenhouse gas emissions, policy makers and business leaders can benefit from a thorough understanding of the relative economics of different possible approaches to abatement, as well as their implications for business and the global economy.

Source: McKinsey and Company, 2007