[silk] McKinsey Quarterly: Estimating costs for greenhouse gas reduction

[Udhay Shankar N]

Some interesting charts at the URL below (registrattion required).
Udhay

http://www.mckinseyquarterly.com/Energy_Resources_Materials/Strategy_Analysis/A_cost_curve_for_greenhouse_gas_reduction

A cost curve for greenhouse gas reduction

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

Per-Anders Enkvist, Tomas Nauclér, and Jerker Rosander

2007 Number 1

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.

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. To that end, we 
have developed an integrated fact base and 
related cost curves showing the significance and 
cost of each available approach, globally and by 
region and sector. Our other purpose is to help 
business leaders understand the implications of 
potential regulatory actions for companies and 
industries. Indeed, regulation is already on the 
minds of many executives. A recent survey1 
indicates that half of all companies in Europe’s 
energy-intensive industries regard the European 
Union’s Emissions Trading Scheme (EU ETS) as one 
of the primary factors affecting their long-term investment decisions.

As the baseline for our study, we used the 
“business-as-usual” projections for emissions 
growth2 from the International Energy Agency 
(IEA) and the US Environmental Protection Agency 
(EPA). We then analyzed the significance and cost 
of each available method of reducing, or 
“abating,” emissions relative to these 
business-as-usual projections. Our study3 covers 
power generation, manufacturing industry (with a 
focus on steel and cement), transportation, 
residential and commercial buildings, forestry, 
and agriculture and waste disposal, in six 
regions: North America, Western Europe, Eastern 
Europe (including Russia), other developed 
countries, China, and other developing nations. 
It spans three time horizons—2010, 2020, and 
2030—and focuses on abatement measures that we 
estimate would cost 40 euros per ton or less in 
2030. Others have conducted more detailed studies 
on specific industries and geographies. But to 
our knowledge, this is the first microeconomic 
investigation of its kind to cover all relevant 
greenhouse gases, sectors, and regions.
Reading the cost curves

The cost curves we developed show estimates of 
the prospective annual abatement cost4 in euros 
per ton of avoided emissions of greenhouse 
gases,5 as well as the abatement potential of 
these approaches in gigatons of emissions. The 
abatement cost for wind power, for example, 
should be understood as the additional cost of 
producing electricity with this zero-emission 
technology instead of the cheaper fossil 
fuel-based power production it would replace. The 
abatement potential of wind power is our estimate 
of the feasible volume of emissions it could 
eliminate at a cost of 40 euros a ton or less. 
Looked at another way, these costs can be 
understood as the price—ultimately, to the global 
economy—of making any approach to abatement cost 
competitive or otherwise viable through policy 
decisions. A wide range of assumptions about the 
future cost and feasible deployment rates of 
available abatement measures underlie the 
estimates of their cost and significance. For 
example, the significance of wind power assumes 
that actions to abate greenhouse gases will have 
already begun across regions by 2008. The volumes 
in our model (and this article) should be seen as 
potential abatement, not as forecasts.

Our model for the “supply” of abatement can be 
compared with any politically determined target 
(“demand”) for abatement in the years 2010, 2020, 
and 2030. The science of climate change is beyond 
the scope of our study and our expertise, 
however. We thus compare, for illustrative 
purposes, our findings on supply with three 
emissions targets discussed in the debate—targets 
that would, respectively, cap the long-term 
concentration of greenhouse gases in the 
atmosphere at 550, 450, or 400 parts per million 
(a measure of the share of greenhouse gas 
molecules in the atmosphere). The goal of each 
target, according to its advocates, is to prevent 
the average global temperature from rising by 
more than 2 degrees Celsius. Any of these 
emissions targets would be challenging to reach 
by 2030, for they would all require at least a 50 
percent improvement in the global economy’s 
greenhouse gas efficiency (its volume of 
emissions relative to the size of GDP) compared with business-as-usual trends.

A simplified version of the global cost curve 
(Exhibit 1) shows our estimates of the 
significance and cost of feasible abatement 
measures in 2030—the end year of a period long 
enough for us to draw meaningful conclusions but 
short enough to let us make reasonably factual 
assumptions. We have developed similar cost 
curves for each sector in each region and for each of the three time frames.

At the low end of the curve are, for the most 
part, measures that improve energy efficiency. 
These measures, such as better insulation in new 
buildings (see “Making the most of the world’s 
energy resources”), thus reduce emissions by 
lowering demand for power. Higher up the cost 
curve are approaches for adopting more greenhouse 
gas-efficient technologies (such as wind power 
and carbon capture and storage6) in power 
generation and manufacturing industry and for 
shifting to cleaner industrial processes. The 
curve also represents ways to reduce emissions by 
protecting, planting, or replanting tropical 
forests and by switching to agricultural 
practices with greater greenhouse gas efficiency.

We have no opinion about the demand for abatement 
or the probability of concerted global action to 
pursue any specific goal. But the application of 
our supply-side research to specific abatement 
targets can help policy makers and business 
leaders to understand the economic implications 
of abatement approaches by region and sector, as 
well as some of the repercussions for companies 
and the global economy. Our analysis assumes that 
the focus would be to capture all of the cheapest 
forms of abatement around the world but makes no 
judgment about what ought to be the ultimate 
distribution of costs. Of course, the ability to 
pay for reducing emissions varies greatly between 
developed and developing economies and among 
individual countries in each group.

For simplicity’s sake, we compared our cost curve 
with the 450-parts-per-million scenario—in the 
midrange of the targets put forward by advocates. 
This scenario would require greenhouse gases to 
abate by 26 gigatons a year by 2030 (Exhibit 2). 
Under that scenario, and assuming that measures 
are implemented in order of increasing cost, the 
marginal cost per ton of emissions avoided would 
be 40 euros. (As a point of reference, since 
trading under the EU ETS began, in 2005, the 
price of greenhouse gas emissions has ranged from 6 to 31 euros a ton.)

We had to make many assumptions about future cost 
developments for these measures and the practical 
possibilities for realizing them. We assumed, for 
instance, that the cost of carbon capture and 
storage will fall to 20 to 30 euros per ton of 
emissions in 2030 and that 85 percent of all 
coal-fired power plants built after 2020 will be 
equipped with this technology. These assumptions 
in turn underpin our estimate that it represents 
3.1 gigatons of feasible abatement potential.

In a 25-year perspective, such assumptions are 
clearly debatable, and we make no claim that we 
are better than others at making them. We believe 
that the value of our work comes primarily from 
an integrated view across all sectors, regions, 
and greenhouse gases using a uniform methodology. 
This model allows us to assess the relative 
weight of different approaches, sectors, and regions from a global perspective.
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 
(Exhibit 3). 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 (Exhibit 4).

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. Combined, these 
measures hold the potential to reduce the power 
sector’s total emissions to 7.2 gigatons by 2030 (Exhibit 5).

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.
About the Authors
_______________________________________________________________________
Per-Anders Enkvist is an associate principal and 
Tomas Nauclér and Jerker Rosander are principals 
in McKinsey’s Stockholm office.

The authors would like to thank Richard Duke, a 
project manager of the underlying research 
effort, as well as acknowledge the contributions 
of Malavika Jain, Thomas Koch, Enrico Villa, and Nick Zuo to this article.
_______________________________________________________________________

Notes

1 Review of EU Emissions Trading Scheme, 
conducted by McKinsey on behalf of the EU 
Commission, was published in November 2005. Its 
findings reflect responses from 167 companies and 163 other institutions.

2 Growth in emissions is driven mainly by the 
increasing demand for energy and transport around 
the world and by the deforestation of tropical areas.

3 Launched in spring 2006, the study has been 
conducted as a joint effort with the Swedish 
utility Vattenfall. However, the views expressed 
here are ours alone, and we are solely 
responsible for any errors. The results of the 
study have been reviewed by an academic panel 
consisting of professors Dennis Anderson 
(Imperial College London), Lars Bergman 
(Stockholm School of Economics), and Steve 
Pacala, Robert Socolow, and Robert Williams (Princeton University).

4 Calculated as the annual additional operating 
cost (including depreciation) less potential cost 
savings (for example, from reduced energy 
consumption) divided by the amount of emissions 
avoided. This formula means that costs can be 
negative if the cost savings are considerable. 
Possible costs for implementing a system to 
realize the abatement approaches are not included.

5 Such as carbon dioxide, methane, nitrous oxide, and sulfur hexafluoride.

6 A technology for separating greenhouse gases 
from the combustion gases of fossil fuels and 
industrial processes and then storing the 
greenhouse gases in natural underground cavities.

7 As trees grow, they bind greenhouse gases. When 
they are cut down and burned, the greenhouse 
gases are released back into the atmosphere.

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((Udhay Shankar N)) ((udhay @ pobox.com)) ((www.digeratus.com))