The Economic Value of Pneurop ’ s Green Challenge 2020: The Economic Value of Sustainability

1. The Economic Value of Pneurop’s Green Challenge 2020: The Economic Value of Sustainability Scientific Director CEO Prof. Dr. Phoebe Koundouri Dr. Osiel González Dávila phoebe.koundouri@icre8.orgosiel.davila@icre8.org

2. Prof. Dr. Phoebe Koundouri Scientific Director, ICRE8: International Centre for Research on the Environment & the Economy http://www.icre8.org Professor in Environmental, Natural Resources, Energy Economics & Econometrics, Athens University of Economics & Business, GREECE http://www.aueb.gr/users/koundouri/resees/ Senior Research Fellow, London School of Economics, UK http://www.lse.ac.uk/GranthamInstitute/profile/phoebe-koundouri/ e-mails:phoebe.koundouri@icre8.org; pkoundouri@aueb.gr Vice president of the European Association of Environmental and Resource Economists http://www.eaere.org/

3. Session plan The Pneurop Green Challenge 2020. How can ICRE8 help you? The Economic Value of Sustainability. Valuation Methods with Applied Examples. Cost-Recovery Mechanisms and Policies. European Commission: Horizon 2020.

4. 1.The Pneurop Green Challenge 2020

5. What is the Pneurop Green Challenge 2020? • To put Compressor and Vacuum technologies on the agenda of sustainable technologies, contributing to meet the overall EU challenge of 2020. • To bring forward the capability of compressors and vacuum pumps as natural, innovative and viable solutions for a large number of process applications. • By confining or increasing efficiency of various processes in reducing usage of harmful chemicals. • By allowing development and manufacture of materials that will allow the meeting of energy efficiency targets. • By enabling the new hydrogen economy. • By allowing the use of a safe energy media compatible with various demanding environments.

6. Externalities, Public Goods, Total Economic Value • Reduction of Externalities: Health and Environment • Energy Efficiency and Energy Safety • Investment in Renewable Energy Resources • Economic Translation of Pneurop Green Challenge 2020:

7. External Costs of Energy • The price you see is the price paid by the final user. • This is mainly based on the private cost of producing the service. • But in addition to the private cost we also have some external costs – pollution from emissions, fires caused by open lamps, climate change, etc. • The true cost is called: TOTAL ECONOMIC COST = SOCIAL COST = PRIVATE + EXTERNAL COST

8. Externality: Air pollution from a factory Price and cost (€ per unit) Marginal damage from pollution Quantity of output

9. Externality: Air pollution from a factory MSC Price and cost (€ per unit) Deadweight loss MPC P1 P0 D=MB MSC = Marginal Social Cost MPC = Marginal Private Cost Q1 Quantity of output Q0 Demand curve is the same as the marginal benefit curve: D = MB MSC = MPC + Marginal Damage from pollution

10. Market Failure • Environmental resource is a Public Good • Not explicitly traded in any market • No market price exists to reveal TEV (Hidden demand). • We need to retrieve TEV via WTP • Non-market Valuation Methods

11. 2. How can ICRE8 help you?

12. Environment, Energy, Economy, Eco-innovation and e-versions www.icre8.org

13. ICRE8 MISSION STATEMENT ICRE8 does interdisciplinary research on environmental, natural resources and energy issues, for a variety of circumstances and stakeholders and across different temporal and spatial scales. The overreaching goal of ICRE8 is to support the understanding and implementation of Sustainable Development, as the only non-self-destructive path of socio-economic development, and the pursuit of excellence in the conduct and presentation of research.

14. Define Sustainable/Green Development (SD): Why do we care? • SD: a pattern of resource use • that aims to meet human needs • while preserving the environment • so that these needs can be met not only in the present, but also for future generations. • Any other development path puts the society • consumers • producers • businesses, including financial institutions on self-destructing rotations.

15. Research tools include • financial analysis • socio-economic and econometric analysis • environmental valuation • political and institutional analysis • integrated environmental-economic modeling • cost-benefits analysis • multi-criteria analysis • life cycle analysis • risk analysis • geographical information systems • multi-stakeholder mediations techniques • game theory • information technology decision making tool development

16. Completed & Ongoing Projects • Funded Research Projects e-LUP - Simulating Land Use Processes

17. 3. The Economic Value of Sustainability

18. Total Economic Value Provides a systematic tool for considering the full range of impacts on the environment and on human welfare. TEV reflects the preferences of individuals. Preferences can be studied and estimated by stated preference methods and revealed preference methods Quantifying the impacts of environmental degradation on human welfare is essential for the development of well-informed investments and policies.

19. Valuation Anthropocentric Values  Structure & Processes  Environmental Functions  Human Benefits Use Non-Use Values Values Environment Total Economic Value Use Value Non Use Value Actual Use Value Option Value Existence Value For Others Direct Use Value Indirect Use Value Bequest Value Altruistic Value

20. Total Economic Value

21. 4.Valuation Methods with Applied Examples

22. Valuation Methods with Applied Examples Relevant to Pneurop’s Green Challenge The main approaches for environmental impact valuations can be broadly classified into revealed and stated preference techniques. Revealed preference methods use market data to elicit preferences of a consumer among bundles of goods, given their budget constraint. Stated preference methods use structured questionnaires to elicit individuals’ preferences for a given change in a natural resource or environmental attribute.

24. Hedonic Price Method • Can be used to estimate the demand for air quality improvements. • The most common implementation of hedonic pricing is in the housing markets. • The theoretical structure behind hedonic pricing assumes that households, when making housing choices, consider a vector of characteristics including among others environmental factors as air pollution.

25. HPM Example • Koundouri, P., & Kougea, E. (2011). Air Quality Degradation: Can Economics Help in Measuring its Welfare Effects? A Review of Economic Valuation Studies. • Air pollution and environmental degradation can have direct impact on property values. It is expected that properties in areas with severe pollution problems will experience lower prices compared with properties located in areas of high air quality.

26. HPM Example • HPM involves the estimation of a hedonic housing value equation with air pollution or other environmental factor as one of the housing attributes. • Econometrical analysis will reveal each household’s willingness to pay for a marginal change in air pollution from the hedonic housing value equation. • A marginal WTP function for all households in the urban area examined is analogous to a demand curve for clean air.

27. Results Marginal WTP for air quality, $| Pollution Variables Particles (TSP) Carbon monoxide (CO) Sulphur dioxide (SO2) Nitrogen oxides (NOX) Hydrocarbons (HC)

28. Choice Experiment Method In a CE framework, the good in question is broken down into its component attributes, which are presented to respondents normally as a set of combinations of the attributes. Respondents are then presented with a sequence of choice sets differentiated by its attributes and levels

29. CEM Example Yoo, S. H., Kwak, S. J., & Lee, J. S. (2008). Using a choice experiment to measure the environmental costs of air pollution impacts in Seoul. Journal of environmental management, 86(1), 308-318. Air pollution, a by-product of economic growth, has been incurring extensive environmental costs in Seoul, Korea. Air pollution impacts are not treated as a commercial item, and thus it is difficult to measure the environmental costs arising from air pollution. There is an imminent need to find a way to measure air pollution impacts so that appropriate actions can be taken to control air pollution.

30. CEM Example This study applies a choice experiment to quantifying the environmental costs of four air pollution impacts (mortality, morbidity, soiling damage, and poor visibility), using a specific case study of Seoul. The trade-offs between price and attributes of air pollution impacts for selecting a preferred alternative and derive the marginal willingness to pay (WTP) estimate for each attribute. According to the results, the households’ monthly WTP for a 10% reduction in the concentrations of major pollutants in Seoul was found to be approximately 5494 Korean won (USD 4.6) and the total annual WTP for the entire population of Seoul was about 203.4 billion Korean won (USD 169.5 million).

31. Laboratory Experiment Method Experimental methods provide an important and inexpensive means for weeding out and improving bad theories. By studying the decisions of individuals motivated by real money within well defined and controlled institutional contexts, one can gain deep insights about valuation of public goods or bads!

32. LEM Example Drichoutis, A., Koundouri, P., & Remoundou, K. (2014). A Laboratory Experiment for the Estimation of Health Risks: Policy Recommendations. In Water Resources Management Sustaining Socio-Economic Welfare (pp. 129-137). Springer Netherlands. In order to assess the social cost from consuming products produced in an area where water resources are not in good condition the authors conducted a lab experimental auction. Participants were asked to bid to exchange an agricultural product (potatoes) from region A (polluted with heavy metals) with a similar product from a region in a good ecological status, region B. The aim was to elicit WTP a premium to avoid potential health risks related to heavy metal contamination.

33. Results • Consumers are indeed WTP a premium to exchange their agricultural endowment. • Mean bid is 60 cents per kilo of potatoes. • Gender, income, households with underage kids and education do not seem to influence bidding behaviour in a statistically significant way.

34. Contingent Valuation Method The CVM is based on the development of a hypothetical market or scenario in which the respondents to a survey are given the opportunity to state their Willingness-to-Pay (WTP) or Willingness-to-Accept (WTA) for marginal changes in a non-market good or service.

35. CVM Example Koundouri, P., Kountouris, Y. and Remoundou K. (2009).“Valuing a Wind Farm Construction: A Contingent Valuation Study in Greece”. Energy Policy, 37, 1939-1944. The analysis is based on data from a double-bounded dichotomous choice contingent valuation study implemented to elicit public attitudes towards renewable energy generation and their willingness to pay for the construction of a wind farm in the area of Messanagros in the island of Rhodes, Greece.

36. CVM results • Significant positive values deriving from the proposed project. • Respondents report a mean willingness to pay a premium in their bi-monthly electric bills of €8.86 for the sole purpose of the construction of the wind farm. • The estimated economic benefits to the local population are weighed against the investment cost in a cost–benefit analysis to inform policy making and implications for EU energy policy are provided.

37. Cost - Benefit Analysis CBA is a technique that assesses the monetary social costs and benefits of an investment project over a time period in comparison to a well-defined baseline alternative. In a CBA framework, the estimated economic values accrued by the involved stakeholder groups are aggregated over their relevant populations and added to capture the TEV generated by the investment project. To assess the economic efficiency of the wind farm construction, the aggregate benefits estimated from the contingent valuation application are used to conduct CBA for the construction of the wind farm based on the total economic value.

38. CBA FutureCash Flows

39. Discounting • Once costs and benefits are expressed in monetary units they should be converted to present value terms by discounting • NPV= NBt[(1+r)-t] • where X= cost or benefit • r = discount rate • [(1+r)-t] discount factor • t = time • The higher the value of (t) the lower the discount factor. • The higher the discount rate for a given (t) the lower the discount factor.

40. Cost-Benefit Analysis • The economic life of the wind farm is 20 years • The construction cost that will be incurred exclusively in the first year is €5,121,000 • The maintenance cost is 0.0108 €/KWh/year • NPV of the anticipated benefits appears to be large enough to cover the construction and maintenance costs for the economic life of the project • The wind farm construction results in an increase of the overall social welfare. Discount Rate NPV under the low estimates NPV under the midpoint estimates NPV under the high estimates

41. Is Discounting so straight forward? ‘Humanity has the ability to make development sustainable: to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs.’WCED, 1987. ‘There is something awkward about discounting benefits that arise a century hence. For even at a modest discount rate, no investment will look worthwhile.’The Economist (1991), March 23, p 73. In the decade since that comment in The Economist, the nature of the problem with long-run discounting has become clearer.

42. Discounting

43. Example Climate Change Time Schedule of 1 tone of CO2 emission

44. Example Climate Change

45. Example Climate Change Themain result is that estimates of the social cost of CO2 emissions will at least double if declining discount rates are used!This will have a huge impact on policies: (a) Increase the NPV of Kyoto Protocol target achievement. (b)  Increase the estimate of the social benefit of replacing dirty with clean energy and hence change relevant subsidization. (c) Increase incentives for green innovation and renewable energy investments.

46. The Need for Time Declining Social Discount Rate… There are powerful reasons for choosing a declining social time preference rate. This conclusion is supported by robust recent theoretical work, which has taken several different approaches to the subject. The data best suited the policy-makers' need were produced by Newell & Prizer (2003) and Koundouri et al (2005).

47. Suggested Step Schedule of Discount Rates

48. Project Time Horizon Potential Effect on Project NPV 0 - 30 years SMALL, generally insignificant 30 - 100 years SIGNIFICANT (± 50%) 100-200 years LARGE (± 100%) 200-400 years MAJOR (± 150%) Effect of shift from flat 3.5% to the step schedule of discount rates

49. Declining Discount Rates have been adopted by: • UK: 2003: 3.5% for first 30 years, then declining schedule http://www.aueb.gr/users/koundouri/resees/uploads/socialdiscounting.pdf • FRANCE: 2005 (reviewed on 5 year cycle) : 4% for t < 30 years, 2% for t > 30 years. • USA: 2006: 3.0% or 7.0% depending type of cash flow, lower rates for longer-term.

50. Meta-Analysis Method Meta-analysis is the use of statistical methods to combine results of individual studies. This allows the best use of all the information gathered in a systematic review by increasing the power of the analysis. By statistically combining the results of similar studies one can improve the precision of our estimates of treatment effect, and assess whether treatment effects are similar in similar situations.