Niall Enright explains how to use a marginal abatement cost curve to evaluate the benefits of different energy-efficiency projects.
Most environmental professionals will undoubtedly have heard of marginal abatement cost curves (MACCs).
They are regularly used in climate change circles to help visualise complex data about carbon costs and emissions volumes.
The example (below) from Bloomberg New Energy Finance illustrates the potential for different technologies to reduce greenhouse-gas (GHG) emissions in the US.
It ranks technologies in ascending order of cost per tonne CO2 equivalent (tCO2e) – that is to say that those projects that have the lowest cost (in terms of per tCO2e reduced are on the left and those with the highest cost are on the right.
Technologies below the line actually make a saving (a negative cost) over their lifetime – perhaps because they reduce energy consumption as well as carbon.
The Bloomberg curve illustrates that lighting is the most cost-effective technology, at a net saving of just under $50 per tCO2e abated (on the left-hand side), while way over to the right there are solar-thermal and gas industry projects, which have a net cost of more than $100 per tCO2e over their life cycles.
There is another very useful piece of information in this chart. The width of each of the bars illustrates the total potential annual CO2e saving for each technology.
So, a wide bar represents a large emissions reduction compared with a narrow bar, with wind (high cost), towards the middle of the chart, delivering the largest CO2 abatement potential in reduction terms.
Because the projects are ranked side by side, the horizontal axis actually shows the annual cumulative emissions reductions for all the preceding technologies.
Taking both these factors into account, savings and cumulative emissions reductions, you can see that this MACC demonstrates that the US can save just under 280 million tonnes of CO2 equivalent (mtCO2e) emissions, up to and including those emissions from landfill gas power generation, by using technologies that are either break-even or have a net saving. After that, each subsequent project has a cost for each tCO2e it abates.
If the US were to introduce a price of carbon of, say $50 per tonne, then all the technologies to the left of nuclear would become financially viable, as they’re cheaper, from a whole-life perspective, than paying a carbon price.
Looking at the horizontal axis, this shows a cumulative total of just under 1,500 mtCO2e potential emissions reduction, 1,200 mtCO2e over and above the 280 mtCO2e achieved without a carbon price.
Projects to the right of nuclear are more expensive than the $50 carbon price per tonne of abatement – therefore the carbon price alone is not enough to make them financially attractive.
This is why policymakers like MACC curves so much; it gives them an “at a glance” indication of the impact of various carbon-price signals.
Your own MACC
Creating each entry in a MACC involves a number of steps.
First, you need to determine the lifetime of the technology or project and then calculate the cost/saving of the technology for each year it is in operation.
These annual costs/savings need to be discounted to the net present value (NPV) – that is, the difference between the costs of the investment (cash outflow) compared with the return (cash inflows), using a given discount rate.
Discounting reflects the fact that a cost or saving today is more valuable than a similar cost or saving in the distant future.
The discount rate that is used varies, but reasonable choices would be about 9% for a private business or as low as 3% for a government body.
The choice here is important as low discount rates increase the long-term net benefit of a technology compared with its initial cost and so bring more technologies under the horizontal line of the MACC.
The discount rate used should be appropriate to the entity developing the MACC, if they’re the ones financing the projects.
The £/tCO2e is obtained by dividing the sum of the total NPV of the project/technology by the total CO2e abated by the project, which is not discounted.
Calculating NPVs from a series of annual costs is relatively easy with the NPV function in Excel.
However, creating the actual MACC chart is less straightforward as Excel does not have the ability to draw variable-width bar charts.
There are a number of techniques available to help do this (see Further information below).
Environment Investment Return
There are other ways that MACC presentations can be used, extending beyond the analysis of carbon.
For example, MACCs can be created with cumulative kWh electricity on the horizontal axis and discounted£/kWh on the vertical, which is entirely analogous to the carbon analysis.
There are other approaches that can factor multiple environmental benefits rather than just carbon or just electricity.
One such approach is an Environment Investment Return (EIR) (below).
This takes a number of environmental impacts of a project – for instance water use, CO2e, nitrogen oxide and volatile organic compounds, etc – expressed in financial terms and compares the environmental benefit with the discounted cost of the project.
It is important when using multiple factors to select equivalent costs, so as not to favour one factor over another.
These environmental costs are usually either “market” prices, such as the cost of carbon allowances, or estimated/projected prices, which can be obtained from academic studies, for example.
Example: Environment Investment Return
In the EIR approach, the equivalent of the marginal abatement cost is the environmental benefit divided by the NPV of the project, so that those projects that have the greatest positive environmental impact per £ spend appear on the left, as in the MACC, while the size of the environmental benefit is shown on the horizontal axis.
As the pricing of “externalities” becomes more commonplace and organisations look to understand and differentiate options for capital expenditure, this type of analysis will become increasingly common.
The MACC is a powerful way of comparing a range of different investment choices. While such curves are usually employed for assessing carbon, it is quite feasible to use the same techniques to compare other environmental factors, and help inform decision-making whether for investment choice or for pricing externalities.
Given the powerful presentational benefits on offer, MACCs should be part of every environmentalist’s communications toolkit, and it is well worth investing effort in understanding how to construct them.
Energy technology firm Somar has examples of MACCs here.
Niall Enright can also help. Send him an email.
9th March 2011