What measures will get us the biggest emissions bang for our buck? How much will these measures cost residents and businesses in our city? These are the two questions we hear most often. A climate action plan (CAP) benefit-cost analysis (BCA) addresses both of these questions, providing insights into the cost-effectiveness of CAP measures and the financial impacts to those who are directly involved in CAP activities. This is the third post in our series of CAP cost analyses; the first post provided an introduction to CAP cost analyses and, in the second, EPIC director Scott Anders provided greater details on CAP implementation cost analyses. Here we will discuss an approach to CAP BCAs developed by EPIC, including: perspectives to consider, types of benefits and costs to include, and metrics to calculate.
A CAP BCA has two parts; the first answers how cost-effective are CAP measures at reducing greenhouse gas (GHG) emissions and the second answers what are the financial impacts to those who participate in CAP measure activities? This is done through a cost-effectiveness analysis and an analysis on the impacts on participants. A CAP BCA is designed to align with GHG estimates used in CAP calculations and results capture the estimated impacts of all activity necessary to achieve GHG reductions in specific target years.
Where a BCA Fits in the Climate Action Planning Cycle
When a CAP BCA is conducted will vary by jurisdiction, but the results can inform decision makers and the public at all stages of the climate planning cycle (Figure 1). A BCA can help in the measure selection process and tailoring of already implemented strategies (blue box), assist in identifying ways to more efficiently use jurisdiction funds to implement (orange box), and identify the actual financial impacts being felt by those engaging in CAP activities (green box).
The five perspectives analyzed in a CAP BCA were introduced in our first post, but are worth a second mention (Figure 2). These perspectives represent different stakeholder groups who could potentially be experiencing benefits and/or costs as a result of a CAP measure.
Let’s take an example – a solar photovoltaic (PV) ordinance for new residential construction. Administrator costs would be those costs to the city to develop and enforce the ordinance (staff, consultants, etc.). Participants would be the home builder who now has to pay for the installation of PV on the home they are building. Participants also receive benefits, however, in the form of energy bill reductions over the life of that PV system. One point worth highlighting is that a measure can have multiple participants. In the case of our solar PV ordinance, a developer may install the PV system, but the eventual homeowner will experience the energy bill reductions. If the home builder applies for rebates or incentives—like the New Solar Home Partnership (NSHP)—then Non-participants would include the group of ratepayers who fund the NSHP program. These three perspectives all contribute to achieving the GHG reductions specified in the CAP and, together, are considered the Measure perspective. The Society perspective takes things one step further by also recognizing the externalities resulting from the installation of PV on new residential construction.
Types of Benefits and Costs
The benefits and costs experienced by the five perspectives fall into one of two categories: direct and external (Figure 3).
Direct benefits and costs are those directly related to implementing a CAP measure or engaging in an action defined by a CAP measure. Typical direct benefits include cost savings in the form of a utility bill or fuel purchase reductions. Typical direct costs include the purchase, installation, and maintenance of equipment or other services (e.g., a solar PV system). Financial incentives or subsidies, such as rebates and tax credits, are considered cost reductions, or negative direct costs, for Participants.
Benefits and costs associated with positive or negative externalities (external benefits and costs) are the result of indirect effects of an action and tend to be more difficult to quantify. Positive externalities generally associated with a CAP include public health benefits from reduced air pollution, increased ecosystem service value, and reduced national dependency on imported fossil fuels. Examples of negative externalities include pollution created from the disposal of solar panels at the end of their useful life and public health costs associated with poor air quality from fossil fuel extraction, production, and combustion to manufacture solar panels. Valuing external costs and benefits can be difficult due to limited data. Acknowledging this and including a qualitative assessment when appropriate is a possible strategy to address this challenge.
There are a handful of metrics used in CAP BCAs that deserve some explanation (Figure 4). A cost-effectiveness analysis presents results in dollar per metric ton of carbon dioxide equivalent ($/MT CO2e). Impacts on participants can be explained with a suite of metrics: benefit-cost ratio (BCR), payback period, return on investment (ROI), and internal rate of return (IRR). A robust BCA looks at these metrics together and in coordination with calculated GHG reductions to understand the feasibility and practicality of a given measure.
The $/MT CO2e represents the total benefit or cost associated with reducing one MT CO2e as a result of taking an action defined in that particular CAP measure. It standardizes the results of all measures, allowing for comparisons across measures. A negative value represents a net cost per MT CO2e over the life of the project. A positive value represents a net benefit per MT CO2e.
The BCR is a metric commonly used to assess the relationship between the benefits and costs of a project or action. If a BCR is greater than one, then benefits of the measure outweigh costs; if it is less than one, costs outweigh benefits. This can be useful in comparing measures to assess the relative impacts of each on participants.
A payback period is the amount of time required for the cumulative benefits of a project to equal or surpass the cumulative costs of an action or measure (Figure 5), as such, the payback period can only be shown for measures (or perspectives) that have a positive net present value (NPV) over their respective useful life. There are two types of payback periods that can be considered: simple and discounted. Simple payback does not account for the time value of money (discounting), while the discounted payback does.
Other metrics, which are typically less understood by the general public, are the ROI and IRR. Both are expressed as percentages; higher percentages generally mean a project is more desirable or profitable. The ROI is a metric that measures the rate of return, or profitability, for a project to evaluate its efficiency and the IRR represents the discount rate necessary to achieve a NPV equal to zero given the benefits and costs of a measure or action over its useful life.
CAP BCAs in Practice
This was the third in a series of posts about CAP cost analyses. Our next two posts will continue the discussion on the cost-effectiveness of CAP measures and then focus on the impacts on participants. They will discuss what results mean, highlight effective ways to present them, and shed light on some of the challenges and limitations faced.