Social Cost of Methane: Garbage In, Garbage Out

by Ryan Streams, Regulatory Affairs Analyst on April 11, 2016 - 2:36pm

Computer models are powerful tools, but as the old saying goes, “garbage in, garbage out” and models of the Social Cost of Methane (SCM) are no exceptions. The Environmental Protection Agency’s (EPA) new methane rules rely heavily on the SCM to show a benefit. Now, the Bureau of Land Management (BLM) is following suit in its venting and flaring rule, with supposed benefits between $115 million and $188 million that are largely based on the SCM.

The SCM models are highly technical works that require teams of skilled economists to really get “under the hood,” but the SCM is essentially a measurement of the external costs that come from the release of methane. The concept was first applied to carbon dioxide as the Social Cost of Carbon and has since been adapted to methane. It relies on economic and environmental models that project out to the year 2100 and beyond, making numerous shaky assumptions along the way. Even with the best information, developing a forecast that far into the future is a nearly impossible task. Even if we could credibly assume that models can accurately predict global economic and environmental conditions nearly a century into the future, we still run into another problem. Regulatory agencies like EPA and BLM are biased in their assumptions, because regulators always have an interest in more regulation. It’s tempting for them to make assumptions that overstate the benefits of new regulations.

There are specific guidelines for how agencies should conduct cost-benefit analyses to make them uniform and fair, but in many instances agencies disregard these basic guidelines. One important way that agencies stray from official guidelines is through their use of discount rates. Discounting is a way to account for the time value of money. In other words, money spent today can be worth more in the future depending on how it’s invested. A good investment will drive a stronger return and be worth a lot more in the future. A bad investment may be worth only slightly more, and perhaps even less than its value today.

Given that the impacts of climate change may be felt far into the future, SCM models favor low discount rates that weigh more heavily towards future financial impacts. Discount rates of 2.5%, 3%, and 5% all place an emphasis on future values. However, standard guidance dictates that agencies use 3% and 7% discount rates for their analyses. SCM models don’t incorporate that standard 7% discount rate for benefits, yet the agencies still analyze the costs of compliance of new rules at the 7% rate. This disproportionately favors the long-term benefits over today’s real-world costs, despite the fact that the agencies regularly admit long-term effects are highly uncertain and difficult to predict. The slanted use of discount rates put a heavy thumb on the scale in favor of the regulations.

The SCM is critical to justifying EPA’s and BLM’s new rules. Without SCM benefits, both rules would have net negative costs on society. We’re not suggesting that the social cost of methane is zero, but merely that it’s inflated in agency analysis. So if we correct for EPA and BLM’s biased assumptions, what is a more accurate number for the SCM?

NERA Economic Consulting took a look at SCM models to evaluate EPA’s proposed methane rule. NERA corrected for the flawed assumptions in SCM models regarding things like discount rate, radiative forcing rates, geographic inconsistencies in analysis, and inappropriate extrapolations about future mitigation policy. After correcting for these problems, NERA’s results were remarkable: the SCM may be 27 times too high. By correcting for many overstated assumptions, the SCM plummets from as high as $1,900/ton to just $69-$115/ton. For EPA and BLM rules, that means the SCM benefits crater from the $210 million range to below $20 million, putting both well into the red.