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2.4 Measuring Cost Effectiveness

There are several technical measures and practices that have a great potential to reduce CO2 emissions, see for instance Chap. 5. It is obviously very important to evaluate the various reduction measures based on their environmental effectiveness, that is, the proposed measure should be able to contribute to achieving a particular stabilization level or, consequently, a specific reduction target to avoid dangerous climate change in accordance with Article 2 of the UNFCCC. However, emission reductions come at a cost, which in some cases is very high. Thus, costeffectiveness plays a very important role in decision-making. In line with the above, Article 3(3) of the Convention states that the

Parties should take precautionary measures to anticipate, prevent or minimize the causes of climate change and tak[e] into account that policies and measures to deal with climate change should be cost-effective so as to ensure global benefits at the lowest possible cost.

2.4.1 Cost Effectiveness Index

Without entering into details, cost effectiveness is measured by a simple ratio, usually referred to as the Marginal Abatement Cost (MAC), which is defined as the ratio of the net present value (NPV) of a specific abatement measure, divided by the corresponding emissions reduction for the entire lifetime of the project, see Eq. (2.8). The net present value of the emissions reduction measure takes into account the costs and the benefits.

In general, the cost component (present value of costs) consists of the one-time (initial) and running costs of the measure, cumulating over the lifetime of the system. The benefit part (present value of monetary benefits) is much more intricate. In addition, benefits and costs occurring in different time periods within the lifetime of the project have to be aggregated to obtain the net present value (NPV). All actions have an associated flow of costs and benefits during their life time (T years) that have to be added to obtain the NPV.

The net present value (NPV) of implementing an abatement measure is calculated using the following equation:

where

Bt are benefits in period t; Ct the costs in period t;

r is rate used for discounting (per period); and

T the number of periods (usually years) the project will last.

To discount a flow of n equal amounts A (can be costs or benefits) that incur at regular intervals (for instance at the end of each period for a total of T periods) assuming that the discounting rate is constant, it can be easily shown (see for example Brealey and Meyers (2003)) that the present value (PV) of this money flow (cost or benefit) is:

The denominator is the mass of emissions averted. For the case of GHGs the notion of CO2eq can be used.

2.4.1.1 MAC for a Specific Emissions Reduction Measure: An Illustrative Example

Based on the previous definition we now illustrate a way to estimate the cost effectiveness of a reduction measure by using the following example. Assume a GHG reduction measure is repeated every L years (L is the life of the measure) during the N years, which is the lifetime of the project. The times that the measure is repeated is λ and is equal to the nearest integer rounded down of the fraction N/L. The annual costs (AC) of the project are supposed to be known and occur every year except the years when the measure is applied and there exist only capital costs (C).

Furthermore, the benefits are supposed to be equal to the bunker savings (although this may be extended to include other benefits too). The benefits are estimated as follows:

B ¼ p • α • FC

where p is the bunker price ($ per tonne), α is the abatement potential (%) and FC is the annual fuel consumption (without the measure).

The Net Present Value can be estimated as follows

The potential CO2 abatement for this project is equal to

ΔR ¼ N • a • f • FC

where f is the CO2 emissions factor.

Therefore, the marginal abatement cost of this project is equal to

 
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