Social Discount Rate and the Energy Transition Policy

Energy transition is driven by policies that require investment in long-term undertakings such as energy infrastructures and/or the pricing of environmental externalities such as carbon emissions. The efficiency of such policies, in terms of resource allocation, is usually evaluated through cost–benefit analysis (CBA). As benefits and costs extend over long time horizons, they are converted to present value using a measure of the social discount rate. The higher the value of the social discount rate, the greater the importance given to the present at the expense of the future. Furthermore, the discount rate plays a central role in establishing the speed at which energy transition policy should achieve its objectives. A key problem is that certain aspects of the individual’s economic behaviour – such as those concerning the long term as well as other intertemporal preferences – cannot be easily reflected in the cost–benefit approach and discounting mechanism. Moreover, the long-term financial implications of energy transition policy are not generationally neutral, and this is hardly ever taken into account when using a social discount rate in the evaluation of energy policies. The economic net present value – a mere aggregation of discounted benefits and costs – alongside the well-known limits of the theoretical framework, from which the discount rate stems, are unmanageable obstacles for the appraisal of the importance of wealth transfers that may occur among multiple generations during long-term initiatives such as energy transition. This all means that the criteria under which energy transition policies achieve efficiency need to better reflect the preferences of society, with respect to the compensation that is required to renounce immediate consumption for future benefit. Furthermore, the efficiency of transition policies is necessary but not sufficient, the distributional impact of these policies needs to be examined with the aim of minimizing intergenerational equity issues that may arise.

By: Rahmat Poudineh , Domingo Penyalver