Imagine peacefully cruising and suddenly hearing a loud noise from your car. You feel a sense of unease as you realise something might be wrong. As you keep driving, the noise gets louder and more persistent, making you worry even more.
This feeling of unease and worry is similar to what we're experiencing with climate change. It's a problem that's gradually worsening, and we can't ignore it any longer. The consequences of inaction are dire. We're already seeing the effects of rising temperatures, extreme weather events, and biodiversity loss.
But just like how you wouldn't ignore the strange noise, we can't ignore climate risks. We need to take action to solve it, and one of our best tools is carbon pricing.
Carbon pricing puts a price on carbon emissions. This incentivises businesses and individuals to reduce emissions and invest in cleaner technologies. By implementing carbon pricing, we can tackle the costs of climate change head-on while benefiting the economy.
What is the Social Cost of Carbon?
The social cost of carbon is the monetary value of the damages caused by emitting one tonne of carbon dioxide into the atmosphere. It reflects the costs imposed on society, including the impact on human health, property, and ecosystems.
We can account for these costs by pricing carbon and incentivising polluters to reduce emissions. Theoretically, the social cost of carbon should equal the carbon price levied.
How Does Carbon Pricing Work?
Carbon pricing schemes create economic incentives for reducing emissions.
There are two main types of carbon pricing mechanisms: Carbon Tax and Cap-and-Trade System. Additionally, organisations may use Shadow Carbon Pricing to plan for a low-carbon future.
Carbon Taxes
A carbon tax directly imposes a fee on industries for each tonne of carbon emitted. Increasing costs incentivises companies to invest in cleaner technologies and carbon reduction projects.
Carbon taxes are straightforward to implement and predict. This provides certainty for businesses planning long-term strategies.
Cap-and-Trade Systems
The cap-and-trade system sets a cap on carbon emissions for specific industries. It is also known as an Emissions Trading System (ETS). Allowances to emit carbon are distributed, and companies may trade allowances among themselves.
Companies emitting less than their allocation can sell surplus allowances. While those exceeding their limit must purchase more allowances or face penalties.
This system creates a market that encourages low-emission practices and innovative technologies.
Shadow Carbon Pricing
Companies use shadow carbon pricing to predict the financial impact of future carbon-related regulations.
An artificial price for carbon emissions is assigned in financial analyses. It helps companies evaluate the long-term viability of projects and investments.
The practice prepares businesses for policy changes and identifies opportunities to transition to a low-carbon economy.
Economic Benefits
Less Burden on Individuals, More on Large Emitters
The financial burden of climate change mitigation moves from the public to the producers.
Producers can reduce their emissions or be financially accountable for their actions.
Revenue Generation and Investment
Carbon pricing revenue can be invested in various ways, benefitting the economy and environment. For example, governments can:
- Fund clean energy projects
- Support research and development of low-carbon technologies
- Help vulnerable communities adapt to climate change impacts
In 2021, global carbon pricing raised $84bn in revenue.
Promoting Energy Efficiency and Cleaner Technologies
Economic and climate benefits can be simultaneously achieved by encouraging energy efficiency.
- Carbon-intensive fuels and goods become more expensive.
- Companies and households reduce emissions in response.
- They seek cleaner and more efficient alternatives to save money.
- This drives innovation in low-carbon technologies.
Market-Based Approach and Business Opportunities
Carbon prices are a market-based approach to reducing greenhouse gas emissions. It allows businesses and households to choose how they reduce emissions. This flexibility leads to cost-effective emission reductions across industries.
Carbon markets create new business opportunities. Companies that cut emissions more than required can sell their excess allowances to other firms. This incentivises low-carbon innovation and growth.
Regional and National Carbon Pricing Initiatives
European Union Emissions Trading System
The European Union Emissions Trading System (EU ETS) is a cornerstone of the EU's action on climate change. It works as a cap-and-trade system where companies can buy and sell allowances. The EU ETS covers:
- 30 countries, including EEA members
- 10,000 installations in the energy, manufacturing and aviation sectors
- Approximately 40% of the EU's greenhouse gas emissions
This system encourages businesses to invest in clean technologies, thereby reducing emissions.
Regional Greenhouse Gas Initiative in the United States
The Regional Greenhouse Gas Initiative (RGGI) is a cooperative between twelve eastern states in the USA. The initiative aims to reduce carbon dioxide emissions from power plants.
RGGI is a market-based cap-and-invest initiative. Regulated power plants in RGGI states must obtain one RGGI CO2 allowance for every short ton of CO2 they emit.
Since RGGI's inception, emissions have reduced by over 50%, twice as fast as the national average. The initiative has raised nearly $6 billion to invest in local communities.
RGGI funds are reinvested into clean energy and other consumer benefit programs.
Carbon Pricing in Canada
Canada's carbon pricing system has a federal backstop policy for provinces that do not meet the minimum standard. The plan consists of:
- A carbon levy on fossil fuels
- An output-based pricing system for industrial facilities emitting over a certain threshold
Provinces can implement their carbon pricing programs, provided they satisfy federal requirements.
State-Based Initiatives in the United States
Several US states have implemented their carbon pricing policies. The carbon pricing efforts include California's cap-and-trade program and Washington's emissions tax. Highlights include:
- California: Implemented in 2013, covers 80% of the economy, known for efficient market performance
- Washington: Carbon fee on large emitters, raising $558 million by 2023, funds renewable energy and environmental projects
These state-based initiatives demonstrate various carbon pricing instruments and their potential impacts.
How Effective is Carbon Pricing?
The effectiveness of carbon pricing depends on various factors, including design and implementation. Carbon pricing can lead to:
Efficiency in Emission Reductions
Businesses and households are incentivised to reduce emissions, spurring innovation. This market-based approach touches different sectors like electricity, manufacturing, and transportation.
Economic Benefits
Carbon pricing generates government revenue. This money can fund projects that support low-income groups or further climate action. It stimulates economic growth by promoting clean technologies.
Reliability and Environmental Integrity
Effective carbon pricing reduces practices that harm the environment. Design and enforcement play a crucial role in ensuring long-term benefits.
Challenges and Limitations
Despite its benefits, carbon pricing faces certain challenges:
- Public acceptance. Some groups oppose carbon pricing due to the economic impact, as it may increase the cost of goods and services
- Compatibility. Carbon pricing must align with existing policies for maximum effectiveness and to avoid unintended consequences.
- Global cooperation. Coordinated efforts are required to create a level playing field for international trade.
- Fairness. Pricing should be implemented fairly so that vulnerable and low-income communities are not disproportionately affected.
- Limited Scope. Governments are not accounting for other dangerous gases like methane by focusing exclusively on carbon. This makes meeting net zero goals harder.
Summing Up
Carbon pricing offers significant benefits. It stimulates economic growth, incentivises cleaner alternatives, and enables emissions reduction. However, effective design and enforcement are crucial in ensuring long-term benefits.
