The world bank has recently released a briefing on the trends regarding pricing of carbon. With the upcoming COP 26 meeting and the promises of governments to hit carbon neutral targets in the coming decades the price of carbon becomes a vital theme which I’ll discuss here. The price of carbon can predominantly mean two things: The cost of the damage caused per tonnes CO2e released into the atmosphere or the cost of carbon credits / carbon taxes currently set by governments / the market.
If this is something that interests you, visit the website to review the briefing yourself.
World Map of Carbon Taxes
One of the key themes set out in this paper describes the vast variety in how carbon pricing works around the world and the different mechanisms designed to price carbon. The first thought that comes intuitively in regards to carbon pricing is that the damage 1 tonnes CO2e does to the environment is the same everywhere and CO2 emissions are a global problem. If we were to amalgamate the hard work accomplished by scientists across the globe we would probably be able to find something close to the true single figure. Until that happens, we will have to deal with the confusion of not having a single global cost of carbon and dealing with a massive variety of carbon pricing mechanisms to reach net zero.
Carbon credits Vs carbon taxes:
A quick explanation is required to discuss how carbon “reduction” prices work. By carbon reduction prices I mean the price we put on allowing ourselves to release carbon into the atmosphere whether that be taxing businesses per tonnes of CO2e they release or allowing businesses to purchase carbon credits to offset their emissions.
Carbon taxes are set by governments and charged to certain business that emit CO2e. Usually these taxes only kick in when a business emits over a certain limit which will be based on factors such as the industry average emissions and overall size of company. One of the problems with carbon tax is that is that it only provides a negative incentive to businesses to reduce their emissions. If a company goes above and beyond to reduce their emissions, they are only rewarded by not being taxed as much. This is where ETS schemes / compliant carbon credit markets can make a difference.
Emissions trading / cap and trade (ETS) work similarly to a carbon tax but allow markets to provide a reward / punishment system to businesses for their emissions. Like a carbon tax a government will set emissions limits for businesses; the key difference with ETS schemes is that instead of paying tax to the government, businesses will trade carbon credits with each other. If a company emits emissions higher than its annual limit then it will have to buy and retire carbon credits to reduce its footprint to the limit. If a company emits emissions lower than its annual limit it can produce carbon credits and sell on the national carbon exchange market. This structure provides a very healthy incentive structure which is allowing companies like TESLA and other green manufacturers to significantly improve net profits. One of the more beautiful aspects of this system is that it allows the direct flow of capital from the inefficiency businesses that emit to the efficient businesses that are reducing emissions. This means that this simple structure of carbon markets is providing direct private investment into green technologies and incentivizing investors to account for emissions when making investment decisions.
Going back to the discussion on the lack of a global single damage cost of carbon we also notice a similar mismatch in price of carbon credits produced from compulsory carbon credit markets between different countries.
Carbon Prices 2021
This mismatch could be due to a few things. First of all, the price will be very heavily based on the emissions limits provided by national government. If these limits are too low businesses will struggle to beat their emissions targets, struggle to produce additional credits for their market and therefore the price of carbon will increase due to market supply and demand. If the emissions targets are too high the opposite will happen. There will also be instances in which businesses in certain countries may manage to reduce their emissions more so than businesses in other countries. This is obviously a good thing but the net effect of this will be a significant increase in the availability of compulsory carbon credits and a drop in the market price. This would reduce further incentives for emissions reductions.
Is there a major problem the mismatch in the price of carbon between countries?
Should we strive to reach a single global market for compulsory carbon trading?
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 The World Bank. 2021. “State and Trends of Carbon Pricing 2021” (May), World Bank, Washington, DC. Doi: 10.1596/978-1-4648- 1728-1. License: Creative Commons Attribution CC BY 3.0 IGO
This is an adaptation of an original work by The World Bank. Responsibility for the views and opinions expressed in the adaptation rests solely with the author or authors of the adaptation and are not endorsed by The World Bank.
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