The World Bank has long held the view that putting a “price on carbon” is, and would be, the most efficient and cost-effective means of reducing emissions, and ultimately addressing climate change . This outlook has been reiterated over the past few months by business leaders, senior political figures and institutional leaders - all of whom have called for increased use of carbon pricing.
But what is a carbon price...
A carbon price is a cost applied to greenhouse gas (GHG) emissions to encourage individuals, organisations and nation-states to reduce the amount they emit .
... and why do we need it?
Climate change is considered a market failure by economists because the huge costs and risks on future generations are not fully reflected in market prices. Economists widely agree that, to address this market failure, a cost (or carbon price) should be applied to GHG emissions to achieve deep decarbonisation for several reasons:
By putting a price on and internalising the costs of future environmental damage; investors and consumers understand the true cost of generating GHG emissions.
Markets can efficiently encourage emission reductions by rewarding those who improve and punishing those who stagnate.
A carbon price has the effect of encouraging lower-carbon behaviour (e.g. using a bike rather than driving a car).
The money raised by a carbon price can be used to finance lower-carbon activities.
Interestingly, there are a number of carbon pricing already in existence at various levels.
At a global level
Perhaps the best known example is at a regional level, with the EU quota (or cap-and-trade) system. In this model, the total allowable emissions in a country or region are set in advance ("capped"). Permits to pollute are created for the allowable emissions budget, and either allocated or auctioned to companies. The companies can trade permits between one another, introducing a market for pollution that should ensure that the carbon savings are made as cheaply as possible. In this model, a ton of carbon currently costs approximately $5 .
At a national level
China is preparing to launch a national carbon market and California has established a cap-and-trade model. At this scale, there is a diverse range of carbon prices - for instance; from less than $1 per ton in Mexico to more than $100 per ton in Sweden .
At an organisational level
A number of companies are already exposed to a price on carbon emissions by participating in the above national or regional carbon markets. Further, implementing internal or shadow carbon prices in their own businesses can test whether investments will be viable in a world where carbon has a higher price, or as part of carbon reduction strategies. At least 150 major corporations have tested internal carbon pricing as of 2014, ranging from Google and Mars to Exxon Mobil. Some have disclosed the ‘internal’ or ‘shadow’ carbon price in their investment decisions, e.g. BP uses $40/tCO2, Google uses $14/tCO2, Mars uses $20-30/tCO2 and Microsoft uses $6-7/tCO2 .
Microsoft have announced the results of their first three years of an internal carbon pricing program and a related carbon fee investment fund. Within which, individual Microsoft departments have added a budget line item reflecting the financial value of their emissions. For instance, instead of a paper clip costing $1 a box, by including the hidden carbon cost the box is actually $1.20. Through this initiative, Microsoft report $10 million in annual energy savings - emissions reductions on the order of 7.5 million metric tons of carbon dioxide equivalent and 10.2 billion kilowatt-hours worth of new renewable energy investments .
The overall principles of carbon pricing
The use of carbon pricing offers a unique market-led way to address climate change, which does not necessarily require a radical overhaul of our market-economics, rather the market simply decarbonises itself.
Internal carbon prices are important new tools for business - not only to address their carbon footprint, but also to prepare for future national, industry and regional carbon prices.
Having a price is the most obvious and direct way to force (or allow) companies to consider carbon in their investment decisions, and consumers to think about it in their purchasing decisions.
There needs to be a uniform carbon price across the world, reflecting the fact that a ton of carbon dioxide does the same amount of damage over time regardless of where it is emitted. Uniform pricing would also remove the risk that polluting businesses flee to so-called "pollution havens" – countries where a lack of environmental regulation enables them to continue to pollute unrestrained.
Governments should also play a role whenever distorted incentives or behavioural biases prevent prices alone from succeeding.
For more information, please contact Dr Jim Ormond or Jane Fiona Cumming.
NOTE: This article was originally written in 2016, therefore some of the data and prices may have fluctuated.
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