Carbon price

Emission trading and carbon taxes around the world (2021)

  Carbon emission trading implemented or scheduled

  Carbon tax implemented or scheduled

  Carbon emission trading or carbon tax under consideration

Carbon pricing (or CO₂ pricing) is a method for nations to address climate change. The cost is applied to greenhouse gas emissions in order to encourage polluters to reduce the combustion of coal, oil and gas – the main driver of climate change. The method is widely agreed and considered to be efficient. Carbon pricing seeks to address the economic problem that emissions of CO₂ and other greenhouse gases (GHG) are a negative externality – a detrimental product that is not charged for by any market.

A carbon price usually takes the form of a carbon tax or a Cap and Trade system (generally via an emissions trading scheme (ETS)), a requirement to purchase allowances to emit.

21.7% of global GHG emissions are covered by carbon pricing in 2021, a major increase due to the introduction of the Chinese national carbon trading scheme. Regions with carbon pricing include most European countries and Canada. On the other hand, top emitters like India, Russia, the Gulf states and many US states have not yet introduced carbon pricing. Australia had a carbon pricing scheme from 2012 to 2014. In 2020, carbon pricing generated $53bn in revenue.

According to the Intergovernmental Panel on Climate Change, a price level of $135–5500 in 2030 and $245–13,000 per ton CO₂ in 2050 would be needed to drive carbon emissions to stay below the 1.5°C limit.

Latest models of the social cost of carbon calculate a damage of more than $3000/tCO₂ as a result of economy feedbacks and falling global GDP growth rates, while policy recommendations range from about $50 to $200. Many carbon pricing schemes including the ETS in China remain below $10/tCO₂. One exception is the European Union Emissions Trading System (EU-ETS) which exceeded 100€/tCO₂ ($118) in February 2023.

A carbon tax is generally favoured on economic grounds for its simplicity and stability, while cap-and-trade theoretically offers the possibility to limit allowances to the remaining carbon budget. Current implementations are only designed to meet certain reduction targets.

Purposes

Carbon pricing is considered by many economists to be the most efficient way to reduce emissions. This means that it reduces emissions for the least possible cost, where these costs include the cost of efficiency measures as well as the cost of the inconvenience of making do with less of the goods and services provided by fossil fuels. This efficiency comes about by eliminating a market failure (the un-priced external costs of carbon emissions) at its source – by pricing these costs.

Economics points out that since regulators would have an extremely hard time finding out the value that each emitter receives from emitting, this efficient outcome is extremely unlikely if the regulator chooses who can emit and who cannot. This is why economics teaches that command and control regulation will not be efficient, and will be less efficient than a market mechanism, such as carbon pricing. In the words of the IPCC, "[renewable energy subsidies] are less efficient alternatives to carbon taxes and emissions trading for inducing mitigation" (section 3.8.1.2).

Concepts

Emissions Trading

Carbon emission trade – allowance prices from 2008

Main article: Carbon emission trading

In a cap-and-trade design, the market for permits automatically adjusts the carbon price to a level that insures that the cap is met. The government establishes an emissions cap, for example 1000 tCO₂ per year. Then it either gives the allowances to stakeholders, or auctions them off to the highest bidder. After the permits have been distributed, they can be traded privately. Emitters without the required allowances face a penalty that would cost more than buying permits. If the cap is low, permits will be in short supply (scarcity) and the price of permits will be high.

The EU ETS uses this method. In practice it resulted in a fairly strong carbon price from 2005 to 2009, but that was later undermined by an oversupply as well as by the Great Recession. Recent policy changes have led to a steep increase of the carbon price since 2018, exceeding 100€/tCO₂ ($118) in February 2023.

Carbon tax

This section is an excerpt from Carbon tax.[edit]

A carbon tax would add a fee for the carbon dioxide emitted from this coal-fired power plant in Luchegorsk, Russia.

A carbon tax is a tax levied on the carbon emissions from producing goods and services. Carbon taxes are intended to make visible the hidden social costs of carbon emissions. They are designed to reduce greenhouse gas emissions by essentially increasing the price of fossil fuels. This both decreases demand for goods and services that produce high emissions and incentivizes making them less carbon-intensive. When a fossil fuel such as coal, petroleum, or natural gas is burned, most or all of its carbon is converted to CO₂. Greenhouse gas emissions cause climate change. This negative externality can be reduced by taxing carbon content at any point in the product cycle.

In its simplest form, a carbon tax covers only CO₂ emissions. It could also cover other greenhouse gases, such as methane or nitrous oxide, by taxing such emissions based on their CO₂-equivalent global warming potential.

Hybrid designs

Cap-and-trade systems can include price stability provisions with floor and ceiling limits. Such designs are often referred to as hybrid designs. To the extent the price is controlled by these limits, it can be considered a tax.

Carbon tax versus emissions trade

Carbon emissions trading works by setting a quantitative limit on the emissions produced by emitters. As a result, the price automatically adjusts to this target. This is the main advantage compared to a fixed carbon tax. A carbon tax is considered easier to enforce on a broad-base scale than cap-and-trade programs. The simplicity and immediacy of a carbon tax has been proven effective in British Columbia, Canada – enacted and implemented in five months. A hybrid cap-and-trade program puts a limit on price increases and, in some cases, sets a floor price as well. The upper limit is set by adding more allowances to the market at a set price while the floor price is maintained by not allowing sales into the market at a price below the floor. The Regional Greenhouse Gas Initiative, for example, sets an upper limit on allowance prices through its cost containment provision.

However, industries may successfully lobby to exempt themselves from a carbon tax. It is therefore argued that with emissions trading, polluters have an incentive to cut emissions, but if they are exempted from a carbon tax, they have no incentive to cut emissions. On the other hand, freely distributing emission permits could potentially lead to corrupt behaviour.

Most cap and trade programs have a descending cap, usually a fixed percentage every year, which gives certainty to the market and guarantees that emissions will decline over time. With a tax, there can be estimates of reduction in carbon emissions, which may not be sufficient to change the course of climate change. A declining cap gives allowance for firm reduction targets and a system for measuring when targets are met. It also allows for flexibility, unlike rigid taxes. Providing emission permits (also called allowances) under emissions trading is preferred in situations where a more accurate target level of emissions certainty is needed.

Revenue policies

Standard proposals for using carbon revenues include

• a return to the public on a per-capita basis This can compensate the risk of rising energy prices reaching high levels as long as cheap wind and solar power is not available yet. Rich people who tend to have a larger carbon footprint would pay more while poorer people can even benefit from such a regulation.
• subsidies accelerating the transition to renewable energy
• research, public transport, car sharing and other policies that promote carbon neutrality
• subsidies for negative emissions: Depending on the technology, such as PyCCS or BECCS, the cost for generating negative emissions is about $150–165 per ton of CO₂. The removal past emissions – 1,700 Gt in total – can theoretically be addressed by auctioning allowances starting with a price that exceeds the removal costs of the proposed emissions.

Social cost of carbon

Main article: Social cost of carbon

The exact monetary damage caused by a tonne of CO₂ depends on climate and economic feedback effects and remains to some degree uncertain. Latest calculations show an increasing trend. Dynamic models include discount rates. This results in lower costs in the current state and higher costs once that carbon budgets are used up.

Source	Year	carbon price per tCO2	remarks
Interagency Working Group (US government)	2013 / 2016	$42	Central estimate for 3% discount rate in 2020
		$212	high impact value for 2050 / 3% discount / 95th percentile
German Environmental Agency	2019	$213 (180 €)	with 1% time preference
		$757 (640 €)	without time preference
Kikstra et al.	2021	$3372	including economic feedbacks

Price levels

About one third of the systems stays below $10/tCO₂, the majority is below $40. One exception is the steep incline in the EU-ETS reaching $60 in September 2021. Sweden and Switzerland are the only countries with more than $100/tCO₂.

Carbon prices (USD) in 2021

Market price surge in fossil fuels

Unexpected spikes in natural gas prices and commodities such as oil and coal in 2021 caused a debate whether a carbon price increase should be postponed to avoid additional social burden. On the other hand, a redistribution on a per-capita-basis would even release poorer households which tend to consume less energy compared to wealthier parts of the population. The higher the high carbon price the greater the relief. Looking at individual situations though, the compensation would not apply to commuters in rural areas or people living in houses with poor insulation. They neither have liquidity to invest into solutions using less fossil fuels and would be dependent on credits or subsidies. On the other hand, a carbon price still helps to provide an incentive to use more effective fossil fuel technologies such as CCGT gas turbines in contrast to high-emission coal.

Scope and coverage

In the relevant countries with ETS and taxes, about 40% to 80% of emissions are covered. The schemes differ much in detail. They include or exclude fuels, transport, heating, agriculture or other greenhouse gases apart from CO₂ like methane or fluorinated gases. In many EU member states like France or Germany, there is a coexistence of two systems: The EU-ETS covers power generation and large industry emissions while national ETS or taxes put a different price on petrol, natural gas and oil for private consumption.

Carbon pricing schemes with more than $2 bn revenue

country / region	type	share	coverage / remarks	revenue 2020
			EU		ETS	39%	industry, electricity, intra-EU aviation	$22.5 bn
China	ETS	40%	electricity, district heating	launched 2021
Canada	tax	22%	National pricing in Canada, additional taxes and ETS in provinces	$3.4 bn
France	tax	35%	non EU-ETS	$9.6 bn
Germany	ETS	40%	non EU-ETS: transport, heating	$ 8.75 bn (€7.4 bn) expected, launch 2021
Japan	tax	75%		$2.4 bn
Sweden	tax	40%	transport, buildings, industry, agriculture	$2.3 bn

Other taxes and price components

The final consumer price for fuels and electric energy depends on individual tax regulations and conditions in each country. Though carbon pricing is playing an increasing role, energy taxes, VAT, utility expenses and other components are still the main cause for completely different price levels between countries.

Impact on retail prices

The table gives examples for a carbon price of $100 or 100 units of any other currency accordingly. Food calculation is all based on CO₂ equivalents including the high impact of methane emissions.

FUEL	impact
1 L petrol	$0.24
1 L diesel	$0.27

TRANSPORT	impact	remarks
500 km car travel, 1 passenger	$8.40	7 L petrol per 100 km
500 km jet aircraft per seat	$6.70	0.134 kgCO2/km, Domestic flight NZ, A320, 173 seats, all occupied, with radiative forcing multiplier
500 km small aircraft per seat	$32.95	0.659 kgCO2/km, Domestic flight NZ, less than 50 seats, all occupied
5000 km jet aircraft, economy class, per seat	$76.50	0.153 kgCO2/km, >3700 km
5000 km jet aircraft, first class, per seat	$292.50	0.585 kgCO2/km, >3700 km

ELECTRICITY	impact
1 kWh lignite	$0.11
1 kWh hard coal	$0.10
1 kWh natural gas	$0.06
1 kWh natural gas (CCGT)	$0.04

HEAT	impact
1 KWh from natural gas	$0.02
1 KWh from light fuel oil	$0.03
1 L light fuel oil	$0.29

FOOD	at farm gate	life cycle assessment	source / remarks
1 kg lamb	$2.04	$3.92
1 kg beef	$1.52	$2.70	$33.50 with land-use in tropical rain forests
1 kg butter	$1.47
1 kg cheese	$0.98	$1.35
1 kg pork	$0.46	$1.21
1 kg rice	$0.24	$0.27	white rice
1 kg chicken	$0.23	$0.69
1 kg fish	$0.41	$0.61	salmon / canned tuna
1 kg eggs	$0.20	$0.41	100 g per egg
1 kg nuts	$0.13	$0.23
1 L milk	$0.11	$0.19	2% fat
1 kg tofu	$0.07	$0.20
1 kg potatoes	$0.03	$0.29	Eastern Idaho

Economics

See also: Economics of climate change mitigation

Many economic properties of carbon pricing hold regardless of whether carbon is priced with a cap or a tax. However, there are a few important differences. Cap-based prices are more volatile and so they are riskier for investors, consumers and for governments that auction permits. Also, caps tend to short-out the effect of non-price policies such as renewables subsidies, while carbon taxes do not.

Carbon leakage

Carbon leakage is the effect that regulation of emissions in one country/sector has on the emissions in other countries/sectors that are not subject to the same regulation. There is no consensus over the magnitude of long-term carbon leakage.

The leakage rate is defined as the increase in CO₂ emissions outside the countries taking domestic mitigation action, divided by the reduction in emissions of countries taking domestic mitigation action. Accordingly, a leakage rate greater than 100% means that actions to reduce emissions within countries had the effect of increasing emissions in other countries to a greater extent, i.e., domestic mitigation action had actually led to an increase in global emissions.

Estimates of leakage rates for action under the Kyoto Protocol ranged from 5% to 20% as a result of a loss in price competitiveness, but these leakage rates were considered very uncertain. For energy-intensive industries, the beneficial effects of Annex I actions through technological development were considered possibly substantial. However, this beneficial effect had not been reliably quantified. On the empirical evidence they assessed, Barker et al. (2007) concluded that the competitive losses of then-current mitigation actions, e.g., the EU-ETS, were not significant.

Under the EU ETS rules Carbon Leakage Exposure Factor is used to determine the volumes of free allocation of emission permits to industrial installations.

A general perception among developing countries is that discussion of climate change in trade negotiations could lead to green protectionism by high-income countries Eco-tariffs on imports ("virtual carbon") consistent with a carbon price of $50 per ton of CO₂ could be significant for developing countries. In 2010, World Bank commented that introducing border tariffs could lead to a proliferation of trade measures where the competitive playing field is viewed as being uneven. Tariffs could also be a burden on low-income countries that have contributed very little to the problem of climate change.

Interactions with renewable energy policies

Cap-and-trade and carbon taxes interact differently with non-price policies such as renewable energy subsidies. The IPCC explains this as follows:

A carbon tax can have an additive environmental effect to policies such as subsidies for the supply of RE. By contrast, if a cap-and-trade system has a binding cap (sufficiently stringent to affect emission-related decisions), then other policies such as RE subsidies have no further impact on reducing emissions within the time period that the cap applies [emphasis added].

Carbon pricing and economic growth

According to a 2020 study carbon prices have not harmed economic growth in wealthy industrialized democracies.

In order for such a business model to become attractive, the subsidies would therefore have to exceed this value. Here, a technology openness could be the best choice, as a reduction in costs due to technical progress can be expected. Already today, these costs of generating negative emissions are below the costs of CO₂ of $220 per ton, which means that a state-subsidized business model for creating negative emissions already makes economic sense today. In sum, while a carbon price has the potential to reduce future emissions, a carbon subsidy has the potential to reduce past emissions.

Advantages and disadvantages

See also: Carbon emission trading

In late 2013, William Nordhaus, president of the American Economic Association, published The Climate Casino, which culminates in a description of an international "carbon price regime". Such a regime would require national commitments to a carbon price, but not to a specific policy. Carbon taxes, caps, and hybrid schemes could all be used to satisfy such a commitment. At the same time Martin Weitzman, a leading climate economist at Harvard, published a theoretical study arguing that such a regime would make it far easier to reach an international agreement, while a focus on national targets would continue to make it nearly impossible. Nordhaus also makes this argument, but less formally.

Similar views have previously been discussed by Joseph Stiglitz and have previously appeared in a number of papers. The price-commitment view appears to have gained major support from independent positions taken by the World Bank and the International Monetary Fund (IMF).

The "Economists' Statement on Climate Change" was signed by over 2500 economists including nine Nobel Laureates in 1997. This statement summarizes the economic case for carbon pricing as follows:

The most efficient approach to slowing climate change is through market-based policies. In order for the world to achieve its climatic objectives at minimum cost, a cooperative approach among nations is required – such as an international emissions trading agreement. The United States and other nations can most efficiently implement their climate policies through market mechanisms, such as carbon taxes or the auction of emissions permits.

This statement argues that carbon pricing is a "market mechanism" in contrast to renewable subsidies or direct regulation of individual sources of carbon emissions and hence is the way that the "United States and other nations can most efficiently implement their climate policies."

Carbon offsets for individuals and businesses may also be purchased through carbon offset retailers like Carbonfund.org Foundation.

A new quantity commitment approach, suggested by Mutsuyoshi Nishimura, is for all countries to commit to the same global emission target. The "assembly of governments" would issue permits in the amount of the global target and all upstream fossil-fuel providers would be forced to buy these permits.

In 2019 the UN Secretary General asked governments to tax carbon.

The economics of carbon pricing is much the same for taxes and cap-and-trade. Both prices are efficient; they have the same social cost and the same effect on profits if permits are auctioned. However, some economists argue that caps prevent non-price policies, such as renewable energy subsidies, from reducing carbon emissions, while carbon taxes do not. Others argue that an enforced cap is the only way to guarantee that carbon emissions will actually be reduced; a carbon tax will not prevent those who can afford to do so from continuing to generate emissions.

Besides cap and trade, emission trading can refer to project-based programs, also referred to as a credit or offset programs. Such programs can sell credits for emission reductions provided by approved projects. Generally there is an additionality requirement that states that they must reduce emissions more than is required by pre-existing regulation. An example of such a program is the Clean Development Mechanism under the Kyoto Protocol. These credits can be traded to other facilities where they can be used for compliance with a cap-and-trade program. Unfortunately the concept of additionality is difficult to define and monitor, with the result that some companies purposefully increased emissions in order to get paid to eliminate them.

Cap-and-trade programs often allow "banking" of permits. This means that permits can be saved and can be used in the future. This allows an entity to over-comply in early periods in anticipation of higher carbon prices in subsequent years. This helps to stabilize the price of permits.

See also

• European Union Emissions Trading System

References

Sources

• IPCC (2018). Masson-Delmotte, V.; Zhai, P.; Pörtner, H.-O.; Roberts, D.; et al. (eds.). Global Warming of 1.5°C. An IPCC Special Report on the impacts of global warming of 1.5°C above pre-industrial levels and related global greenhouse gas emission pathways, in the context of strengthening the global response to the threat of climate change, sustainable development, and efforts to eradicate poverty (PDF). Intergovernmental Panel on Climate Change. Global Warming of 1.5 °C —.
  • de Coninck, H.; Revi, A.; Babiker, M.; Bertoldi, P.; et al. (2018). "Chapter 4: Strengthening and Implementing the Global Response" (PDF). IPCC SR15 2018. pp. 313–443.

• Kikstra, Jarmo S; Waidelich, Paul; Rising, James; Yumashev, Dmitry; Hope, Chris; Brierley, Chris M (September 6, 2021). "The social cost of carbon dioxide under climate-economy feedbacks and temperature variability". Environmental Research Letters. 16 (9): 094037. Bibcode:2021ERL....16i4037K. doi:10.1088/1748-9326/ac1d0b. S2CID 237427400.

• Bank, World (2021). State and Trends of Carbon Pricing 2021. The World Bank. doi:10.1596/978-1-4648-1728-1. ISBN 978-1-4648-1728-1. S2CID 242987579.

• "Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866" (PDF). Interagency Working Group on Social Cost of Greenhouse Gases (US govt.). 2016. Retrieved September 12, 2021.

• "Measuring Emissions: A Guide for Organisations" (PDF). Ministry for the environment, New Zealand. 2020.
• Quaschning, Volker. "Specific Carbon Dioxide Emissions of Various Fuels". Retrieved September 23, 2021.
• "Meat Eater's Guide" (PDF). Environmental Working Group. 2011.
• Noleppa, Steffen (2012). "Klimawandel auf dem Teller" (PDF) (in German). WWF Germany. Archived from the original (PDF) on November 1, 2020.

External links

• Our Climate Put A Price On It campaign
• CDM Rulebook — Defines Kyoto commitments
• UN Climate Change Framework — Lists national commitments for 2020
• Pricing Carbon Initiative — US focused effort for carbon-pricing commitments