As countries prepare their updated national climate action plans, known as NDCs, which are essential to meet the temperature targets agreed under the Paris Climate Change Agreement, momentum is growing to put a price on carbon pollution as a means of bringing down emissions and driving investment into cleaner options.
A price on carbon sends a financial signal to investors that low-carbon investments are valuable today and will be even more valuable in the future and lets polluters decide for themselves whether to discontinue their polluting activity and reduce emissions or continue polluting and pay for it. By pricing carbon, governments capture the costs that the public pays for in other ways, such as health care costs from heatwaves and droughts, or damage to property from flooding and sea level rise.
Economists, businesses, governments, NGOs and international bodies like the World Bank, International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD), are advocating carbon pricing as a key instrument in transitioning to a low-carbon economy. UN Secretary-General António Guterres has also added his voice, saying “we need to see much more progress on carbon pricing.”
The two main types of carbon pricing are emissions trading systems (ETS) and carbon taxes. An ETS – sometimes referred to as a cap-and-trade system – caps the total level of greenhouse gas emissions for countries or companies and allows those with low emissions to sell their extra allowances to a larger emitter. Acarbon tax directly sets a price on carbon by defining a tax rate on greenhouse gas emissions or – more commonly – on the carbon content of fossil fuels.
Offsets and carbon reduction credits can be largely categorized into nature-based solutions such as afforestation or land management, and technological solutions where emissions in emerging markets are avoided through the adoption of low-carbon alternatives.
The European Union emissions trading system (EU ETS) is the world’s first major carbon market, and the biggest to date. The EU ETS is a cornerstone of the EU’s policy to combat climate change and its key tool for reducing greenhouse gas emissions cost-effectively. Korea also has a successful emissions trading scheme and many other countries are initiating and designing their own schemes.
Some 40 countries and more than 20 cities, states and provinces already use carbon pricing mechanisms, with more planning to enact them in the future. UN Climate Change is supporting countries in implementing these and other measures as part of their national climate plans through the Regional Collaboration Centres (RCCs) around the globe.
“It makes sense to recognize the price of carbon, otherwise we are not going to change our behavior,” says John Scott, Head of Sustainability Risk for Zurich and a member of the World Economic Forum’s Global Future Council on Frontier Risks.
“Until you get global transparency on carbon price and recognize the value of carbon in everything we buy as consumers and as companies, then we cannot make the rational economic decisions that will drive the right behaviors,” says Scott.
Using carbon pricing to lower emissions has seen some success in Europe, where the rising cost of allowances and cheaper natural gas have helped reduce the role of coal in the power sector, leading to an 8.3% drop in emissions last year, while global carbon trading jumped to a record high of USD214 billion in 2019. The EU’s Emissions Trading Scheme (ETS) made up about 80% of this volume, and the rollout of China’s national ETS is likely to increase this further.
A report released this month and endorsed by energy titans including Morgan Stanley, JPMorgan Chase & Co. and BP Plc. and more than two dozen other global businesses, investors and nonprofit organizations stated that the U.S. should price greenhouse gas pollution to ensure that financial markets reduce risks “consistent with the Paris agreement.”
Its authors stressed how unprepared financial markets are to deal with climate change, warning that without a carbon price “capital will continue to flow in the wrong direction, rather than toward accelerating the transition to a net-zero emissions economy.” According to the report, free trading of carbon offsets under a global scheme could cut costs of the Paris Agreement by up to 33% by 2030.
Article 6 of the Paris Agreement stipulates that countries can cooperate in delivering their NDCs, but the rules for international transfers and for the mechanism have yet to be finalized by Parties. This important issue will be picked up at COP26 in Glasgow in 2021.