Why Pricing Carbon Is Still More Theory Than Reality

(Bloomberg) -- It’s an idea that’s been around for more than two decades: To slow climate change, make polluters pay for the damage they cause. Worldwide, more than 60 nations, states and cities have adopted what’s known as carbon pricing. The approach is held up by environmentalists, politicians and even many oil companies as an elegant, free-market approach compared with direct regulation. But while the concept may have broad support, the actual working of such systems have proved hugely controversial in Canada, Australia and other countries.

1. How does carbon pricing work?

There are two main approaches. In one, carbon prices are set by governments as a tax or fee on carbon dioxide emitted. In the other, governments create a market and an incentive to reduce emissions but let the market’s participants determine the exact price of carbon. Such markets usually cover a select portion of a country’s total emissions, with most charges focused on utilities that produce electricity. The government sets a limit on the total volume of emissions allowed; then permits are either allocated to or purchased by polluters. The credits can be bought and sold, a system known as cap-and-trade.

2. Is carbon pricing effective?

Environmentalists say most policy makers have been unwilling to set prices high enough to force changes in behavior. That said, the levies from Europe’s carbon trading systems have encouraged more switching to cleaner natural gas. The U.K.’s carbon tax is credited with helping the country rapidly phase out coal.

3. What programs are making headlines?

• European Union officials spelled out in July how exactly the 27-nation bloc plans to become carbon neutral by the middle of the century. That will include the biggest overhaul to date of its 16-year-old emissions market. The permits will be harder to come by, with new rules increasing the rate at which the pollution cap shrinks each year to 4.2% from 2.2% now. It will be extended to include maritime transport. Airlines will eventually have to pay for all their pollution in the cap-and-trade program, as their free allowances will be phased out. A parallel emissions trading plan will also be created for heating and road transport fuels.
• China plans to reach net-zero by 2060 and sees its emissions peaking before the end of this decade. Its multifaceted approach includes a national carbon market, with trading in Shanghai. After multiple delays, the cap-and-trade system will start in July. Authorities will quickly work on setting emissions accounting rules and on guidance for pollution rights for industries beyond the power sector, the first to be covered under the initiative, according to Vice Minister of Ecology and Environment Zhao Yingmin. The program has been criticized for not being tough enough and is expected to have limited real-world impact at its outset. It probably won’t be enough to avoid the European Union imposing its planned so-called Carbon Border Adjustment Mechanism on Chinese goods to ensure European businesses have a level playing field vis-a-vis their competitors in jurisdictions with laxer pollution rules.
• President Joe Biden in April vowed to cut U.S. greenhouse gas emissions in half by 2030. While regional carbon markets will play their part, critics say that the absence of a policy for a national price on emissions could slow progress. At the same time, support for such a measure is growing among the nation’s biggest energy producers and businesses. The American Petroleum Institute in March voted in favor of a tax or a national cap-and-trade program to replace existing regulations on greenhouse gases.
• The Supreme Court of Canada in March ruled that the nation’s carbon tax is constitutional, effectively settling years of political debate about its legality. The measure is a major policy tool for Prime Minister Justin Trudeau, who has faced criticism from environmentalists that his government isn’t doing enough to stem global warming. Canada’s national target is less ambitious than both that of the U.S. and the U.K.’s.

4. How widespread is carbon pricing?

Carbon markets in existence include the EU’s and a dozen U.S. states. Almost 30 nations have carbon taxes. They range from less than $1 a metric ton in Mexico to about $140 in Sweden. Many countries use permit trading alongside targeted taxes on dirty fuels such as coal. Still, carbon pricing only covers about 20% of global emissions.

5. How high does the price need to be?

Currently, only 3.76% of emissions are covered by a carbon price above $40 a ton. But a price range of about $40-$80 a ton is needed to achieve the 2015 Paris Agreement’s main goal of limiting warming to 2 degrees Celsius (3.6 degrees Fahrenheit) above preindustrial levels, according to a 2021 World Bank report. Keeping warming below the more ambitious Paris goal of a 1.5-degree Celsius limit would require introducing a price of $160 per ton or more by the end of the decade, according to consultant Wood Mackenzie Ltd.

6. What’s happening with carbon prices?

They’re going up. The most reliable price signal is the European market. Prices jumped more than 30% last year and the rally has continued since then, with benchmark December futures trading at a record 58.64 euros ($69.45) on July 1. Most analysts are predicting higher prices, with the most bullish targeting more than 100 euros by the end of the year.

6. What kind of opposition has there been?

Some political leaders have struggled to sell the system, since it raises the cost of goods and services, especially steel and cement. Some business leaders say it distorts markets for goods that come from countries that don’t levy a price on pollution. Australia repealed its carbon tax in 2014 after it was blamed for destroying jobs. In the U.S., even as many big businesses, including energy companies, have embraced the idea, conservative politicians, including most of the Republican party, have opposed carbon taxes and cap-and-trade systems. Carbon prices can hit the poor hardest by raising household energy prices, though that burden can be offset by redirecting revenue raised.

7. What conflicts lie ahead?

Almost half of the biggest 500 companies in the world already have an internal carbon price they use to test the viability of new projects, according to the World Bank. That reflects the belief among most corporate leaders that governments are getting serious about forcing emissions reductions. The bigger conflicts ahead are likely to be over how high the price should be pushed. Many environmentalists say the world will continue to fall short of its emissions goals unless there are carbon prices with real teeth.

The Reference Shelf

• A Bloomberg graphic shows the price of carbon around the world as of April 1, 2018, and the share of each country’s economy covered by the charges.
• A Bloomberg Opinion column by Michael R. Strain: Pay for Infrastructure Bill With a Carbon Tax.
• The World Bank’s 2021 report on trends in carbon pricing.
• QuickTakes on China’s carbon market and Europe’s carbon border tax.

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