An effective strategy for reducing greenhouse gas (GHG) emissions is of vital importance for the success of policies to combat climate change. Carbon pricing is a method used by policymakers and businesses to reduce GHG emissions by putting a price on carbon. So what is carbon pricing and what are some of the key arguments in promote his success ?
What is carbon pricing?
Climate change is no longer seen as a “soft” policy issue with overwhelming scientific evidence linking anthropogenic emissions of fossil fuels, such as carbon dioxide and methane, to global warming. Carbon pricing has become an increasingly important strategy in global environmental policy to mitigate GHG emissions since the idea was first introduced in the early 1990s.
Since carbon dioxide is the primary GHG, it is often simply referred to as carbon. Carbon pricing works by assigning a monetary value to carbon, which makes the cost of carbon emission explicit to those who pollute. This offers a solution to what renowned Indian economist Pavan Sukhdev describes as “the economic invisibility of nature”. Until now, polluters could emit GHG emissions at no additional cost, making industrial pollution vulnerable to unregulated exploitation. By putting a monetary value on carbon, this is supposed to internalize the external cost of carbon emissions, thus correcting this market failure.
The logic is that once a price has been set for carbon, it is cheaper and easier for countries to reduce their emissions by making carbon a tradable commodity that they can use to trade in the carbon markets. carbon. There are two key contemporary examples of carbon markets and they can both be found in Article 6 of the most recent international treaty on climate change, The Paris Agreement.
The first is an emissions trading system (ETS), also known as acap and trade‘, which work by setting a cap on the total aggregate emissions target and allocating ‘carbon permits’ accordingly within that threshold. An entity can emit a ton of carbon by surrendering a permit or if it needs more or less of those permits, it can save, buy or sell them as needed. The cap is supposed to be reduced over time so that total emissions will eventually decrease. There are a number of examples outside of the Paris agreement, such as the EU ETS, Chinese ETSand California ETS.
The second is a carbon offset program which provides tradable carbon credits in exchange for emission reduction projects in different parts of the world, outside the capped area. The amount of credits earned is decided by speculating on the difference between the level of emissions with or without the project. This means that emitters can build carbon-saving projects such as monoculture tree plantations or renewable energy projects or invest in green projects, in exchange for a tradable credit.
There is currently a third type of carbon pricing which is a carbon tax. It is a form of pollution tax put in place by governments that set a price that emitters must pay for each ton of GHG emissions polluted. The aim being that the tax encourages polluters to invest in greener technologies to avoid spending extra money on the tax.
Although carbon pricing varies in logistics they all offer a market-based solution to climate change by placing a monetary value on carbon emissions. This is supposed to provide a financial incentive for the protection of natural resources. According to United Nations Development Pprogram (UNDP), the overall objective is tointernalize the environmental and social costs of carbon pollution and permit trading, which reduces the economic cost of reducing emissions”. Therefore, the primary goal is to create accountability for emissions that were previously unaccounted for in a business-friendly and cost-effective manner.
A “green political success”?
Since the creation of the first carbon markets, others have been introduced across the world every year, with even more plans currently expected to be rolled out. These methods have been introduced internationally, nationally, regionally and by companies. You can see the 65 carbon pricing initiatives established as of 2021 pictured below.
Picture 1: World Bank Carbon Pricing Dashboard
This growing popularity and political commitment implies consensus on the success of carbon markets as a tool to fight climate change and transition to a decarbonized economy. Proponents of carbon markets hail them as a “great political achievement” and an important achievement for global environmental governance. Crucial factors in their popularity are their flexibility and cost-effectiveness, in which proponents claim that these business-friendly attributes help build a green, low-carbon future.
Market mechanisms that allow for flexible business opportunities make it a particularly attractive strategy for politicians and businesses reluctant to commit to rigid goals that require significant regulation or subsidies. They argue that it can be used to spur investment, technology development and create green jobs. This growing popularity translates into price growth and market growth, which Financial Markets Data Analyst, Revivalfinds in part the result of the ambitious objectives set Paris Agreement.
Figure 2: Revinitiv Global Carbon Market Value
Collectively, the business-friendly attributes of carbon pricing set the stage for what can be calledClimate capitalism“, a model that promotes the decarbonization of the global economy simultaneously with economic growth.
Limits of carbon pricing
Despite the growing popularity of carbon pricing as an emissions reduction tool, critics say there is a disparity between its popularity and empirical results as an effective emissions reduction tool, with various limits to its success.
Environmentalists argue that rather than offering a way to achieve ambitious climate goals, it actually undermines them because they act as a ‘trash license‘. This refers to the idea that carbon permits enable “business as usual” practices while claiming a progression towards more sustainable practices, otherwise known as “greenwashing‘. They argue that this leads to maintaining the status quo rather than addressing the root causes of climate change, which they argue requires more systemic changes.
There were serious logistical problems for carbon pricing which subsequently led to success in producing real emission reductions. Below, five major challenges for carbon markets have been highlighted by UNDP with five possible solutions proposed.
Figure 3: UNDP Carbon Markets
Another factor limiting the effectiveness of carbon markets’ ability to reduce emissions is its flexibility. This factor can be seen as both a strength and a weakness because as a market mechanism it is vulnerable to market volatility as there is little regulation and is guided by the invisible hand of the market. A recent example is the invasion of Ukraine which has resulted in a lower cost of a carbon permit in the EU ETS.
The main takeaway
Overall, it looks like carbon pricing is here to stay. Under the latest international treaty on climate change, The Paris Agreement, market mechanisms such as carbon pricing are becoming a pervasive reality in climate policy. Their exponential growth since its inception three decades ago is largely due to its popularity in the political and economic sphere, with its proponents touting it as a flexible and cost-effective method of making polluters accountable for their emissions. As a market mechanism, it allows polluters to reduce emissions in the way they deem most efficient, but is this necessarily the most efficient way to reduce emissions?
Despite its growing popularity, it is attracting serious criticism from those who question the gap between its popularity and verifiable success in reducing emissions. Logistically, carbon pricing requires further work to modify some of the key operational challenges. This could go through some of the solutions put forward by the UNDP such as more robust accounting rules or the imposition of an expiry date on carbon credits.
Ideologically, some of the questions boil down to whether one believes there can really be a capitalist solution to climate change. A more holistic approach to climate policy includes other methods with greater command and control that rely on direct regulation rather than financial incentives. Alongside, as the UNDP suggests in its recommendations, more ambitious climate goals. It is not a simple task without a unique approach. Carbon pricing is not a stand-alone solution and does not claim to be. It offers a possible solution that can be implemented in conjunction with others on the path to a more sustainable future.
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