WHAT IS CARBON PRICING?
WHAT IS CARBON PRICING?
Carbon pricing is a method of lowering carbon emissions (also known as a greenhouse gas, or GHG) by utilizing market mechanisms to pass on the cost of releasing to emitters. Its overarching purpose is to reduce the use of carbon dioxide–emitting fossil fuels in order to conserve the environment, address climate change causes, and comply with national and international climate agreements.
The "polluter pays" notion is an important part of carbon pricing. By placing a price on carbon, society can hold emitters accountable for the high costs of adding GHG emissions to the atmosphere, which include filthy air, rising temperatures, and a slew of other negative consequences (threats to public health and to food and water supplies, increased risk of certain dangerous weather events). Carbon pricing can also provide financial incentives for polluters to reduce their emissions.
The advantages of carbon pricing are enormous. It is one of the most powerful policy tools for combating climate change. It has the potential to decarbonize global economic activity by altering consumer, corporate, and investment behavior, while also spurring technical innovation and producing income for productive use. In short, well-designed carbon taxes benefit the environment, promote investments in clean technology, and generate income.
What Are Carbon Pricing Instruments and How Do They Work?
Carbon pricing instruments come in a variety of shapes and sizes. Governments, organizations, and institutions can choose from a variety of techniques and paths to find the solution that best fits their policy context.
- A carbon tax imposes a direct cost on GHG emissions, requiring economic actors to pay for each tonne of CO2 emitted. As a result, moving to more efficient processes or cleaner fuels creates a financial incentive to reduce emissions (i.e., less pollution means lower taxes). Because the price per tonne of pollution is fixed, this technique provides a lot of pricing certainty; nevertheless, it provides less assurance regarding the extent of emissions reduction.
- Emission trading systems (ETSs), often known as cap-and-trade systems, put a limit ("cap") on total direct GHG emissions from specified sectors and create a market where rights to emit (in the form of carbon permits or allowances) are sold. This method allows polluters to satisfy emissions reduction targets in a flexible and cost-effective manner. It guarantees emissions reductions but not the price of emitting, which is subject to market fluctuations.
- Emission reductions that occur as a result of a project, by a business or government, or policy are awarded credits, which can subsequently be bought or sold, according to a crediting process. Companies that want to reduce their emissions can acquire credits to offset their actual emissions. Before the emission reduction may be acknowledged, a professionally recognized third-party verifier must sign off on it.
- Entities receive cash under the results-based climate finance (RBCF) framework if they satisfy pre-defined climate-related goals, such as emissions reductions. This strategy, like crediting mechanisms, necessitates the engagement of independent verifiers (in this case, to confirm that a goal has been met). RBCF encourages carbon pricing and the formation of carbon markets, assists polluters in meeting climate goals, and stimulates private sector investment by tying financing to particular results.
- Governments, businesses, and other entities utilize internal carbon pricing to assign their own internal price to carbon consumption and factor it into their investment decisions. This method fosters investment in low-carbon technologies and prepares institutions to operate under future climate rules and regulations when used as part of a larger decarbonization effort. There are two types of internal carbon pricing:
- The first determines a potential cost for carbon consumption by assigning a shadow price to it. Entities assess this price for their activities with the purpose of reducing emissions and avoiding long-term expenditures in high-carbon capital and infrastructure by recognizing possibilities in operations, projects, and supply chains. The World Bank Group, for example, has announced plans to apply a shadow carbon price to relevant investment projects in accordance with the High-Level Commission on Carbon Prices' recommendations.
- The second type is an internal carbon price, in which firms charge their business units for their emissions on a voluntary basis. The money raised from this levy goes back into greener technology and activities that help with the low-carbon transition.
What is the Best Way to Create an Effective Carbon Pricing Mechanism?
Although the design of carbon pricing schemes may vary depending on the policy objectives and settings, successful schemes will share several traits. The FASTER Principles for Successful Carbon Pricing, a guide published jointly by the World Bank and the Organisation for Economic Co-operation and Development (OECD), distill six fundamental features of successful carbon pricing based on practical experience from various jurisdictions:
Fairness. Effective projects adhere to the "polluter pays" principle and guarantee that expenses and rewards are distributed equally.
Policies and goals must be in sync. Carbon pricing isn't a self-contained mechanism. It is most effective when it is aligned with and promotes broader policy goals, both climate-related and not.
Predictability and stability. Effective initiatives are those that operate within a solid policy framework and deliver a clear, consistent, and (with time) increasingly powerful signal to investors.
Transparency. Effective carbon pricing is planned and implemented in a transparent manner.
Efficiency and cost-effectiveness are two terms that come to mind while discussing efficiency and cost-effectiveness Carbon pricing that is fair and effective decreases the cost and improves the economic efficiency of decreasing emissions.
Reliability and environmental integrity are two important factors to consider. Effective carbon price eliminates environmentally harmful practices in a quantifiable way.
Designing Efficient Carbon Pricing Faces Difficulties
A well-designed carbon pricing mechanism can encourage innovation and investment in low-carbon technologies that give businesses a competitive edge. However, there are several obstacles to overcome in order to achieve the best design:
Leakage of carbon. Some policies have had the unintended consequence of reducing corporate competitiveness. Carbon leakage—the phenomena by which carbon-intensive businesses or firms transfer operations to lower-cost jurisdictions—can occur when there is an inconsistent patchwork of carbon pricing policies and regulations at the regional and global levels. This approach, according to the Partnership for Market Readiness (PMR), can be discouraged by focused and well-designed policies, such as product or investment tax credits, R&D funding, and company support services.
Inconsistency or overlap in policy is a problem. If carbon pricing mechanisms are correctly connected with complementary policies, such as energy efficiency measures, emissions performance criteria, and research and technology policies, among others, they can be much more successful. Policymakers must work carefully and purposefully to avoid policy instrument overlap and interaction, which could jeopardize the effectiveness of carbon pricing schemes. The Carbon Pricing Leadership Coalition (CPLC) contains a lot of information about how policies and efforts to prevent climate change need to be consistent.
Inefficient revenue management. Carbon pricing devices can generate substantial money, but the effectiveness of many carbon pricing efforts is determined by how those monies are utilized. Revenues can be repurposed to lower other taxes, protect lower-income households, support cleaner technologies, resolve concerns about fairness and competitiveness, or redirect public monies toward other public policy goals. However, as CPLC points out, each of these techniques comes with its own set of costs and benefits, and some are more suited to specific policy situations than others.
Carbon Pricing Recommendations
There is a lot of information on carbon pricing. Governments, corporations, and other stakeholders can study the two documents produced or co-authored by the World Bank's Partnership for Market Readiness (PMR) in addition to FASTER Principles for Successful Carbon Pricing:
PMR published the Emissions Trading in Practice: Handbook on Design and Implementation, a guide for policymakers that distills best practices and key lessons from more than a decade of practical experience with emissions trading around the world, in collaboration with the International Carbon Action Partnership (ICAP). The goal of this handbook is to assist decision-makers, policymakers, and stakeholders in developing and implementing a successful ETS. It outlines why an ETS is needed and lays out a 10-step method for creating one, with each phase containing a series of decisions or activities that would form the policy's primary aspects.
The Carbon Tax Guide: A Handbook for Policymakers was also released by PMR. This guide is intended to assist policymakers in determining if a carbon price is the best tool for achieving national policy objectives. It is also a tool to help with the design and implementation of a tax that is tailored to the demands, circumstances, and goals of national policy. The guide includes a philosophical study as well as key practical lessons learned from carbon tax implementation around the world.
Visit the PMR website and the CPLC resource hub for more information on carbon pricing.
Article 6 of the Paris Agreement establishes a carbon price.
Carbon pricing's success at the national and regional levels has sparked the growth of worldwide carbon markets. Article 6 of the Paris Agreement, which lays out a framework for keeping global warming well below 2 degrees Celsius, includes provisions that would allow countries to work together to meet their Nationally Determined Contributions (NDCs), particularly through carbon pricing to meet mitigation commitments.
Articles 6.2 and 6.3 introduce provisions that allow governments to collaborate on emissions reduction. To put it another way, country A can transfer its emission reduction to country B, which can then use it to meet its NDC. Existing national and regional instruments can be used under this system to build an international carbon market, whose size and cost-effectiveness would allow governments to set more ambitious emissions reduction targets.
Article 6.4 offers a method for countries to reduce GHG emissions while still contributing to long-term development. The mechanism attempts to broaden the scope of carbon pricing schemes globally by promoting mitigation efforts by both public and private entities, despite the fact that its architecture and methods are still being debated. It, too, encourages governments to collaborate and transfer emission reductions to other countries for inclusion in the second country's NDC total, and it, too, encourages countries to set more aggressive emission reduction objectives.
It's unclear how these Article 6 provisions will be implemented. However, once in place, the new mechanisms will aid carbon pricing in realizing its promise of cost-effective decarbonization and adaptation. Given that the Paris Agreement principles, including the procedures for operationalizing cooperative efforts to decrease emissions under Article 6, are due to be finalized by December 2018, there is a lot of pressure to reach a quick agreement on the rules that will lead to the new mechanisms.