A report published by the OECD (Organisation for Economic Cooperation and Development) last week concluded that carbon prices are not high enough to bring about the emissions reductions required to keep global warming to less than 2 degrees Celsius above pre-industrial levels, as stipulated in the Paris Agreement. However, it concluded that even modest collective action could bring about significant change.
As a means of measuring the average amount charged per tonne of carbon, the OECD calculated an “effective carbon rate” (ECR), comprised of energy taxes, carbon taxes, and the price of tradeable emissions permits. The average ECR for six economic sectors across 41 countries was calculated to as €14.40/tCO2, significantly below the real cost of climate change, which is considered to be at least €30/tCO2. Rates varied across countries and sectors, with the highest occurring in the transport sector.
Under the polluter pays principle, carbon taxes and charges mean that the party responsible for producing the pollution is responsible for paying for the damage done to the natural environment. This takes into account the cost of damage to crops or to property from flooding and rising sea levels and healthcare costs as a result of heatwaves or drought.
A carbon price provides an economic signal so that the polluter can decide whether to change their activity and reduce emissions because it reduces their costs. It also encourages emissions reductions where they are the cheapest. Approximately 40 countries and over 20 cities and provinces already use carbon taxes or emission trading schemes, but the OECD’s findings are that the cost of carbon is not high enough to bring about the changes required.
A cap and trade scheme allows the trading of CO2 permits. Polluting installations have a cap on their emissions levels but can purchase permits from installations that have surplus emissions. The EU Emissions Trading System (EU ETS) was the first large trading scheme and an increasing number of regional schemes are now in operation, including pilot schemes in seven provinces of China in the lead-up to the launch of its national scheme due in 2017. However, to date, the EU ETS has not reflected a meaningful price for carbon because an oversupply of allowances has kept the price low. The front year is currently trading at around €5.00/tCO2. The European Commission is seeking to address the oversupply from 2019.
Many large firms are now using their own internal carbon pricing structures, outside a regulatory regime, in order to incorporate a carbon cost to decision-making processes. The pricing can be linked to the existing or expected future price of carbon and helps to address regulatory uncertainty. Businesses have often called for a global carbon price, which would set a level playing field, as well as long-term pricing to aid investment decisions.
In the UK, regulatory uncertainty persists in relation to carbon pricing, as the Brexit vote raises questions over the UK’s continuing participation in the EU ETS. An announcement on the carbon price floor, a UK tax designed to uplift the low cost of EU allowances, is due in the Autumn budget this year.
The outcome of the 2015 climate negotiations in Paris is that carbon pricing is increasingly being put in place across the globe. However, the report from the OECD is now calling for the price to be at a level that can bring about the required emissions reductions.
