1. What is carbon pricing?
Carbon pricing is based on the "polluter pays" principle. It consists of treating the pollution, or what is also called, negative externality of emitting greenhouse gases (GHG), as an economic cost or "price".
2. Where did carbon pricing arise, and why?
The first attempt to quantify monetarily the cost of emitting polluting gases was made by the creation of emission markets, specifically in the United States, regulating emissions of nitrogen oxides and sulfur dioxide. Since the first climate summits, governments have looked for formulas to drive a reduction in pollutant emissions. As part of the Kyoto Protocol, the parties agreed to create a regulated market in which governments and companies could buy or sell emission certificates as a function of whether their activity created pollution or helped reduce pollution (for example, renewable energy). This resulted in an Emissions Trading System (ETS) and a carbon tax. At the same time, a voluntary (i.e. unregulated) market was created in which public and private sector also buy and sell emission rights.
All in all, prices in the market are set by the interplay of market forces, and they can be passed on in a number of ways, e.g. carbon taxes, trading of emission rights, the assignment of a monetary cost when costing a project, etc.
3. How does a company assign a price to its carbon emissions?
There are various ways of carbon pricing. One approach is to offset the emissions being produced by an activity (the offset price), and another is to assess the risk of future investments (the shadow price). We will discuss each one in detail.
- Offset price. A company may emit GHG because of its activities. It can voluntarily price and offset the environmental damage by acquiring emission certificates in the carbon markets referred above. Why would a company impose an extra cost on itself? Because assigning a cost in this way acts as a driver for the implementation of energy efficiency measures that make it possible to reduce those emissions and, consequently, the related economic cost.
- Shadow price. This is the result of the inclusion of the cost of emissions as an economic variable when a company is analysing potential future investments. Again, the question arises: why would a company want to impose an additional cost on itself? The answer is that it redirects investments towards decarbonised projects. By including a shadow carbon price, a company remedies the fact that markets fail to properly account for the cost that emissions impose on society.
This is not an isolated practice: according to a recent report by CDP, 1,249 of the world's leading companies already take account of the Paris Agreement in their business plans by incorporating a carbon price, or plan to do so soon.
4. How can a government assign a price on carbon?
The Canadian province of British Columbia is a benchmark. The province adopted a carbon tax on certain fossil fuels in July 2008. Since then, energy efficiency has improved and fossil fuel consumption has declined, with no adverse impact on economic growth.
The BC carbon tax is revenue-neutral, i.e. every dollar collected under this heading is matched by a reduction in other taxes. In this case:
- A 5% reduction in the first two personal income tax rates.
- A reduction in the general corporate income tax rate.
- A reduction in the small business corporate income tax rate.
5. What are the advantages of carbon pricing?
Carbon pricing has horizontal benefits — it needs to be understood in the social, environmental and (of course) economic dimensions. Some of the main advantages are as follows:
- It puts a price on emissions, assigning responsibility to the emitters.
- It reveals hidden costs and redirects investment towards projects that are socially and environmentally responsible.
- It incentivises energy efficiency measures.
- It fosters innovation in clean technology.
- It reduces pollutant emissions and limits global warming.
- It helps offset the impact of emissions in economic, social and environmental terms.
Emitting greenhouse gas cannot be cost-free; the "polluter pays" principle should assign greater responsibility to the public and private sectors in order to reduce this negative impact on society and the environment. Assigning a price to carbon helps the emitter to offset the environmental damage they produce, while rewarding those that reduce emissions.