The price of carbon has never been higher. In April, a metric ton of carbon in Europe traded above $50 for the first time—and then kept rising, smashing through the ceiling set over the last decade. Global carbon prices have followed suit, breaking national records from the US to China.
While efforts to fix a cost to carbon emissions have been around for more than a decade, carbon prices have remained persistently low—ranging from a few cents per ton to a few dollars in most cases. That meant businesses and governments could ignore them when making long-term investment decisions. Emissions, meanwhile, continued their inexorable global rise.
But carbon prices, in both taxes and trading schemes, are now crossing the threshold analysts say are needed to trigger sustained reductions in greenhouse gas (GHG) emissions. While those prices are still the exception, rather than the rule, they are the bellwether of what’s to come.
What’s behind the rising cost of carbon?
Two factors have pushed up the cost of carbon: a rebounding economy and renewed national pledges to cut emissions. The world’s economies are recovering faster than expected, buoyed by unprecedented $15 trillion (and counting) in stimulus spending. Industrial activity and energy consumption have followed, sending atmospheric concentrations of carbon dioxide to unprecedented heights.
At the same time, governments under the Paris Agreement are pledging to reverse these trends. Already, countries emitting 60% of the world’s greenhouse gas emissions are committed to net-zero targets by mid-century. More are expected to set their own caps or emission targets when countries meet later this year in Scotland.
Even the pandemic hasn’t slowed the recent rally, says Marissa Santikarn a climate change specialist at the World Bank. Tax and trading schemes advanced without many delays in the last year, and regulators haven’t blinked as carbon prices climbed this year.
In the US, where regulators historically have aimed for minimal price increases, prices rose to a record $8 per ton in the Regional Greenhouse Gas Initiative (RGGI), an emission trading system led by 11 northeastern states.The European Union, home to the world’s most established emission trading system known as the EU-ETS, is even upping the ante as prices climb. The European Commission signaled it will double down on plans to auction (rather than give away) emission credits; expand coverage to include shipping, road transport, and buildings by 2026; and tamp down its GHG emissions cap. Europe’s trading partners will soon face carbon “border adjustment” taxes if they don’t price their GHG emissions.
But to reach net-zero emissions, today’s prices must just be the beginning, say experts. Forecasters suggest carbon prices will climb through 2030, even as countries chart their own emissions path. Putting the world on the path to net-zero emissions by 2050 means prices will need to exceed $100 per ton in major economies within a decade, estimate researchers. “Broadly, prices will gradually rise as governments get serious about net-zero targets,” predicts Darragh Conway, a lawyer at the consultancy Climate Focus. “But we’re still very far from where we need to be.”
Pricing isn’t easy (the pros and cons of a carbon tax)
Carbon is a global pollutant. From the atmosphere’s point of view, it doesn’t matter if carbon molecules originate in Mongolia or Manhattan: as far as global warming is concerned, one is as destructive as the other.
That’s great for economists. As a global pollutant, a uniform global price on carbon means it can be abated efficiently anywhere. Companies and governments can scour the world investing in the cheapest emission reductions. No need to pick winners and losers, and regulators never need to set the “right” price (difficult given the “information asymmetry” of companies’ knowledge about the true costs of mitigation). Paying $1 for CO2 emissions in China can, theoretically, deliver identical benefits as $100 in Canada.
Such cap and trade schemes have worked before, on a smaller scale. In the 1990s, the US Environmental Protection Agency pioneered a cap-and-trade system to curb sulfur dioxide (SO₂), the pollutant behind acid rain. After pricing SO₂ emissions from about 1,100 coal-fired power plants, sulfur dioxide emissions in the US fell to record lows, declining 43% from 1990 levels by 2007, at just one-sixth the expected cost.
But it hasn’t quite worked out that way for greenhouse gases, especially carbon dioxide. First, carbon dioxide and other greenhouse gases are emitted by billions of cars, buildings, homes, and power plants (not just a few thousand power plants). Secondly, imposing a cost on carbon (and thus fossil fuels) affects a nation’s industrial competitiveness, and countries have been loath to surrender their right to pollute the atmosphere.
As a result, a plethora of carbon schemes (and prices) have emerged from less than $1 in Poland to more than $100 in Sweden. While climate regulations still outnumber pricing schemes, the number of carbon taxes and trading systems are growing steadily, notes Robert Stavins, a professor of energy and economic development at the Kennedy School of Government at Harvard University. Roughly 20% of global emissions are now subject to one or the other. In all, 31 carbon emissions trading systems and 30 carbon tax systems have been implemented in various countries or regions around the world, says Stavins. The EU-ETS arrival in 2005 led other industrialized nations to trade the pollutant. Middle-income countries from China to Mexico now operate their own programs.
Their popularity means they’re here to stay. “It is fair to say that national carbon-pricing systems (either carbon taxes or cap-and-trade) will be necessary to achieve political emissions reduction targets,” wrote Stavins in an email.
Does it work? Reaching net-zero by 2050 through carbon pricing
In theory, almost any carbon price is better than zero, argues the Organisation for Economic Cooperation and Development (OECD) calling carbon pricing “a very effective decarbonization policy.” For every $12 per ton increase in the cost of a ton of CO2, emissions fall by 7% over time, it found. But prices today are just too low to have much of an impact. The average global carbon price is around $3 per ton of CO2; Only 4% of global emissions are priced above $40 per ton. At those prices, companies and governments are not incentivized to pay for emission reductions.
Recent studies have revealed meager progress. A 2020 study (pdf) by European researchers in the journal WIREs Climate Change concluded carbon pricing schemes “have had no effect at all” on long-term carbon-free investments, despite some short-term changes (such as switching from coal to gas). There’s “no empirical evidence,” the authors argue, that existing carbon prices in the European Union, New Zealand, British Columbia, and the Nordic countries have driven the deep technological change needed to reach net-zero emissions.
Yet that’s not a terminal diagnosis for emission trading and carbon pricing schemes, says Santikarn. It’s an argument prices are too low, and not enough thought has been given to just how to marry regulations (such as renewable energy standards) with economy-wide carbon pricing.
“How effective it is, much like policy instruments, depends on how it’s designed,” says Santikarn, a co-author of the World Bank’s most recent report on carbon pricing trends. “You can have a really good one or a really bad one. What we generally found was that carbon prices are quite effective tools driving cost-effective mitigation. The barrier is a price issue.”
Global CO2 prices need to rise dramatically to achieve the Paris Agreement targets: €40 to €80 ($47 to $94) per metric ton today, estimates the High-Level Commission on Carbon Prices (a UN-affliated body), and between €50 to €100 per metric ton by 2030. And even that might be quite low. The IMF recommends prices around €75 per metric ton, while the French government commission recommends a carbon price of €250 by 2030 (and €775 in 2050) if technology forecasts don’t turn out as optimistic as expected.
Meet the resistance to higher carbon prices
High prices have already inspired political pushback. In 2014, Australia rolled back its carbon tax after an opposition party ran against it, and took power in national elections. In France, efforts by President Emmanuel Macron to raise carbon taxes in 2018 collided with the “Yellow Vest” street protests, a loosely organized movement opposed to diesel fuel-tax hikes (which were eventually scrapped).
“The political liabilities are clear, says Chris Busch, the research director at the California-based research firm Energy Innovation. “If there’s too much of a price shock, there’s a push back. But if changes are incremental enough people have time to adjust, it’s more avoiding shocks.”
Countries are learning. In the UK, where fuel costs for the average household using gasoline and natural gas could rise by about £300 a year, depending on the carbon price. To dampen price spikes for heating and transportation, the UK (and Europe) are already setting up funds to compensate citizens. In the US, the White House is narrowly tailoring climate policy through a mix of credits, fees, and industrial regulation less likely to provoke a backlash. “You’re seeing the Biden Admin [do this] in ways that are politically savvy and that might not be recognized as carbon pricing,” says Busch.
Here comes a minimum global carbon price
It’s hard to imagine most countries succeeding at decarbonizing without a carbon price, even if it won’t solve the challenge on its own. The optimal solution, says the World Bank’s Santikarn, is a mixed approach: performance standards, R&D spending, regulation and a price on climate pollution, the backstop that holds the climate effort together. A minimum carbon price can reassure every actor in the economy that there will always be a cost to add another ton of CO2 to the atmosphere.
In fact, the International Monetary Fund has already proposed just such a global price floor for G-20 countries accounting for 85% of projected global emissions. So far, only wealthy countries have been willing to impose both high prices and economy-wide coverage, with Sweden, Switzerland, Finland, and Norway leading the way. Since about 80% of global emissions remain unpriced, an ambitious international effort to cut emissions must ensure countries they won’t be at a disadvantage if they were to raise carbon prices.
“Hybrid” systems are emerging to do this by borrowing the best aspects of both taxes and trading systems, says Busch. Economists, learning from past volatility, have begun designing systems with price floors and ceilings ( known as “price collars”) to give businesses certainty about the return on climate investments, and to give governments a “safety valve” if rising prices threaten domestic industries. Almost every emission trading scheme in the world now incorporates these elements to ensure market stability, up from a handful just a few years ago.
For countries that chose to delay climate pricing schemes, trading blocs like the EU are moving to ensure countries do so now or lose unfettered access to their markets. The world’s first carbon border tariff, due in 2023, will tax high-carbon imports from trading partners that don’t impose comparable prices on emissions. Gold, steel, wood pulp, coal, cement, and other crucial commodities are expected to be included under the policy. Foreign producers’ profits could fall by about 20%, estimates the Boston Consulting Group, with a modest levy of $30 per metric ton of CO2 emissions.
The border tax, sure to be contested under World Trade Organization rules, could increase political acceptance of higher carbon prices, or inspire a backlash among trading partners who refuse to go along. Europe’s attempt to tax CO2 emissions on international flights in 2011 failed after a revolt by countries including Brazil, Russia, China, and the US.
But countries now seem to be harmonizing their carbon pricing schemes, rather than fighting them. Even authors of the 2020 study questioning their effectiveness admitted carbon prices may already be an unavoidable feature of the global economy: “The political capital already spent on introducing and reforming carbon pricing, makes it unlikely that policy-makers will abandon them.”
The era of polluting the atmosphere for free is likely coming to a close. The challenge could now be finding the right price.