Mariyan Nikolov / Nov 2021
The world is going through a rough patch. With increased fires, floods and droughts, the consequences of climate change have never been more apparent.
Leaders are gathered at COP26 to agree on common approaches to the challenges we all face, yet concrete solutions appear far from sight. At least, on a few of the pressing global issues.
So far, pledges have focused on ending deforestation, limiting methane emissions and phasing-out coal power. However, nations are still not convinced on Article 6 of the Paris Agreement and associated carbon pricing policies.
What is carbon pricing and why does it matter?
As a relatively nascent phenomenon, carbon pricing translates to a certain cost that is applied to carbon pollution, which is aimed to encourage polluters to reduce emissions. This is important as it establishes a level of market value for reduction in emissions. For governments, carbon pricing generates fiscal revenue and supports transition to net-zero. For companies, internal carbon pricing or the value that companies voluntarily set for themselves, can be used as a risk management instrument.
Nations can impose carbon pricing through a carbon tax or an Emission Trading System (ETS). The former involves a pre-determined price that emitters must pay for each ton of greenhouse gas (GHG) emissions they emit. In this scenario, market forces and businesses are left to determine emissions reductions i.e. adopt new technologies to reduce emissions and avoid being taxed.
Under the ETS there are two approaches: cap-and-trade which puts a limit on emissions in the form of allowance permits, and baseline-and-credit whereby there is no fixed limit on emissions. Polluters that reduce their emissions more than they are obliged to can earn ‘credits’ that they sell to others.
Regardless of the form that carbon pricing takes, it ensures that emitters carry the cost of their own GHG emissions. Consequently, all actors who participate are incentivised and encouraged to reduce their emissions on a level playing field. Carbon pricing can therefore play a significant part in disincentivising emitters of long-term emissions and stimulate adoption of innovative and carbon-free technologies.
How does it relate to Article 6 of the Paris Agreement?
Under the Paris Agreement - which was agreed in 2015 – Article 6 proposed to establish an international carbon market, in order to trade credits and mitigate global emissions. Negotiations over the latest text of the proposal are still ongoing, and there is some hope to break the stalemate at COP in Glasgow. Full adoption could lead to a global price on carbon and generate new channels for climate finance. Considering that different jurisdictions price pollution differently, establishing a common and equitable price on a global scale might remain as a scenario reserved for an ideal world.
Where does the world stand on carbon pricing?
At present, 64 carbon pricing initiatives have now been established or scheduled for implementation globally, representing a quarter of GHG emissions. The EU’s Green Deal set out an ambitious agenda for the road to net-zero, but there are still member states who express critical views of carbon pricing policies. In 2020, only 15% of global emissions were covered by carbon pricing instruments and the increase is largely due to the launch of the national ETS in China. South Africa became the first African country to price carbon, Singapore was the latest jurisdiction to introduce a carbon tax in Asia, and Mexico’s cap-and-trade pilot system paves the way for emissions trading in Latin America. Even with such significant progress, less than 5% of these initiatives are priced at levels consistent with achieving the temperature goals of the Paris Agreement, according to the World Bank.
Maybe it was easier to agree on a minimum corporate tax than it is to establish a minimum standard for pricing pollution. Maybe an international carbon price floor will be negotiated instead, setting a minimum price of carbon around the globe.
One thing is clear: the challenge that lies ahead is responding to the urgency of climate change in a level commensurate with the urgency itself.