Carbon price

Carbon emission trade – allowance prices from 2008

In a cap-and-trade design, the market for permits automatically adjusts the carbon price to a level that insures that the cap is met.[13][14] The government establishes an emissions cap, for example 1000 tCO₂ per year. Then it either gives the allowances to stakeholders, or auctions them off to the highest bidder. After the permits have been distributed, they can be traded privately. Emitters without the required allowances face a penalty that would cost more than buying permits. If the cap is low, permits will be in short supply (scarcity) and the price of permits will be high.

The EU ETS uses this method. In practice it resulted in a fairly strong carbon price from 2005 to 2009, but that was later undermined by an oversupply as well as by the Great Recession. Recent policy changes have led to a steep increase of the carbon price since 2018, exceeding 100€/tCO₂ ($118) in February 2023.[10]

Cap-and-trade systems can include price stability provisions with floor and ceiling limits.[31] Such designs are often referred to as hybrid designs.[12]^: 47 To the extent the price is controlled by these limits, it can be considered a tax.

Carbon emissions trading works by setting a quantitative limit on the emissions produced by emitters. As a result, the price automatically adjusts to this target. This is the main advantage compared to a fixed carbon tax. A carbon tax is considered easier to enforce on a broad-base scale than cap-and-trade programs. The simplicity and immediacy of a carbon tax has been proven effective in British Columbia, Canada – enacted and implemented in five months.[32] A hybrid cap-and-trade program puts a limit on price increases and, in some cases, sets a floor price as well. The upper limit is set by adding more allowances to the market at a set price while the floor price is maintained by not allowing sales into the market at a price below the floor.[33] The Regional Greenhouse Gas Initiative, for example, sets an upper limit on allowance prices through its cost containment provision.

However, industries may successfully lobby to exempt themselves from a carbon tax. It is therefore argued that with emissions trading, polluters have an incentive to cut emissions, but if they are exempted from a carbon tax, they have no incentive to cut emissions.[34] On the other hand, freely distributing emission permits could potentially lead to corrupt behaviour.[35]

Most cap and trade programs have a descending cap, usually a fixed percentage every year, which gives certainty to the market and guarantees that emissions will decline over time. With a tax, there can be estimates of reduction in carbon emissions, which may not be sufficient to change the course of climate change. A declining cap gives allowance for firm reduction targets and a system for measuring when targets are met. It also allows for flexibility, unlike rigid taxes.[32] Providing emission permits (also called allowances) under emissions trading is preferred in situations where a more accurate target level of emissions certainty is needed.[36]

Standard proposals for using carbon revenues include

• a return to the public on a per-capita basis[37] This can compensate the risk of rising energy prices reaching high levels as long as cheap wind and solar power is not available yet. Rich people who tend to have a larger carbon footprint would pay more while poorer people can even benefit from such a regulation.
• subsidies accelerating the transition to renewable energy
• research, public transport, car sharing and other policies that promote carbon neutrality
• subsidies for negative emissions: Depending on the technology, such as PyCCS or BECCS, the cost for generating negative emissions is about $150–165 per ton of CO₂.[38] The removal past emissions – 1,700 Gt in total[39] – can theoretically be addressed by auctioning allowances starting with a price that exceeds the removal costs of the proposed emissions.

Unexpected spikes in natural gas prices and commodities such as oil and coal in 2021 caused a debate whether a carbon price increase should be postponed to avoid additional social burden. On the other hand, a redistribution on a per-capita-basis would even release poorer households which tend to consume less energy compared to wealthier parts of the population. The higher the high carbon price the greater the relief. Looking at individual situations though, the compensation would not apply to commuters in rural areas or people living in houses with poor insulation. They neither have liquidity to invest into solutions using less fossil fuels and would be dependent on credits or subsidies. If the fossil price surge persists, the necessity for an additional carbon price to gain competitiveness for renewable energies comes into question. On the other hand, a carbon price still helps to provide an incentive to use more effective fossil fuel technologies such as CCGT gas turbines in contrast to high-emission coal.[43]

The final consumer price for fuels and electric energy depends on individual tax regulations and conditions in each country. Though carbon pricing is playing an increasing role, energy taxes, VAT, utility expenses and other components are still the main cause for completely different price levels between countries.

Carbon leakage is the effect that regulation of emissions in one country/sector has on the emissions in other countries/sectors that are not subject to the same regulation.[58] There is no consensus over the magnitude of long-term carbon leakage.[59]

The leakage rate is defined as the increase in CO₂ emissions outside the countries taking domestic mitigation action, divided by the reduction in emissions of countries taking domestic mitigation action. Accordingly, a leakage rate greater than 100% means that actions to reduce emissions within countries had the effect of increasing emissions in other countries to a greater extent, i.e., domestic mitigation action had actually led to an increase in global emissions.

Estimates of leakage rates for action under the Kyoto Protocol ranged from 5% to 20% as a result of a loss in price competitiveness, but these leakage rates were considered very uncertain.[58] For energy-intensive industries, the beneficial effects of Annex I actions through technological development were considered possibly substantial. However, this beneficial effect had not been reliably quantified. On the empirical evidence they assessed, Barker et al. (2007) concluded that the competitive losses of then-current mitigation actions, e.g., the EU-ETS, were not significant.

Under the EU ETS rules Carbon Leakage Exposure Factor is used to determine the volumes of free allocation of emission permits to industrial installations.

A general perception among developing countries is that discussion of climate change in trade negotiations could lead to green protectionism by high-income countries[60] Eco-tariffs on imports ("virtual carbon") consistent with a carbon price of $50 per ton of CO₂ could be significant for developing countries. In 2010, World Bank commented that introducing border tariffs could lead to a proliferation of trade measures where the competitive playing field is viewed as being uneven. Tariffs could also be a burden on low-income countries that have contributed very little to the problem of climate change.

Cap-and-trade and carbon taxes interact differently with non-price policies such as renewable energy subsidies. The IPCC explains this as follows:

A carbon tax can have an additive environmental effect to policies such as subsidies for the supply of RE. By contrast, if a cap-and-trade system has a binding cap (sufficiently stringent to affect emission-related decisions), then other policies such as RE subsidies have no further impact on reducing emissions within the time period that the cap applies [emphasis added].[61]^: 29

According to a 2020 study carbon prices have not harmed economic growth in wealthy industrialized democracies.[62]

In order for such a business model to become attractive, the subsidies would therefore have to exceed this value. Here, a technology openness could be the best choice, as a reduction in costs due to technical progress can be expected. Already today, these costs of generating negative emissions are below the costs of CO₂ of $220 per ton,[63] which means that a state-subsidized business model for creating negative emissions already makes economic sense today. In sum, while a carbon price has the potential to reduce future emissions, a carbon subsidy has the potential to reduce past emissions.

• IPCC (2018). Masson-Delmotte, V.; Zhai, P.; Pörtner, H.-O.; Roberts, D.; et al. (eds.). Global Warming of 1.5°C. An IPCC Special Report on the impacts of global warming of 1.5°C above pre-industrial levels and related global greenhouse gas emission pathways, in the context of strengthening the global response to the threat of climate change, sustainable development, and efforts to eradicate poverty (PDF). Intergovernmental Panel on Climate Change. Global Warming of 1.5 °C —.
  • de Coninck, H.; Revi, A.; Babiker, M.; Bertoldi, P.; et al. (2018). "Chapter 4: Strengthening and Implementing the Global Response" (PDF). IPCC SR15 2018. pp. 313–443.

• Kikstra, Jarmo S; Waidelich, Paul; Rising, James; Yumashev, Dmitry; Hope, Chris; Brierley, Chris M (September 6, 2021). "The social cost of carbon dioxide under climate-economy feedbacks and temperature variability". Environmental Research Letters. 16 (9): 094037. Bibcode:2021ERL....16i4037K. doi:10.1088/1748-9326/ac1d0b. S2CID 237427400.

• Bank, World (2021). State and Trends of Carbon Pricing 2021. The World Bank. doi:10.1596/978-1-4648-1728-1. ISBN 978-1-4648-1728-1. S2CID 242987579.

• "Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866" (PDF). Interagency Working Group on Social Cost of Greenhouse Gases (US govt.). 2016. Retrieved September 12, 2021.

• "Measuring Emissions: A Guide for Organisations" (PDF). Ministry for the environment, New Zealand. 2020.
• Quaschning, Volker. "Specific Carbon Dioxide Emissions of Various Fuels". Retrieved September 23, 2021.
• "Meat Eater's Guide" (PDF). Environmental Working Group. 2011.
• Noleppa, Steffen (2012). "Klimawandel auf dem Teller" (PDF) (in German). WWF Germany. Archived from the original (PDF) on November 1, 2020.