How to introduce the carbon pricing into economy

With the latest technological advances and regulatory pressures all aiming in the direction of a fast global energy transition from carbon-based fuels to renewable energies, it is becoming apparent that some form of carbon pricing must be introduced into the economy. The discussed forms are the following:

  • Carbon Tax: the government sets a price that emitters must pay for each ton of greenhouse gas emissions they emit.
  • Emission Trading Scheme: sometimes referred to as a cap-and-trade system — caps the total level of greenhouse gas emissions and allows those industries with low emissions to sell their extra allowances to larger emitters.
  • Carbon Fee: Carbon fees are proposed fees collected for the cost of burning each ton of fossil fuels. Very similar to a Carbon Tax.
  • Carbon Dividend: the dividends are the fees collected (minus administrative costs) and returned to citizens to spend as they see fit. This scheme has been set up by Canada and Switzerland, trying to lead the way in public sector-driven sustainability transition to carbon-free economy.
  • Carbon Credits: a market-based solution aiming at pricing carbon with market mechanisms without any regulatory pressure. A subject doing a project compliant with “additionality principles,” i.e. sequestering carbon from the atmosphere decides to sell such a project to another subject who wishes to reduce its carbon footprint through Carbon Credits. The advantage of Carbon Credits aside from the carbon sequestration are the Ecosystem Effects, i.e.planting a tree not only sequesters carbon but also creates a habitat for other species living around and in the tree.
  • Carbon Allowances: Compensation from the government for each ton of CO2 captured. It works as a reverse tax, where businesses sequestering emissions from the environment will be compensated. It works together with Carbon Credits and motivates businesses to capture emissions. It however doesn’t reduce the emissions overall.

Regardless of the chosen method, the extent of implications on individual companies will depend on two main drivers;

  1. Carbon Price Sensitivity: describing the relationship between policy-driven carbon price and the economic performance of a given industry.
  2. Low-Carbon Transition Readiness (LCTR): scoring companies’ preparedness for the transition to a low-carbon economy, taking a forward-looking view on the evolution of a company’s reliance on fossil fuels and ranking each company in relation to its peers

As it is evident from the graph below, some industries will be impacted hard (e.g. Materials and Energy), whereas other industries will even benefit from this transition (e.g. Information Technology).

Blackrock, http://ieefa.org/wp-content/uploads/2021/03/BlackRock-Phase-Two.pdf

In order to mitigate the industry-specific impact demonstrated above, a combination of several mechanisms ranging from emission reduction, market-driven emission sequestration and standardised global reporting must be introduced;

  1. Progressive Cap-And-Trade scheme reducing the emission thresholds set for different industries on an annual basis. The price of the allowance acting as a “minimum market price.”
  2. Market-driven carbon sequestration through Carbon Credits that can be accounted for up to a certain threshold (e.g. 20%) in the Cap-And-Trade scheme. In other words, companies will be able to purchase Carbon Credits that will reduce their carbon footprint in a given year.
  3. Standardised and transparent reporting practices covering not only the carbon footprint, but also about the entire ESG spectrum. Namely focusing on Biodiversity, Water Treatment and Social Impacts of a company’s activities.

Although the transition to a carbon-neutral economy has already begun, the carbon price is not yet set globally. Politicians and industry experts alike are struggling with finding the right balance between market and public interests. Nevertheless, the sooner these mechanisms will be put in place, the lower the carbon price will be (thanks to the still reversible effects), hence the smaller the impact on the economy.

Politicians, investors and businesses should act now.

Leave a Reply

Your email address will not be published. Required fields are marked *