Carbon pricing is gaining awareness in transport and logistics amongst other industries because of increasing regulatory requirements. In this article you’ll learn about the three main concepts, effects on mitigation measures and differentiated price dynamics on a global scale.
What is carbon pricing?
Carbon pricing is an economic instrument designed to internalize and reflect the true societal costs of greenhouse gas emissions. These external costs, such as environmental and health damage caused by climate change and air pollution, are incorporated into the market by assigning a price to CO2 emissions. It records the cost usually paid by the public for the consequences of heat waves, droughts, floods and rising sea levels.
How does carbon pricing work?
The toolbox for carbon pricing is diverse. Worldwide, there are already 75 different direct carbon pricing instruments, with carbon markets being categorized as either voluntary or compliance.
There are three main concepts for carbon pricing:
- Emissions trading schemes often termed cap-and-trade systems in which governments set a maximum emissions limit for industries and issue carbon credits accordingly. These grant companies the right to emit within prescribed limits, with the financial proceeds directed towards emission reduction activities.
- Carbon taxes provide a straightforward compliance method by offering a stable and fixed price for CO2 emissions, resulting in incentives for companies and consumers to reduce them. However, validating the effectiveness of emission reduction activities can pose challenges under this system.
- Crediting mechanisms assess emissions from various activities, and credits are then allocated to ensure funding for offsetting them. These mechanisms allow organizations to offset their emissions by investing in projects that reduce carbon output.
All approaches aim to make the costs of CO2 emissions transparent and create economic incentives for adopting climate-friendly technologies and behaviors.
What is the status of carbon pricing instruments?
According to the World Bank, 24% of global greenhouse gas emissions are now covered by various carbon pricing instruments, marking a significant increase from just 7% a decade ago.[1] Further expansion of carbon pricing measures and their inclusion in international climate agreements signals a growing recognition of the need for climate action beyond industrialized countries. The coverage is becoming broader, encompassing not only certain sectors but also electricity generation, transport, industry and buildings, reflecting a more comprehensive approach to climate policy.
In 2022 alone, governments worldwide were able to raise USD 67 billion from Emission Trading Systems and USD 30 billion from carbon taxes through carbon pricing, an upward trend.[2]
However, only a fraction of these emissions is subject to sufficiently high pricing, as defined by experts. Besides the question of how these revenues are fully channeled into mitigation measures and the actual amount required globally for efficient reduction strategies, it is also obvious that there are considerable differences in the prices for CO2e t in the respective systems.
Why do carbon price levels vary on a global scale?
The High-Level Commission on Carbon Pricing proposes that explicit carbon price levels are needed to achieve specific emission reduction targets, which are expected to be between $50 and $100/tCO2 by 2030 and depend on an enabling policy framework.[3] This requires a nuanced understanding of each country’s unique characteristics, including income levels, quality of institutions, renewable energy resources, economic structure, social security systems and political landscape.
Unlike the uniform pricing favored by traditional economic theory, differentiated pricing is necessary due to
- political constraints limiting financial transfers between countries, justifying lower carbon prices in developing countries
- market failures, especially around innovation, requiring complementary measures to achieve intended targets
- non-climate related development goals, since these overlap with climate goals and influence the appropriate carbon pricing level
Both short- and long-term price dynamics are determined by fluctuations in the scarcity of emission allowances due to economic conditions, regulatory changes and interactions with other climate and energy policies. As a result, direct comparisons between prices are flawed due to differences in coverage, compliance, and offsetting schemes.
It is important to recognize that carbon pricing operates within a broader framework of different policies and initiatives. Whilst pricing carbon plays a crucial role, it cannot therefore alone enable an efficient, just and acceptable transition to decarbonization.
What must be done to increase the efficiency of carbon pricing?
Despite the progress made, the journey towards effective carbon pricing, its integration into global climate policy and implementation into business operations faces challenges. From a policy side to sustainably improve global alignment, several strategies are imperative. Firstly, carbon pricing mechanisms must reflect the true cost of carbon, necessitating the removal of fossil fuel subsidies, higher direct carbon prices, and broader tax rates based on carbon content.[4] Furthermore, international cooperation is essential for harmonizing carbon pricing efforts across borders and ensuring consistency and effectiveness.
Since carbon pricing is emerging as a cornerstone of climate policy, exerting a significant influence on market dynamics and shaping the transition to a low-carbon economy understanding how firms’ expectations of future carbon constraints influence their investment practices is crucial. By anticipating expected future carbon limitations and investing in low-carbon activities, firms can mitigate carbon risk and contribute to the transition towards a sustainable future.
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Sources:
[1] World Bank. 2024. State and Trends of Carbon Pricing 2024. Washington, DC: World Bank. DOI: 10.1596/978-1-4648-2127-1. License: Creative Commons Attribution CC BY 3.0 IGO.
[2] World Bank. 2024. State and Trends of Carbon Pricing Dashboard.
[3] High-Level Commission on Carbon Prices. 2017. Report of the High-Level Commission on Carbon Prices. Washington, DC: World Bank.
[4] World Economic Forum. 2024. Flagship Report. Bold Measures to Close the Climate Action Gap: A Call for Systemic Change by Governments and Corporations
