THE CARBON PRICING VOYAGE
Nigel Topping
Carbon pricing was one of the hot topics of debate during Climate Week Paris, last week. Hailed by many of the CEOs on stage as one of the key policy measures which business wants to see.
But the journey from enthusiasm in general to effective implementation is far from simple, so we need to learn to navigate with skill.
We Mean Business and the World Bank have formed the ‘Carbon Pricing Leadership Coalition’ and are working with CDP, CLG, WBCSD, IETA and others to collaborate with business, investment and policy experts on developing the navigational tools to help understand more about future carbon prices – how they could work, how they might evolve and most importantly, what they need to be to enable us to stay on course for a 2 degree future.
Before getting on to some of the navigation tools available to us, we must first learn to avoid the siren call of ‘all we need is a global price on carbon’! This seemingly attractive statement hides two dangerous over-simplifications. Firstly, whilst we know that carbon pricing is one of the most efficient and effective economic signals to drive markets to innovate towards a low carbon economy, we also know that it is not a silver bullet, that there are parts of the economy which pricing does not reach – where efficiency standards or strategic R+D investments will be more effective.
Secondly, we know that we will not get a global price any time soon! Whilst the UNFCCC negotiations may provide some supportive language for future linkages, and we do see encouraging signs such as Ontario committing to link with California and Quebec, the political reality is that any progress towards globally networked markets will necessarily be slow. Linkage will provide increased liquidity, lower prices and more efficient mitigation but many jurisdictions have much to learn before we get there.
Charting the best route – carbon pricing bands and trajectories
Having avoided the siren call pulling us onto the rocks, what are the navigational tools we can use to improve the way we talk about carbon pricing so that we can get to action faster? In this work, I have found two ideas to be particularly helpful – that of carbon pricing bands, and of the future carbon pricing trajectory on our voyage to two degrees.
Not all price levels work in the same way. We can distinguish between four carbon pricing bands – subsidy, introductory, transformational and exceptional
In the subsidy band, fossil fuels receive government support – the equivalent to a negative price on carbon. At the BCS there was universal call to eliminate such subsidies, as a precursor to implementing carbon pricing rules.
Where carbon prices are introduced but have not yet reached a level to generate transformative change, we call this the introductory band. Whilst some will criticise regimes with low carbon prices (say $5-15) as being ineffective, we observe that there are in fact many advantages of launching a carbon pricing scheme in this band. Firstly, it is politically much easier as concerns about economic distortion or competitiveness are diluted. In addition, such price levels allow for institutional learning from all actors and start to generate both new fiscal revenues and to initiate behavioural change. This latter is particularly linked to the level of credible ambition which policy makers project to the business community. For example, although EU ETS prices have remained low, the clarity of the long term direction (cap reducing steadily to zero in the 2050s) along with other factors, have meant that the EU scheme has been a huge success, when judged by delivery of emissions reductions to plan. Crucially, the institutional learning of one country can be used by others – see for example the way California has implemented a ratcheted carbon price floor to avoid the issues affecting the EU ETS.
Beyond a certain threshold price (which we call alpha), rapid transformational change is triggered, so we call this the transformational band. Clearly it should be an objective of all schemes to get beyond alpha within a reasonable period of scheme launch. I estimate alpha to be in the region $20-30. On that basis, the UK floor price and the BC carbon tax are already in the transformational band, and the California price is guaranteed to get there in the early 2020s because of the ratchet. Alpha will of course vary from sector to sector and according to geography. Some theorise that this will equal the marginal abatement cost but behavioural differences and the balance of other policies will also influence it.
Recent member polling from IETA, suggests that a price of EU29.40 is needed to drive investment, and a poll of participants at BCS gave an average price of $73 in 2020 and $123 in 2030 to put us on track to two degrees. So still lots of disagreement! And is there such a thing as too high? We think so – beyond a certain level (lets call it beta) prices become politically difficult to implement, only in exceptional circumstances. We Mean Business estimate this carbon price level to be in the range of $80-120 per tonne. Of course this also varies by jurisdiction – and when business has had time to adjust it may become much higher – as for example is the case in Sweden which has taxed carbon for many years. Beyond beta, we call the ‘exceptional band’.
Plotting a trajectory
Future carbon prices are inherently unpredictable – dependent on scheme architecture, energy prices, technology development and other macroeconomic variables. Nevertheless it can be helpful to envisage possible future trajectories as part of planning the resilience of investment approaches, assessing likelihood of stranded assets etc. What would the carbon price trajectory be if we are to skillfully navigate our way to a two degree future? What role will governments have in getting us there? I see three main phases, with different roles for governments with existing schemes, those with no scheme to date, and for the multilateral bodies with a key role in linking markets.
Phase 1 – 2015-2020 (introductory/transformational bands)
Rapid acceleration of the adoption of Carbon pricing, through tax or cap and trade. Countries with no scheme currently, design schemes to land within the introductory band, often starting around $5 per tonne, and linked to raising levels of mitigation ambition in their INDCs
Countries with existing schemes make the transition beyond alpha to the transformational band. The EU ETS reform, California price floor ratchet, and roll out of ETS across China all ensure prices reach the level of $20-30 and beyond,
Phase 2 – 2020-2030 (transformational band)
New schemes start to mature beyond alpha – emboldened by success and learning from others. Mature schemes continue to see rising prices as emissions caps come down fast. Carbon market networking develops. Average prices reach $30-50
Phase 3– 2030 and beyond (mature transformational band)
All schemes are in the transformational phase, with prices above $50-70, accelerated deployment of low carbon energy generation and rapid innovation. The move to networked carbon markets increases liquidity and sees prices first stabilise then decline gently. Carbon pricing no longer seen as a special issue – just a normal part of any country’s fiscal toolkit
What do you think? Can we reach two degrees without following such a trajectory? What needs to be done to get on this trajectory quickly?
What can business do – specifically?
Although many more businesses are calling for a price on carbon, it is time for the conversation to get more granular if we are to move from rhetoric to action. Very few businesses are explicit in their language about what level of carbon pricing they assume, what level they would like to see or what level would trigger significant investment in their value chains. I encourage you to use the language of carbon pricing bands and carbon pricing trajectory – to be specific about what you think alpha and beta are, about what trajectory we need in which country covering which sectors, about how and when we need to bring about market linking.
Specifically, business can disclose the internal price on carbon which they use in their CDP filing this year – and I look forward to the CDP report on corporate use of carbon pricing that will come out in the Autumn. Also, businesses can sign up to the UNGC Carbon Pricing Leadership Principles, and they can join the World Bank Carbon Pricing Leadership Coalition (CPLC).
We will be discussing these ideas with members of the CPLC here in Barcelona at the Carbon Expo – and I look forward to sharing some of what we learn together.
But in the meantime, next time you want to talk about the need for a price on carbon – don’t be vague, name your price!