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The price of carbon, and the value of none

Jonathan Shopley | 15 December 2014 |

The Climate Conference in Lima ended with a little more clarity of the “what” rather than the “how”. So, what happened to all that talk about “a price on carbon” as a solution to climate change? Jonathan Shopley looks for the elusive pricing signals coming from Lima.

“What is a cynic? A man who knows the price of everything and the value of nothing. And a sentimentalist, my dear Darlington, is a man who sees an absurd value in everything, and doesn't know the market place of any single thing.”

Oscar Wilde, Lady Windemere’s Fan, 1892.

Lima Outcomes

Yesterday, world leaders agreed the 'ground rules' for a new 2015 agreement on climate change which includes action from both developed and developing countries, bringing the two-week COP20 climate talks in Lima to a conclusion.

As well as consensus on the elements of a new global climate deal that is set to be agreed a year from now at COP21 in Paris, the most significant achievement by world governments is guidance developed on how all nations should submit their planned greenhouse gas reduction contributions in the first quarter of the coming year. These pledges, called Intended Nationally Determined Contributions (INDCs), will be the chips on the table for the negotiations on the post-2020 in at COP21 in December 2015, Paris.

Cynics were dismayed by the fact that we are still talking about the ‘why’ and the ‘what’ – primarily what emissions to measure, report and verify; what targets countries can commit to; and, what criteria will be used to examine whether these pledges will amount to more than a hill of beans and deliver a stable climate.

Sentimentalists focused on the ‘why’ – why it’s important to curb climate change, the value of standing forests in both mitigating and adapting to climate change, the urgent and critical need to protect the world’s poor from the ravages of a changing climate, and the imperative to help developing countries escape from high carbon development trajectories to the low- or no- carbon alternative.

I was in Lima as part of the International Emissions Trading Association to represent the private sector and business. Pragmatists in the main, we spent our time looking for signs of the ‘how’ – how the full cost of climate change can be priced into our economy so that private sector innovation and capital can be put to work on building a low carbon economy. We didn’t find much evidence of pragmatic solutions – is all hope lost?

Price on Carbon: Dodo, Holy Grail or Silver Bullet?

At the New York City Climate Summit that Ban Ki Moon called in the autumn to rally the troops, there was much talk about ‘pricing carbon’. The World Bank Group and partners announced then that 74 countries, 23 sub-national jurisdictions and over 1,000 companies and investors had expressed their support for carbon pricing. Together, the governments were responsible for 54% of global greenhouse gas emissions, 52% of GDP and almost half the world’s population, and the private sector signatories accounted for US$24 trillion in assets.

Is all that enthusiasm and support as dead as a dodo? Not by a long way, but business is having to sit on its hands for a bit longer because it’s difficult to start talking seriously about the ‘how’ until we have figured out the ‘what’ – and that will be the focus throughout 2015.

Neither though is the concept a holy grail or elusive myth. The World Bank reported that 22% of global emissions are already covered by some form of carbon pricing. California, the world’s eighth-largest economy, has a de facto carbon price in its cap-and-trade law, which ratchets down the level of allowable emissions over time. The same is true of the European Union. China, the world’s largest annual emitter, is establishing cap-and-trade systems in seven regions and has pledged that its national emissions will peak by 2030. The Obama administration, as part of calculating the risks and benefits of potential energy policies, assigns a $35-a-tonne “social cost” to carbon emissions. Similarly, the UK Government recently updated its carbon pricing scenarios that it uses in policy appraisals. Their base case defines a carbon price of around £4.50/tonne CO2e in 2014 rising to around £55.00 in 2027.

In the private sector, CDP research has surfaced the fact that around 640 companies do not view climate as a cost but as an opportunity; 212 companies are directly engaged with policy makers on carbon pricing legislation because they favor these measures, and that 150 corporates already use an internal price for carbon. The research was summarised by The Economist to show that internal prices for carbon range from US$6 to US$60 per tonne of CO2e.

The majority of companies profiled in CDP’s research use a ‘shadow’ price of carbon to guide their capital investment decisions in the future. That means they are using a price for carbon to future-proof their investments against the expectation that greenhouse gas emissions will be increasingly and more tightly regulated in the future.

Microsoft is a notable exception. It prices carbon not as a defense against possible policy shifts but as a way to improve its profitability and recognition as a leader in the climate action. The profit and loss statement of each Microsoft division has a Carbon Neutral Fee line item and for every tonne of carbon a given division consumes, $5 to $7 is paid quarterly into a central carbon fund that in turn finances investments in low-carbon energy, energy efficiency, and high-quality carbon offsets in developing economies. The Carbon Neutral Fee is vital to achieving the company’s goal of being carbon-neutral by 2020. That means Microsoft is using its price for carbon to make investments in projects that deliver real reductions now when action is most needed.

Extracting value from carbon pricing

Cynics are quick to ask whether governments can be trusted to put a fair, effective and appropriate price on carbon. But can they afford not to? Climate change is causing profound damage—drought slashes crop yields; hurricanes flood subways; rising seas inundate property. Reflecting the costs of that damage in the emissions’ market price is one way in which the costs of climate impacts are paid for by emitters rather than by governments or the effected parts of society as a whole.

Governments impose a price of carbon in three main ways:

  • Carbon taxes such those being implemented in South Africa;
  • Cap, trade and offset programs such as those in the EU, China and California; and,
  • Direct regulation such as the renewable energy portfolio standards in the US.

Most economists argue that any one of these approaches can be an effective at imposing a carbon price, depending upon how the measures are designed to accommodate specific circumstances.

The value of carbon taxes is that they give certainty over the price, and that can be very important to business. However, they do not guarantee the resultant emissions reductions, and that is what is important to stabilising the climate. While Cap & Trade schemes guarantee the reductions (the Cap), prices are set in the market. When there are no safety valves built into the design, prices can be highly volatile, as has been the case for the EU’s Emission Trading Scheme. Direct regulation is appropriate in many circumstances where the risks are high and the solutions are cheap – for example, in cutting emissions of nitrous oxides, a powerful greenhouse gas, from adipic acid production through simple and cost effective technological upgrades.

The acid test for pricing policies is where the money goes and whether it is used to leverage further low-carbon development. Governments have a varied record in directing carbon tax revenues to activities that really accelerate low-carbon progress. Those can include early stage research on low-carbon technologies, subsidies and incentives for low-carbon energy. In too many cases, tax revenues land up redressing budget deficits, promoting muddled and conflicting policies (fossil fuel tax exemptions for example), or in compensating industrial sectors or civic society that are put at risk by carbon pricing.

Cap & Trade systems generate revenues for governments when they auction the emission rights, and the same issue arises as for taxes -- how best to direct those revenues for optimum speed and impact in decarbonising the economy. However, the effectiveness of Cap & Trade schemes is they distribute funds amongst the covered entities in ways which price emissions, reward progress, and deliver the most cost effective solutions. Offsetting improves cost effectiveness by providing access to real emission mitigation opportunities in sectors not covered by the Cap (such as in agriculture in the California Cap & Trade scheme), and which may be lower cost than those which can be achieved directly in the covered sector.

Ensuring we don’t leave value on the table

Carbon pricing is no silver bullet, and for it to work to best advantage, we will need to reframe the politics of international climate action from the narrow focus on ‘pricing the burden to ‘valuing the opportunity’.

Here’s a vivid example. The New Climate Economy Report values the health and mortality burden of air pollution in the top 15 emitting countries at an average of 4.4% of GDP, and more than 10% for China. Substituting coal with natural gas, renewables or nuclear power can lead to major improvements in public health.

The report presents evidence suggesting that more than half of the emissions reductions required to meet an ambitious and safe target generate additional material social, economic and environmental benefits that conventional carbon pricing methods may not be able to value.

Back to reality

I left the cacophony of Lima’s COP20 and headed to Guatemala to visit a project that uses carbon finance to fund the installation of thousands of clean cooking stoves and water filters in rural homes across the country. Managed by social enterprise, Socorro Maya, the project is included in the portfolio for Microsoft’s carbon neutral programme and helps it set a market-based internal price for carbon.

But most importantly, the project delivers a range of health, economic, and environmental value that far eclipses the costs on carbon. Eye infections from smoky cooking fires and gastric infections from dirty water are dramatically reduced, saving lives and health treatment costs. Fuel wood savings of over $400 per year arise because less wood is needed in the efficient stoves and the water filters deliver potable water without the need for boiling. Forest destruction is slowed and ecosystem integrity protected.

A compelling example of how a commitment to carbon neutrality by Microsoft establishes a viable and useful price on carbon and provides carbon finance that not only funds mitigation but a host of valuable and measurable Sustainable Impacts. A clear case of a price on carbon delivering the value of none.