What Does It Mean to Put a Price on Carbon?

June 11, 2014


The World Bank Group and partners are calling on governments and companies to support putting a price on carbon.

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  • Carbon pricing is gaining attention as a way to address climate change. About 40 countries and more than 20 cities, states and provinces use carbon pricing mechanisms such as emissions trading systems and carbon taxes or are preparing to implement them.
  • A price on carbon helps shift the burden for damage from greenhouse gas emissions back to those who are responsible for it and who can reduce emissions.
  • The private sector has been increasingly outspoken in its support for consistent carbon pricing. Many companies already operate in countries with carbon pricing and use shadow carbon pricing in their planning and investments.

United States President Barack Obama talked in a recent interview about a price on carbon as the way to begin solving the challenge of climate change. New York Times columnist Tom Friedman had asked: What is the one thing you would still like to see us do to address climate change? Obama replied: “for us to be able to price the cost of carbon emissions.”

The phrase “put a price on carbon” has become increasingly common as discussions of how to address climate change move from concern to action. The World Bank Group, business groups, and investors have called on governments and corporations around the world to support carbon pricing to bring down emissions.

So what does it mean to put a price on carbon, and why do many government and business leaders support it?

There are several paths countries can take to price carbon, but they all lead to the same result. They begin to capture what are known as the external costs of carbon emissions – costs that the public pays for in other ways, such as damage to crops and health care costs from heat waves and droughts or to property from flooding and sea level rise – and tie them to their sources through a price on carbon.

A price on carbon helps shift the burden for the damage back to those who are responsible for it, and who can reduce it. Instead of dictating who should reduce emissions where and how, the price for carbon gives an economic signal and polluters decide themselves whether to reduce emissions, discontinue their polluting activity, or continue polluting and pay for it. In this way, the overall environmental goal is achieved in the most flexible and least cost way to society. The carbon price also stimulates clean technology and market innovation, fuelling new, low-carbon drivers of economic growth.

How Carbon Pricing Works

Pricing carbon isn’t new.

About 40 countries and more than 20 cities, states and provinces already use carbon pricing mechanisms or are planning to implement them. These jurisdictions are responsible for more than 22 percent of global emissions. Many more are developing systems that will put a price on carbon in the future. Altogether, these actions will encompass almost half of global CO2 emissions.

There are two main types of carbon pricing: emissions trading systems (ETS) and carbon taxes.

An ETS – sometimes referred to as a cap-and-trade system – caps the total level of greenhouse gas emissions but then allows those industries with low emissions to sell their extra allowances to larger emitters. By creating supply and demand for emissions allowances, an ETS establishes a market price for greenhouse gas emissions. The cap helps ensure that the required emission reductions will take place to keep the emitters (in aggregate) within their pre-allocated carbon budget.

A carbon tax directly sets a price on carbon by defining a tax rate on greenhouse gas emissions or – more commonly – on the carbon content of fossil fuels. It is different from an ETS in that the emission reduction outcome of a carbon tax is not pre-defined but the carbon price is.

The choice of the instrument will depend on national and economic circumstances.

There are also more indirect ways of more accurately pricing carbon, such as through fuel taxes, the removal of fossil fuel subsidies, and regulations that may incorporate a “social cost of carbon.” Greenhouse gas emissions can also be priced through payments for emission reductions. Private entities or sovereigns can purchase emission reductions to compensate for their own emissions (so-called offsets) or to support mitigation activities through results-based finance.

What Are Countries Doing?

There are several leaders in pricing carbon.

China has launched six pilot emissions trading systems in four cities and two provinces, and plans to launch in a fifth city, Chongqing, later this month. It has a goal to reduce emissions intensity by 40-45 percent compared with 2005 levels by 2020, establish statistical and verification systems for greenhouse gas emissions, and is considering a national emissions trading systems to start in a few years.

South Africa’s ambition is to reduce emissions by 34 percent by 2020 and 42 percent by 2025, though a carbon tax and offset system expected to be launched after the start of 2016.

Mexico has a national climate change policy and ambitious greenhouse gas emissions reduction targets. It has a voluntary market now and is exploring innovative approaches to carbon pricing as a member of the Partnership for Market Readiness, a group of 31 countries developing carbon pricing systems of the future.

Norway has had a carbon tax since 1991, and about half of its total greenhouse gas emissions are covered today.

The Private Sector Is Ahead

The private sector has been increasingly outspoken in its support for consistent carbon pricing.

Many companies operate in countries that have carbon pricing system in place now, and they are developing the expertise in both managing their emissions and incorporating a real or shadow carbon price in their planning and investments.

According to the investor group Ceres, 96 of the combined 173 companies in the Fortune 100 and Global 100 have gone further to set voluntary greenhouse gas reduction targets, which has led them to accelerate their investment in energy efficiency, renewable energy, and sustainable forestry.

They have also called for more consistency from governments. Nearly 400 companies in the United Nations Global Compact’s Caring for Climate initiative have called for “the urgent creation, in close consultation with business, community, and civil society, of long-term policies to create a stable price for carbon.” Through the Prince of Wales’s Corporate Leaders Group on Climate Change, more than 150 companies have asked for “a clear, transparent and robust price on carbon.”

In the run-up to the UN Secretary-General's Climate Summit in September, the World Bank Group, together with those and other partners, is calling on countries and companies to voice their support for pricing carbon as increasingly necessary to tackle climate change. The World Bank Group has also reviewed best practice for carbon pricing within organizations and is setting its own process for taking into account costs, benefits, and the global impact of projects.