Market signal for GHG mitigation: Make carbon price high enough
Under a carbon tax regime, to make emission expensive, a price is put on per unit of GHG emission released by an entity. It creates two options for the entity – either to enhance mitigation efforts or to pay tax for emissions
We have neither a vaccine at our disposal to inoculate the planet against climate change nor a magic bullet to remove additional greenhouse gases (GHGs) from the atmosphere to revert the planet to the state as close to the pre-industrial levels. We will, perhaps, not have such solutions in the foreseeable future either.
Of course, different innovations might take place over the next decades, but we would still need to advance the clean solutions that we currently have. Likewise, a regulatory environment with suitable instruments is crucial to provide the market signal necessary for GHG mitigation to take place, both sooner and at a rapid pace.
One of the policy instruments is carbon pricing. This is being used in different regions and countries to influence the markets to react and spearhead actions to cut down GHG emissions.
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While carbon pricing is a market-based instrument, many non-market instruments, such as energy efficiency standards, emission standards, etc. are also favored by governments across the globe. In fact, a combination of both market and non-market instruments, if used in a suitable policy mix, has the potential to deliver high levels of emission reductions.
In this piece, I will only dwell upon carbon pricing, which primarily includes carbon tax and carbon trading mechanisms. Energy tax, energy efficiency trading and renewable energy certificate/green certificate also fall under the category of carbon pricing.
In essence, under a carbon tax regime, to make emission expensive, a price is put on per unit of GHG emission released by an entity. It creates two options for the entity – either to enhance mitigation efforts or to pay tax for emissions.
Trading mechanism, on the other hand, enables the (large) GHG emitting organisations to trade GHG emissions among them and thus the price for carbon emerges in a market. Different businesses, under the trading mechanism, either reduce emission or purchase a certificate of emission reduction from others or make a combination of both options, as they find feasible.
What I have mentioned thus far in the foregoing is the modus-operandi of the carbon pricing instruments. But "price" of carbon is the major determinant to induce mitigation projects.
Currently most renewable energies can meet our energy demand at a reasonable cost. But a high carbon price in the form of carbon tax will encourage, for example, business entities to increase the share of renewables to their energy mix as high carbon price makes fossil fuels-based energy sources further expensive. In a very polluting country with an electricity source dependent on coal-fired power plants, carbon tax could ensure the penalty for GHG emission with certainty.
Policymakers, particularly in countries that find it difficult to mitigate GHG emission, in light of the rising disasters and heat-stress related problems linked to the global mean temperature rise, might commit for long-term carbon price trajectory. This strategy would provide the impression to the large business corporations that the price of carbon is going to follow the rising trend in the future.
What is more important, though, is to chart an immediate pathway to increase carbon tax. Several studies, on the basis of modelling, are providing indications on the minimum prices of carbon that we should put to internalise all the external costs of GHG emissions. These models might not be devoid of the caveats and yet, the outputs of them still could be analysed as starting points to revise the prevailing tax rate or to impose new tax.
In a trading system, the market should send the price signal for mitigation to take place. In other word, the price of carbon should deliver the incentive to an entity to respond and to initiate carbon reduction projects. Despite the rising trajectory of carbon prices even in the voluntary market, different studies reveal that the price level is yet to be sufficient with respect to the 1.5° C temperature goal.
While the high carbon price is beneficial to attract GHG mitigation interventions, it also allows the governments to weed-out challenges. Carbon tax helps remove the environmentally harmful fossil fuel subsidies, which are proven hindrances to clean energy promotion.
Simultaneously, by addressing energy price distortion, governments find their resources freed up for use in other areas, including climate change mitigation and adaptation interventions. The tax revenue, being generated from the carbon tax, could be recycled for clean energy promotion and other GHG mitigation projects.
The coal cess of India, though abolished recently, is an excellent example where the revenue from the coal tax used to be channeled to different environment-friendly projects. Billions of USD, collected from coal cess, among other policy and fiscal measures, contributed to the clean energy portfolio of India, which today is more than 94,000 MW (94 GW) on installed capacity basis.
Notably, the carbon revenue could be used to finance climate change adaptation projects in the countries that are vulnerable due to climate change and at the same time, resource constraints affect implementation of such projects. Similarly, proceeds from the auction of allowances in a trading system can support both mitigation and adaptation projects.
On this front, the outcomes of the discussion on article VI at the 26th Conference of the Parties (COP26), to be organised in November this year, might boost the carbon market. The finalisation of the gray areas of article VI, which is essentially the basis for an effective international carbon market, might help raise the price of carbon. This will provide enough rationale to the polluting entities to decarbonise. This might allow developing countries to take the advantage to advance clean transformation as well.
Despite the need to raise the price of carbon, this instrument should be considered a part of the broader policy mix to achieve the 1.5° C temperature goal. Carbon pricing in isolation will not deliver the intended results. It is a necessary instrument in the global race to net zero emission but not a quid pro quo for other instruments and policy measures.
The author is an environmental economist.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.
