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Expansion of Carbon Pricing Can Unlock Potential

Serkan Birgel
Oct 07, 2021

Guidehouse Insights

Buoyed by ambitious climate goals, emissions trading schemes (ETSs) and carbon taxes have grown to cover 21.5% of global greenhouse gas (GHG) emissions—equivalent to around 11.65 GtCO2e. These are a combination of 35 carbon taxes and 29 mandatory ETSs, with the latter representing 16.1% of emissions covered globally per The World Bank’s Carbon Pricing Dashboard. Carbon pricing is an increasingly essential policy instrument in the drive to induce decarbonization and aid the transition into a low carbon economy.

However, there is room for the implementation of carbon pricing to expand, particularly as the urgency of climate change abatement grows. The Organisation of Economic Cooperation and Development quoted a figure of $147/tCO2e by 2030 to facilitate net-zero emissions by 2050. In contrast, global average emissions prices are only $3/tCO2e according to the International Monetary Fund (IMF), with four-fifths of global GHG emissions deemed underpriced. Uncertainty in price hinders further investment in the adoption of the necessary technologies at scale to accelerate the energy transition.

Market-Based Solutions Are Key

A market-based solution, putting a price on carbon shows the broader societal costs of emissions. This encourages decarbonization based on the marginal cost of abatement. Now in its fourth phase, the European Union’s (EU’s) ETS is viewed as a major tool of the EU to deliver its net-zero by 2050 objective. Launched in 2005 as a cap-and-trade system, the EU ETS has seen its allowance prices reach a new record, edging above 60 per metric tonnes at the beginning of September 2021.

The EU ETS has grown to cover around 41% of total EU GHG emissions, has represented 90% of global carbon market value in 2020, and has broken its own price record around 40 times this year. Such a price still falls within the $40-$80 carbon price corridor, defined by the Carbon Pricing Leadership Coalition as the price range across major economies necessary to catalyze GHG emissions reductions by 2020 in line with a 2°C global warming scenario. In one estimation, between 2008 and 2016 the EU ETS saved around 1.2 GtCOe or 3.8% of emissions relative to an estimated counterfactual scenario without carbon markets.

Carbon Pricing Requires More Investment and Expansion to Become Effective

There is variation on the effectiveness of carbon pricing schemes in limiting emissions. One meta-review of ex post qualitative evaluations concludes that aggregate reductions of emissions from carbon pricing are up to around 2% a year (with considerable geographic and sectoral variation). However, carbon taxes, which often command higher prices have been found to have performed better than ETS—especially in Europe.

Discussions for a global price on carbon have been reinvigorated by low global average carbon prices and the fact that the majority of the world’s GHG emissions remain beyond the remit of carbon pricing schemes. The IMF is deliberating a proposal for a minimum global carbon price, while the Net-Zero Asset Owner Alliance (which is made up of institutional investors that manage over $6 trillion in various financial assets) is calling for an internationally binding global carbon price corridor. Legislative proposals have also been introduced that would see the EU ETS cap further reduced annually to induce emissions reductions by 61% by 2030 compared to 2005 levels.

Beyond short-term operational shifts in existing assets such as coal-to-gas switching in power generation, comprehensive and sustained decarbonization at scale will also require the use of carbon pricing schemes alongside other tools and instruments. Expanded regulations, financial incentives, and technology investment can help unleash more of carbon pricing’s potential.