The Cost of Carbon

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When factories belch smoke, everybody pays. Shouldn’t polluters be the ones to feel the sting instead? That’s the big idea behind carbon pricing: Add a levy so that emissions of greenhouse gases have a cost in line with their environmental damage. Using market forces should be the most efficient way to get companies to change their ways and to fight climate change. More countries are warming to the concept, but policy makers can’t agree on the best way to do it. Europe, parts of the U.S. and China use exchanges where companies buy and sell permits to pollute. There's vigorous debate about whether those markets work better than a simple carbon tax.

The Situation

About half of the 195 nations that signed the 2015 Paris agreement to fight global warming expect to use some form of carbon pricing. China, the world's biggest polluter, will launch a nationwide carbon trading system this year for some of its dirtiest industries. Canada will set a national minimum price in 2018, and Singapore will introduce Southeast Asia's first carbon tax the year after. Worldwide, about 40 countries or jurisdictions have developed or plan to start emissions markets, generally systems known as cap-and-trade. About half that number have a tax, ranging from less than $1 a metric ton in Mexico to $131 in Sweden. Many countries — such as the U.K. and most Scandinavian nations — use permit trading alongside targeted taxes on dirty fuels like coal. U.S. President Donald Trump has opposed a tax, though some conservative political and business leaders, including the head of Exxon Mobil Corp., support the idea. They see it partly as a free-market replacement for environmental regulations that Trump is unwinding. Many of those rules were put in place by Trump's predecessor, Barack Obama, after he tried and failed to start a national cap-and-trade system. 

The Background

Carbon pricing creates incentives to invest in clean technology or switch to less carbon-intensive fuels. When a tax is used, it’s up to governments to set the levy at a level that’s high enough to encourage action, but not so high that it forces factories to close or relocate. With cap-and-trade, governments typically set a target for how much pollution-cutting their economies can tolerate, then distribute or sell individual rights to release CO2. Companies that innovate and reduce their pollution can sell their extra allowances to companies that don't. The European Union was the first to require carbon permits, in 2005, only to see the price plunge about 80 percent over a decade to about 5 euros ($5.29) a ton, about half the level needed for companies to feel the bite. There were several reasons: Governments had implemented overlapping policies such as renewable energy subsidies and nations handed out lots of allowances for free to reduce opposition from business groups. Carbon markets of various forms followed in the northeastern U.S., California, New Zealand and South Korea, all of them learning from the EU’s mistakes. As carbon pricing has spread, there have been setbacks. Australia repealed its carbon tax in 2014 and scrapped plans for permit trading after the measures were blamed for destroying jobs. 

The Argument

While carbon pricing has helped countries meet their emissions targets, the idea hasn't been fully tested. The cap-and-trade programs haven't had a big impact on corporate behavior because the price of credits has been low, though they have encouraged some switching by utilities to cleaner natural gas. The U.K.'s carbon tax — about four times the EU market price — helped slash annual coal use by almost 60 percent in 2016. Emissions in Canada's British Columbia province fell after it introduced a tax in 2008, but they've since rebounded. Advocates of cap-and-trade argue that it’s better than a tax because it ensures a certain level of cuts. Emissions markets can also provide important price signals to drive investment in green technologies ranging from energy-saving lightbulbs to carbon capture and storage. Critics of all types of carbon pricing say it hits the poor hardest by raising household energy prices, though the burden can be offset by redirecting revenue raised from polluters to low-income families. Some parties are calling for a global price, though a level making a difference in richer countries could harm poorer ones. 

The Reference Shelf

  • Bloomberg New Energy Finance provides data and analysis on the future of energy, including white papers and blog posts.
  • QuickTake explainers on climate change, solar energy, wind power and cleaner cars
  • The International Carbon Action Partnership says countries accounting for half of the world's gross domestic product are covered by carbon markets. 
  • The World Bank’s report on carbon pricing.
  • New York Times graphic showing how carbon markets work.
  • International Emissions Trading Association’s annual report
  • A series of 2014 editorials from Bloomberg View advocating a carbon tax.

    First published Nov. 28, 2013

    To contact the writer of this QuickTake:
    Mathew Carr in London at m.carr@bloomberg.net

    To contact the editor responsible for this QuickTake:
    Leah Harrison at lharrison@bloomberg.net

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