Carbon pricing

Carbon pricing

Subject: Environment

Section: Climate Change

Concept:                                                                  

What is carbon pricing?

• Carbon pricing is the value ascribed to the external costs – usually social costs – of pollution emitted by an industry
• Carbon pricing is done either through a carbon tax or an emission trading system.
• Carbon tax is the price that governments impose on polluters for each metric ton of carbon dioxide emissions generated.
• Carbon trading is a market-based approach in which each polluter is allotted a specific quota (permit) or allowance of pollution that it can emit and trade these permits.

Background:

• In the 1920s, a British economist, Arthur Pigou, highlighted the social benefits of making industries pay for the costs of the pollution they caused.
• This concept was taken up in different ways in later stages and evolved into the  concept of ‘carbon pricing’.
• According to the World Bank, carbon pricing is the value ascribed to the external costs of pollution emitted by an industry.
• External costs affect the emitting industry the least, whereas the great damage done to planet earth
• Instead, public systems pay a socially tragic price – such as the costs of losing crops because of poisoned air/water and health care costs because of heat/cold waves or extreme weather events from global warming.
• Carbon pricing is an economic tool used to push industries, households and governments to bring down emissions and invest in cleaner options.
• It helps in shifting the burden of damage caused by pollution onto those responsible for the pollution but does not dictate how or where emissions can be reduced.
• Instead, it puts an economic value to pollution and allows polluters to decide whether to reduce emissions or continue polluting but pay the price for it.
• Ideally, these taxes should be used to either offset the extra burden of carbon taxation on low-income groups or on remedial projects to offset the effects of pollution.

Why a price on carbon?

• Carbon is priced because CO2 being the most emitted GHGs
• According to the latest IPCC report, the window of action for reducing emissions to limit global warming to 1.5 – 2 deg C above pre industrial level is rapidly closing.
• And global warming & climate change create conditions beyond human tolerance
• Currently, Carbon pricing is done in two ways: (1) carbon tax, (2) Cap-and-trading or emission trading system (ETS)

What is Carbon tax?

• Governments impose on polluters for each metric ton of CO2 emissions (mt CO2e) generated
• Levied on coal, oil products, and natural gases, according to their carbon content
• It motivates industries to improve energy efficiencies, move towards low-carbon fuels and renewable energy sources.
• Carbon taxes are fairly easy to administer as add-ons to already existent fuel taxes
• Generate revenue for governments that can be  utilised for achieving sustainable development goals.
• However, Carbon tax affects people of lower income groups as it increases fuel prices, and carbon taxes on industries trickle down to consumers
• In addition, carbon taxes may discourage investment and economic growth as businesses may shift production into countries without carbon taxes
• Finally, the administrative costs of monitoring and measuring emissions, and uncertainties in measuring the social costs of carbon pollution can make carbon taxation a difficult task.

What is carbon trading? 

• Market-based approach to pricing carbon emissions and to limit the total amount of carbon-based pollution that can be produced.
• Governments allocate a limited number (set as a cap) of permits that allow a specified amount of emissions over a period of time.
• Polluters are then allowed to trade these permits with each other.
• if a polluter manages to maintains emission levels lower than its assigned permit values, it can sell the right to emit carbon to another polluter which may be emitting more that its quota

What are carbon credits?

• A carbon credit is a generic term for a tradeable certificate or permit to emit a 1 metric tonCO2 or an equivalent amount of different GHGs.
• It is the basic trading unit for carbon markets.
• The carbon trading market was set up in 1997, after the Kyoto Protocol was signed. 
• Under this protocol, all participating countries were to set and adhere to a limit on their carbon emissions over a series of commitment periods.
• However, the protocol also allowed countries to trade emissions permits with each other.
• Apart from these permits, carbon removal units (from activities such as reforestation), emission reduction units, and certified emission reductions (from clean development mechanism projects) can also be traded
• The prices in cap-and-trade schemes, which use carbon credits, are market driven (meaning that their prices vary according to demand and supply), although the government controls how many units/credits are allotted to each industry/stakeholder, and so how many credits are available for sale on the whole.

Criticisms of the carbon pricing system

Currently, the Environmental Defense Fund states that the cap-and-trade system is the most “economically and environmentally” sound approach to limit emissions and mitigate global warming.

This is because the cap sets a firm limit on pollution and trading encourages cutting emissions in the most cost-effective manner.

However, carbon trading is insufficient to mitigate climate change.

Carbon pricing places more importance on increasing efficiency than on effectiveness and encourages optimisation of existing systems rather than on transforming them to reduce pollution.

Furthermore, it has been pointed out that current issues with emissions are a fundamental systemic problem of society, and not just a market problem; therefore, they will require more than just a ‘price on pollution’ to overcome.

“First and foremost, one must remember that carbon pricing, especially carbon taxation, is a tool to make cutting carbon emissions more economical – it is not necessarily a tool to cut the total amount of carbon produced”

“If we take the example of pollution from cars, a tax may not incentivise the owner-users to reduce the use of fossil fuels. After all, in urban areas, owning and using many cars is more of a status symbol, just like owning land in the rural areas. There are just too many incentives – EMI (equated monthly installment) is the most important – that fits nicely with this ‘aspiration’. For most users, fossil fuel is an ‘essential commodity’ and the quantum of its use is independent of price changes.

On the other hand, making the emission standards stricter has the potential to reduce the pollution emitted by a running engine per unit of time.

But according to ‘Jevons Paradox’ or the ‘rebound effect’ (expounded by William Stanley Jevons at the House of Commons two and a half centuries ago), if the rise in car numbers increases at a rate higher than the rate at which emissions are reduced, total emission will increase.

There are no easy solutions here, given the political economy of carbon in India

In addition to these issues, unlike how the cap-and-trade program drove innovations to reduce sulphur dioxide emissions from power plants, the rise in technological innovations for reducing carbon emissions have not met with the same success.

Although there is some evidence that innovations in low-carbon technologies are being driven by the European Union’s ETS (EU ETS) and China’s ETS, there are doubts that this will help in driving climate change mitigation at the desired rate.

What is the current rate at which carbon is priced?

According to The World Bank’s Global Carbon Pricing Dashboard as of April 2021, global carbon pricing initiatives range from less than $1 to as high as $137 per mt CO2e.

There are currently 65 carbon pricing initiatives across 45 national jurisdictions. In 2021, these initiatives would cover 11.65 Gmt CO2e, which represents 21.5% of the global GHG emissions.

However, less than 1% of the global emissions (5 out of 65 initiatives) are currently priced at close to or above the least estimated social cost of carbon, which, according to the IMF, is 75 USD per mt CO2e.

A publication in 2021 in the journal Environmental Research Letters, places the social cost of carbon at a whopping >3000 USD per mt CO2e if climate-economy feedbacks and temperature variabilities are taken into account.

As of November 2021, the average weighted price of carbon stood at 3.37 USD per mt CO2e.

How does carbon pricing work in India?

Currently, India does not have any explicit carbon pricing or cap-and-trade mechanisms; instead, it has an array of schemes that place an implicit price on carbon.

The Perform, Achieve and Trade (PAT) scheme aims to reduce emissions from energy intensive industrial sectors by setting specific energy reduction targets.

Industries that exceed the targets are awarded Energy Saving Certificates (ESCerts), each of which is equal to one metric tonne of oil.

Those industries unable to meet the targets are required to buy ESCerts (from units that have exceeded their targets) through a centralised trading mechanisms hosted by the Indian Energy Exchange.

The Coal Cess is a tax on coal that was introduced in 2010, which aimed to use the collected revenue to finance clean-energy initiatives and research via the National Clean Energy Fund.

However, the idea failed to achieve significant outcomes as a large part of the collected revenue remained unutilised.

In 2017, the coal cess was abolished and replaced by the Goods and Services (GST) Compensation Cess; the proceeds of this tax are used to compensate states for revenue losses due to a shift to the new indirect tax regime.

Renewable Purchase Obligations (RPOs) and Renewable Energy Certificates (RECs) are aimed at encouraging India’s growing renewable energy sector.

All electricity distribution agencies are required to source a specific minimum of their electricity requirements from renewable energy sources. For each state, the RPO is fixed and regulated by the respective State Electricity Regulatory Commission.

The RECs are market-based instruments that aid in achieving RPOs through trading at power exchanges.

Internal Carbon Pricing is a tool used by the private sector in India to reduce emissions voluntarily, so that they can channel investments into cleaner and more energy-efficient technologies to meet corporate sustainability goals.

Currently many major Indian private companies such as Mahindra and Mahindra, Tata, Infosys, and Wipro, use ICP to lower their carbon footprints.

The main issue with the carbon credit system currently, especially for small businesses or individual land holders, is that agencies that provide credentials for and evaluate carbon credit generation, charge very high fees, which may not be offset by the income generated from selling the carbon credits themselves.