The price of carbon

by | 4 Jul 2020 | Economy – Social

Hereafter the highlights of a position paper to be published soon, in the wake of Green Deal proposals, but also in link with our answer to European Commission public consultation on the so called Renewed Sustainable Finance strategy.

As the EU moves towards climate-neutrality and steps up the fight against environmental degradation, the financial and industrial sectors will have to undergo a large-scale transformation, requiring massive investment.

Finance has an undeniable role in this transition as it is the provider of means for the necessary shift to materialize.

Yet the financial system as a whole is not yet transitioning fast enough. Substantial progress still needs to be made to ensure that the financial sector genuinely supports businesses on their transition path towards sustainability, as well as further supporting businesses that are already sustainable.

Albert Einstein once said, “If I were given one hour to save the planet, I would spend 59 minutes defining the problem and one minute resolving it.” While that may sound extreme, it does highlight the importance of defining problems.

Actually, financial flows will always follow projects and investments that have a potential of rentability and feasibility. Therefore, it is necessary that low greenhouse gas emissions and climate-resilient projects become attractive compared to high-emissions activities.

This means that the structure of profitability must change for financial flows to fully reorient towards sustainable initiative.

This implies to give a price to the negative externality caused by economic activities issuing Greenhouse Gas (GHG).

The work of the main climate economists (Nordhaus, Tirole, Weitzman, etc.) tells us the same story: credible and increasing constraints are needed on the quantities of CO2 and on the price of CO2. Almost all academic economists support such a solution.

Carbon prices are intended to incentivize the changes needed in investment, production, and consumption patterns, and to induce the kind of technological progress that can bring down future abatement costs.

European Union should definitely take the lead at a global level on this question of carbon pricing, leveraging on the many “cap and trade” or carbon tax initiatives implemented, scheduled for implementation or under consideration in the world.

At EU level, a well-designed carbon pricing policy should then:

  • Give to an independent authority, kind of “EU Carbon Central Bank”, the task to define the trajectory of carbon price that is consistent with the objective of carbon neutrality in 2050.
  • Within the Common Market, reform the Emissions Trading System (ETS) in order to raise its prices and reduce its volatility and leave the Member States free to choose their method of imposing a single carbon price by a mix of ETS, a reinforced national version of the ETS and carbon tax. The common point of the various systems should be (i) the pre-defined price trajectory, and (ii) a full coverage of the goods and services consumed.
  • Implement ​​an adjustment at the borders (taxation of imports, subsidies for exports) making possible to send the very same price signal to all the goods and services consumed in the Union, so that to address the problem of “carbon leakage”, and to level the competition conditions between the Union and its trading partners.

The proceeds of the carbon ETS and tax should then return to the private sector (corporates and households), leaving the choice of methods of redistribution to the national level.

A high and increasing carbon price over time may not be enough to achieve the targets, but without the powerful incentive it offers, any cocktail of regulatory measures and capital expenditure will fail.

Feel free to contact me if you want the full position paper when published.

Iconography: Drax Power Station, Yorkshire, England, United Kingdom © Martin Sepion