Putting a price on carbon emissions is seen by many as a vital step in moving to a low-carbon economy
CARBON COSTS
A growing array of energy transition processes and technologies depend upon carbon having a reasonable monetary value
DIFFERING VALUES
Carbon has only started to attain a price point that makes decarbonisation worthwhile
KEY QUOTE
We are not yet on track to stabilising climate, and that’s because carbon prices are not yet sufficiently stringent broadly across the globe
Most farmers survey fields with an eye to the money they can make from the earth. Will Shakeshaft, of UK farming group Greens of Soham, is also interested in making money by leaving something in the ground instead—carbon. Current farming practices release carbon into the atmosphere, but it could instead be absorbed by the soil with just a few tweaks to agriculture. Research suggests better land use could take up to 15 billion tonnes of carbon dioxide equivalent out of the air by 2050. One of the improvements being studied at Greens of Soham is regenerative farming to lock carbon in the soil rather than pumping it into the atmosphere. Doing so could also provide a new form of a commodity that farmers can take to market. “We’re looking at how we can sell carbon credits to companies,” Shakeshaft says. Selling credits to organisations that want or need to reduce their climate impact, but cannot do so directly, is potentially a big deal not just for farmers but also for a host of emerging industries, such as those dedicated to carbon capture and storage. However, the technologies, processes and industries needed to reduce carbon in the energy system will only flourish if there is sufficient incentive to curb emissions. In other words, carbon must have a cost when it is emitted and a value when it is saved or sequestered. Moves are afoot to make sure this is the case, overturning decades of climate-damaging operations during which carbon emissions were seen as an externality that would not harm society.
FALLING SHORT
But these moves, such as the establishment of increasingly wide-ranging carbon markets, could be falling far short of what is needed to properly account for climate damage, according to research. One of the first studies to put a real value on carbon emissions was a 2006 report by UK government economic service head Sir Nicholas Stern. The Stern report estimated it would take 1% of the global gross domestic product (GDP) a year to avoid the worst impacts of climate change. Two years later, Stern revised that estimate upwards, to 2% of GDP. Using 2021 figures for global GDP ($97 trillion) and greenhouse gas emissions—51 billion tonnes, according to data collated by the International Monetary Fund—this works out at a cost of $38 per tonne of carbon dioxide equivalent. However, Stern’s report, which has been criticised both for being too pessimistic and not pessimistic enough, also warned that the cost of climate action would increase if emissions reductions were delayed. This appears to have been the case, based on more recent research by academics in the United States. A September 2022 paper on the social cost of carbon dioxide, defined as “the monetised value of the damages to society caused by an incremental metric tonne of CO2 emissions,” came up with a range of $44 to $413. The authors’ preferred average was $185 per tonne of carbon dioxide (tCO2), at 2020 rates. “This is 3.6 times greater than the US government’s current, most commonly cited mean value of $51 per tCO2 using a 3% constant discount rate,” says the paper. 
FAILING MARKETS
The proposed price is also far higher than those seen in global carbon markets, although this will not come as a surprise to observers. Carbon markets have long struggled to put a meaningful cost on emissions. The European Union’s Emissions Trading System (ETS), which started operating in 2005 and for a long time was the world’s largest carbon market, did not reach €30 per tonne of CO2 until the end of 2020. Low prices for carbon are a problem for the energy transition because many decarbonisation technologies require investments that could be difficult to justify below a given price point. One example is direct air carbon capture and storage, or DACCS. This is a technology that promises to suck CO2 out of the air and store it. However, DACCS is pricey, with the United Nations Intergovernmental Panel on Climate Change estimating it would cost between $100 and $300 per tonne of CO2. Until carbon prices hit such levels, there is little chance of DACCS taking off.
HYDROGEN PATHWAY
There is a similar dynamic at play with hydrogen, which is seen by many as key to the decarbonisation of hard-to-abate sectors such as fertiliser production and steelmaking. Today, the cheapest and easiest way to produce hydrogen is through steam methane reforming (SMR), which involves high levels of greenhouse gas emissions. To get rid of these emissions, hydrogen producers would need to either add carbon capture and storage to steam methane reforming or adopt a different production pathway using renewable electricity to power the electrolysis of water. As with DACCS, the increased cost of these alternative production methods is hard to justify unless the carbon savings are priced at close to $100 per tonne. Green hydrogen made with electrolysis, for instance, is much more costly than that made using SMR and is likely to remain so unless the cost of carbon emissions goes up.
PROMPTING ACTION
Carbon pricing can even be instrumental in areas such as development funding for emerging economies. In a 2019 technical note, the European Bank for Reconstruction and Development (EBRD) stipulated that a minimum carbon price of between $40 and $80 per tonne should be used as part of its economic assessment methodology. “For the purposes of a core assumption in project assessment, the EBRD will test the economic viability of projects against the low and the high value,” said the investment bank. These figures illustrate the extent to which the ETS may have failed to prompt climate action for a decade and a half before 2020. The market was set up as part of a cap-and-trade system where greenhouse gas polluters in Europe were allocated a set number of carbon credits that they could trade with each other. Organisations that did not meet their emissions reduction targets would have to buy credits from those that could, with shortfalls driving up the price of carbon and creating more of an incentive for decarbonisation. However, early iterations of the ETS failed to foresee reduced economic growth across Europe in the wake of the Great Recession from 2007 to 2009. Consequently, Europe’s world-leading carbon market found itself with a glut of credits, keeping the cost of emissions low and limiting the financial imperative to adopt low-carbon operations. Matters have only just begun to improve, with carbon pricing on the ETS breaking the €100 barrier for the first time in early 2023. At the same time, a range of other developments are helping to push up the cost of carbon. China has launched a carbon market of its own, albeit with limited pricing impact in the early stages. The daily weighted average price of China Emission Allowances was roughly $7.35 when the market launched in July 2021 and averaged just $8.34 per metric tonne of CO2 in 2022, reports S&P Global Commodity Insights. “China’s carbon market development is expected to slow in 2023 as concerns about energy security and the reopening of the economy take precedence,” it adds.
MISSING IN ACTION
The United States has yet to formalise a federal carbon market
WIDENING RANGE
Other jurisdictions are also increasingly implementing carbon markets, with 30 compliance schemes like the ETS in operation worldwide as of September 2022, according to the analyst firm BloombergNEF.One glaring omission is the US, where state-level schemes covered 8% of emissions in 2021 but a federal programme is unlikely to appear any time soon due to a lack of bipartisan support. However, the US has put a national price of sorts on carbon through the 2022 Inflation Reduction Act (IRA) legislative package. The act includes a tax credit worth $85 per tonne for carbon capture, utilisation and storage (CCUS) in geological formations, and $60 per tonne for storage in oil and gas fields, subject to wage and apprenticeship conditions. For DACCS, and again subject to wage and apprenticeship conditions, the tax credit rises to $180 per tonne with storage in geological formations and $130 in oil and gas fields. “The IRA’s revisions… are likely to result in more liquidity options for project developers… and significantly increased capital investment in CCUS,” said law firm Baker & Hostetler in August 2022.
EU BORDER FORCE
Countries that do not presently put a price on carbon may find themselves having to do so because of tariffs such as the European Union’s Carbon Border Adjustment Mechanism, which is set to take effect from 2026. To protect Europe’s manufacturers from foreign rivals that do not pay carbon costs, the border adjustment mechanism will force non-European companies selling goods in Europe to report emissions and buy credits linked to the ETS. 
VOLUNTARY SCHEMES
One further trend that is helping to put a price on emissions is the rise of voluntary carbon markets. In these, organisations can buy credits or offsets to negate carbon emissions incurred in their operations. Delta Air Lines of the US, for example, pays into schemes that remove the equivalent of its annual carbon emissions. Such schemes can range from tree planting to DACCS installations, with the effectiveness of certain types of offset coming under growing scrutiny in recent years. This scrutiny is prompting the development of voluntary market schemes that have higher levels of effectiveness—and higher prices. Estonian company Kwota is selling offsets based on the use of recycled materials in sectors such as the paper industry. Switching from virgin to recycled materials can have a major impact on emissions—up to 40% in paper and board production, according to a body called the Circularity Gap Reporting Initiative—and is relatively easy to track and validate. To encourage manufacturers to switch to recycled materials, Kwota creates carbon credits based on these CO2 reductions and sells them to companies. To get companies to join the scheme, Kwota started out by offering carbon credits that equated to roughly 1% of manufacturing costs. “They said, ‘Sounds beautiful, but we don’t need it,’” says Rain Vääna of Kwota. It turns out the pricing threshold for meaningful action is roughly ten times what Kwota started out with. “If somebody promises to lower your purchasing cost by 10%, action is immediate,” Vääna says. To get to that 10% level, Kwota has ended up pricing its credits at €120 per tonne of carbon. Of this, 80% goes back to the producer, resulting in an effective CO2 price that is not far off the €100 per tonne that seems to be a tipping point for carbon markets.
RAMPING UP
Voluntary and compliance markets are gradually rising to such levels, but there are questions over whether they are doing so fast enough. As the Stern report noted, the cost of avoiding catastrophic climate change rises over time in the absence of mitigating measures—and although the energy transition is now well underway, emissions are still increasing. From a climate perspective, it would be desirable to hike up carbon prices as quickly and as far as possible, but this is not always politically viable. In 2022, for instance, the Spanish government—an erstwhile staunch supporter of European climate action—asked for a cut in carbon prices to help stem spiralling inflation in energy costs. Amid such challenges, “Existing carbon pricing programmes must significantly ramp up their size and ambition if they are to play a major role in decarbonising the global economy,” said BloombergNEF in September 2022. “While the proliferation of carbon markets is undoubtedly good news, prices are by and large still too low to have a material climate impact. This is particularly true for sectors outside of power generation,” it added. Dale Beugin of the Canadian Climate Institute, a policy think tank, says an effective carbon price will play a significant role in slowing emissions. “We are not yet on track to stabilising climate, and that’s because carbon prices are not yet sufficiently stringent broadly across the globe,” he says. The situation is complicated, he adds, because “it’s not that there’s one magic carbon price globally.” The solution to decarbonisation is not just about pricing instruments, he adds. “We need regulatory and other policies because of political constraints on what you can do with the price of carbon,” he says. “It’s lots of devils, lots of details.” •
TEXT
Jason Deign