- Today, we see the effect of human-induced climate change in the form of weather and climate extremes in almost every region across the globe.
- According to the recent Intergovernmental Panel on Climate Change (IPCC) sixth report, there is a large possibility that global temperature will increase by more than 1.5? compared to the pre-industrial level as early as 2040.
- Ahead of the UNFCC’s 26th annual climate change conference (COP26) in November 2021 — the most important climate conference since Paris 2015—we see promising signs of growing climate ambition.
- Rules regarding Carbon pricing mechanisms will be one of the subjects of negotiation in the COP.
- Carbon Taxes or Carbon Pricing is seen by many as the most effective policy tool to expedite our efforts towards reducing carbon emissions
Understanding the concept of Carbon Pricing
- Carbon pricing is an instrument that captures the external costs of greenhouse gas (GHG) emissions and then ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted.
- The external costs of GHG emission encompasses the costs incurred by the public due to the emissions.
- For example, health care costs from heat waves and droughts, damage to crops, loss of property from flooding and sea-level rise etc.
- Thus, it follows the Polluter-pays principle, i.e. a price on carbon dioxide emissions helps shift the burden for the damage caused, back to those who are responsible for it, and who can reduce it.
- It also helps in giving a general economic signal to all polluters to decide for themselves whether they want to discontinue their polluting activities and reduce emissions, or continue polluting and pay the charges. Thus, it doesn’t target individuals but communities as a whole.
- Thus, it becomes a flexible and least-cost way for the society to reach the overall environmental goal.
Types of carbon pricing
There are three main types of carbon pricing: emissions trading systems (ETS), carbon taxes, and offset mechanisms
1. Emission Trading System (ETS): It is also referred to as a cap-and-trade system, which caps the total level of greenhouse gas emissions.
- It allows industries with low emissions to sell their extra allowances to larger emitters.
- The system creates supply and demand for emissions allowances and establishes a market price for greenhouse gas emissions.
2. Carbon tax: It directly sets a price on carbon by defining a tax rate on greenhouse gas emissions or – more commonly – on the carbon content of fossil fuels.
3. Offset mechanism: It designates the GHG emission reductions from project- or program-based activities, which can be sold either domestically or in other countries. Offset programs issue carbon credits according to an accounting protocol and have their own registry.
Structuring an Effective Carbon Pricing Mechanism
- The World Bank and the Organization for Economic Co-operation and Development (OECD) have jointly developed FASTER Principles for Successful Carbon Pricing.
- These principles highlight six key characteristics for successful Carbon Pricing and are based on practical experiences of various jurisdictions.
- These principles include:
- Fairness: Carbon pricing initiatives should follow the “polluter pays” principle and ensure that costs and benefits are fairly shared.
- Alignment of policies and objectives: Carbon pricing is not a stand-alone mechanism and it should mesh with and promote broader policy goals, both climate and non-climate related.
- Stability and predictability: There should exist a stable policy framework which sends a clear, consistent, and (over time) increasingly strong signal to investors.
- Transparency: Carbon pricing is designed and carried out transparently.
- Efficiency and cost-effectiveness: Carbon pricing should lower the cost and increase the economic efficiency of reducing emissions.
- Reliability and environmental integrity: Carbon pricing should measurably reduce practices that harm the environment.
International Carbon Pricing
- International carbon pricing refers to carbon pricing initiatives that have the potential to cover the whole world.
- There are 3 initiatives under the United Nations Framework Convention on Climate Change (UNFCCC):
- International Emissions Trading (IET)
- Joint Implementation (JI) and Clean Development Mechanism (CDM)
- New approaches under Article 6 of the Paris Agreement
- International Emissions Trading (IET)
- The International Emission Trading system was set up with an aim to allow Annex B countries in the Kyoto Protocol to achieve emission reductions in minimum cost.
- But, the system could not accomplish the desired outcomes, mainly because:
- Individual countries made policies related to priorities and their national context. They did not base their emission reduction efforts on carbon price alone.
- The heterogeneity in National policies meant that IET could not achieve the least-cost outcome.
- There was also a lack of clarity about environmental outcomes, thus it could not attract sovereign investors.
- Joint Implementation (JI)
- JI is an offset mechanism under the Kyoto Protocol.
- The mechanism known as "joint implementation" allows a country with an emission reduction or limitation commitment l (Annex B Party) to earn emission reduction units (ERUs) from an emission-reduction or emission removal project in another Annex B Party,
- An ERU is equivalent to 1 tonne of carbon dioxide. The ERU can be counted towards meeting the Kyoto targets of a country.
- The JI offers parties a cost-efficient and flexible means of fulfilling a part of their Kyoto commitments
- The host party also benefits from foreign investment and technology transfer.
- However, the JI has been less successful than the CDM in terms of emission reduction achievements.
- It faces a dual challenge of the lack of the country’s ambition and the uncertainty over the future regulatory infrastructure to issue credits.
- Most of the credits were issued without the supervision of the Joint Implementation Supervisory Committee. This triggered some speculation on the level of rigor applied while issuing ERUs.
- Clean Development Mechanism (CDM)
- CDM is an offset mechanism under the Kyoto Protocol.
- The Clean Development Mechanism (CDM) allows a country with emission-reduction or emission-limitation targets (Annex B Party) to implement an emission-reduction project in developing countries.
- These emission-reduction projects can earn saleable certified emission reduction (CER) credits, each equivalent to one tonne of CO2, which can be counted towards meeting Kyoto targets.
- CDM is a market-based mechanism that has involved one of the largest number of countries and has also led to significant emission reduction and flow of finances to developing countries.
- But it also faced various challenges:
- It has been reported multiple times that the projects funded under CDM most of the time cannot be considered ‘additional’. That means, they would have been as such even in a business-as-usual case.
- Another criticism has been that Carbon markets are non-transparent and have fallen in clutches of corruption.
- In some cases, they have even given birth to unsustainable practices. Eg. In Thailand, rice husk is used for generation of renewable energy, which was earlier a source of organic fertilisers. This has caused farmers to shift to chemical fertilisers.
- Article 6 of the Paris Agreement
- The article recognizes that Parties to the Paris Agreement can voluntarily cooperate in the implementation of their Nationally Determined Contributions (NDCs) to allow for higher ambition in mitigation and adaptation actions.
- Articles 6.2–6.3 of the Paris Agreement:
- It covers cooperative approaches where Parties could opt to meet their NDCs by using internationally transferred mitigation outcomes (ITMOs).
- ITMOs aim to provide a basis for facilitating international recognition of cross-border applications of carbon pricing initiatives.
- Articles 6.4 of the Paris Agreement :
- It establishes a mechanism for all countries to contribute to GHG emissions mitigation and sustainable development.
- The emission reductions under the mechanism can be used to meet the NDC of either the host country or another country.
- The mechanism incentivizes mitigation activities by both public and private entities.
Challenges of Carbon Pricing
If effectively designed, carbon pricing mechanisms have the potential to spur innovation and investment in low carbon technologies. But the right design for carbon pricing has various challenges:
- Carbon leakage: Due to irregularities in pricing policies and regulations at regional and global levels, firms with carbon-intensive operations shift firms to lower-cost jurisdictions. This phenomenon is termed as Carbon leakage.
- Policy overlap or inconsistency: Aligning carbon pricing instruments with complementary policies such as energy efficiency policies, emissions performance standards, and research and technology policies, can be significantly more effective.
- Ineffective use of revenues: The effective use of huge sums of revenues raised by carbon pricing instruments also dictates how effective the pricing instruments are.
Global Carbon Incentive Fund (GCIF)
- Carbon pricing through ways like cap-and-trade and carbon taxation runs into free rider and fairness problems.
- The Global Carbon Incentive System provides a way out for reducing global emissions in the most cost-effective way.
- The basic rationale is to create a UN-administered Global Carbon Incentive Fund (GCIF) to which countries would contribute if their carbon emissions per capita are above the global average (4.8 tonnes CO2 per annum), and from which they would receive payments if their carbon emissions per capita are below the global average
- In essence, the GCIF will penalize developed nations for extravagant energy use and incentivize developing nations to avoid fossil fuels.
Carbon border tax
- Some industrialized countries are planning to impose a domestic carbon tax alongside a border-adjustment tax
- Through border adjustment tax on imports, countries will be able to effectively apply the same tax rate to goods coming in from countries that do not have a carbon tax.
- The border taxes might push other countries to impose their own carbon taxes.
- However , this will not solve fairness problem
- On the contrary, they would let large importing countries impose their tax preferences on poor exporting countries and might serve as a Trojan horse for protectionism.
How will GCIF solve problems with existing carbon pricing systems?
- Solving the free-rider problem: Through GCIF, every country would face an effective loss of an equal amount for every additional tonne that it emits per capita, regardless of whether it started at a high, low, or average level.
- There would no longer be a free-rider problem because Uganda would have the same incentives to economize on emissions as the US.
- Solving the fairness problem: Low emitters, which are often the poorest countries and the ones most vulnerable to climatic changes they did not cause, would receive a payment with which they could help their people adapt.
Challenges in implementing GCIF
- Modification in computation of per capita emission is required
- What is consumed is as important as how it is produced, so there will need to be some accounting for the portion of emissions embedded in imported goods
- For eg. China’s per capita emission should not include those goods that are being exported to the USA and being consumed there.
- One of the most crucial of the foreseeable challenges will be the willingness, or lack thereof, of countries to participate in the scheme.
- The most powerful countries are also the biggest emitters, and few want to pay into a global fund, especially in these times of massive budget overruns
Global Carbon Incentive is by far the best option available to reduce global emissions in a fair and equitable way. The Pandemic has already increased the gulf between rich countries and poor ones. A fair proposal for reducing emissions would give everyone a greater incentive to save our planet.