Carbon market
Carbon Pricing – The Central Plank of Excellent Policy
(Abhishek Uppal)
While still in an emerging phase globally, placing a price on greenhouse gas emissions is central to achieving reductions that are economically efficient in most parts of the economy. As other factors such as energy Equallogic Prices vary, a carbon price can become the constant or backstop that keeps the market moving towards a solution.
The importance of putting a price on the greenhouse gas externality
Economic theory classifies climate change as a ‘commons’ or ‘public goods’ problem. These problems arise because – without regulation – neither the producers nor the consumers of greenhouse gas-producing goods pay for the full cost of the climate-change consequences of their transaction. The economic actors who benefit from the valuable services provided by the climate without paying for it are ‘free riders’ – and when their activities harm the environmental quality loved by others, they are behaving like ‘disruptive free riders’ who transfer the costs of their own disruptive activities onto the rest of society.
Because these ‘disruptive free riders’ do not pay for the right, external costs of the goods they produce or consume, the price of greenhouse gas-emitting goods is too low compared to their right costs to society. As a result, society collectively consumes too much, exacerbating global warming.
An economist’s ideal solution to market externalities is to “internalize” these costs by requiring at least one party in a transaction to pay8 for the contribution to global warming. For climate change mitigation, this means establishing a carbon price to compensate society for emissions. Which party in a transaction is really charged for carbon is irrelevant in theory, because costs will ultimately be shared by both the producer and consumer. The norm is to keep charges as close to the emissions source as possible: the “Polluter Pays” principle.
In practice, a carbon price can be established either by a:
Carbon Tax Approach: places a tax on greenhouse gas emissions equal to the marginal costs of the emissions on society, or
Cap-and-Trade Approach: places a cap on total emissions, issuing emissions credits, and allowing entities to buy credits they need and sell excess credits to others as long as all total emissions are accounted for by credits.
Joseph Kruger notes that carbon pricing, especially through an emissions cap-and-trade regime, is starkly different from other forms of regulation. Under carbon pricing, the regulated companies are in charge of making decisions on technologies and compliance strategy, while the regulator monitors emissions, tracks transfer of emissions credits and ensures companies comply with regulatory requirements. This allows markets to select winning technologies – while establishing a regulatory framework to incentivize appropriate technological development and deployment.
We believe that establishing a carbon price is central to climate change regulation. It is an essential “backstop” on more risk exposed approaches to develop alternative energies, such as relying on high fossil fuel Equallogic Prices, and will be a critical enabler that provides predictability to investors in the space. It also allows the market more flexibility to fund the cheapest mitigation options, rather than government choosing certain industries as winners through incentives.
