Getting Carbon Prices Right: Whether Incentives or Tax, Climate Costs Must be Part of Production and Consumption Costs
Photo by Patrick Hendry
story highlights

OECD report finds carbon pricing gap prevents efficient decarbonisation as carbon prices and real climate costs will only meet in 2095 at the current rate of adjustment.

New Climate Institute paper addresses difficulties in securing investment for forest protection in the context of volatile market prices and the Paris Agreement.

National Authorities see Paris Agreement as opportunity for the UNFCCC Clean Development Mechanism.

During September 2018, opportunities and challenges with carbon pricing mechanisms were addressed in several reports. An OECD report emphasizes a vast majority of industrial, residential and commercial sector emissions are entirely unpriced and highlights deep carbon pricing gaps in most countries studied. The report notes, however, that China’s emissions trading schemes, and carbon tax efforts in other countries, could significantly reduce these gaps. A UNFCCC report on achievements of the Kyoto Protocol’s Clean Development Mechanism, along with calls by participants at a September workshop in Bonn, suggests consideration of CDM lessons in the creation of the Paris Agreement’s sustainable development mechanism. A New Climate Institute report addresses environmental risks from forest offset credits in the Paris Agreement.

Carbon Price Gaps Remain Too High for Efficient Decarbonization

Carbon prices must be raised much faster to have a significant impact on curbing climate change, confirms a report published in September by the Organisation for Economic Cooperation and Development (OECD). The report entitled “Effective Carbon Rates 2018: Pricing Carbon Emissions Through Taxes and Emissions Trading” presents carbon pricing trends, measuring carbon pricing of CO2-emissions from energy use in 42 OECD and G20 countries.

To analyze carbon pricing data, the authors use an “effective carbon rate” measure, or the sum of taxes on fossil fuels, carbon taxes, and prices of tradeable emission permits. All three instruments increase the price of high-carbon relative to low- and zero-carbon fuels, encouraging energy users to go for low- or zero-carbon options. However, the findings suggest together the 42 countries fall short of pricing emissions at levels needed for decarbonization.

On aggregate, the ‘carbon pricing gap’, which compares actual carbon prices and real climate costs estimated at 30 Euro per tonne of CO2, was 76.5% in 2018. Though this compares favorably with the 83% carbon gap reported in 2012 and the 79.5% gap in 2015, the rate of improvement is not sufficient. At the current pace, carbon prices will only meet real costs in 2095. The report finds the vast majority of emissions in industry and in the residential and commercial sector are entirely unpriced.

At the country level, carbon pricing gaps range from as low as 27% in Switzerland to above 90% in some emerging economies. Most countries studied had pricing gaps of above 50% in 2015. The report suggests initiatives, such as China’s emissions trading scheme and renewed efforts in Canada and France to price carbon, could significantly reduce these gaps. [OECD Report] [OECD Press Release]

Holding on to the UNFCCC Clean Development Mechanism

UNFCCC negotiations on cooperative approaches under Paris Agreement Article 6 will continue in December in Katowice. Work will focus, among other issues, on finding agreement on the modalities of the sustainable development mechanism under Paris Agreement Article 6.4. This mechanism is intended to be used directly by sub-national actors and could mobilize further private sector participation in climate change mitigation by providing suitable incentives. The emissions reductions achieved using this mechanism can be transferred from the country in which they were achieved to another country and counted towards its nationally determined contributions. Focusing on raising ambition, the Paris Agreement requires that use of the mechanism must lead to an absolute reduction in global greenhouse gas emissions.

Views vary on what could be learned from the Kyoto Protocol’s Clean Development Mechanism (CDM) for the creation of the Sustainable Development Mechanism. CDM projects earn a saleable certified emission reduction (CER) credit for each tonne of greenhouse gas they reduce or avoid, measured in carbon dioxide equivalents. Opponents to the offsetting system see no future for the CDM post-2020 and recommend a results-based climate finance scheme instead. Others find it valuable to consider at least the rules of procedure of the CDM Executive Board for the new mechanisms’ supervisory body. In Bangkok in August 2018, the CDM Executive Board used its 100th meeting as occasion to reflect on the achievements of the CDM, captured in a UNFCCC Report. The incentive has led to registration of more than 8,100 projects and programmes in 111 developing countries and the issuance of almost 2 billion CERs. The European Union Emissions Trading System was the largest demand source for CERs in the Protocol’s first five-year commitment period, which ended in 2012.

In a September workshop held in Bonn, Germany, CDM Designated National Authorities from 59 countries expressed their view that the Paris Agreement offers new opportunities for the CDM. They stressed that in order to increase demand for CERs their price must rise. They also called on the CDM Board to step up promotion so the CDM can retain a place in countries’ evolving climate efforts. [UNFCCC Press Release on CDM Milestone][UNFCCC News Countries Urge Continued Use of Clean Development Mechanism][SDG Knowledge Hub on Lessons from Kyoto Protocol’s Clean Development Mechanism for a Paris Agreement Sustainable Development Mechanism]

Environmental Risks from Forest Offset Credits

Preserving and enhancing forests is an essential part of global efforts to mitigate climate change. To increase currently inadequate finance for forest-related mitigation, some countries and stakeholders call for mobilizing further finance through so-called ‘transfer-based finance,’ whereby payments are provided in return for transferring the rights to the emission reductions or removals to the country or entity providing the payments. This can include the crediting of the emission reductions or removals under carbon market programmes to serve demand from international compliance markets. However, as critics have long been pointing out, market-based approaches come with risks and challenges including to ensure environmental integrity.

A Report released in September by the New Climate Institute, a Think Tank based in Cologne, Germany, informs this debate with focus on environmental risks from forest offset credits. Entitled “Crediting Forest-related Mitigation under International Carbon Market Mechanisms” the paper examines approaches to address environmental risks from the inclusion of forest offset credits in the Paris Agreement’s Article 6 and the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). The authors discuss: environmental and social risks, and that of oversupply of offset credits; environmental and social safeguards in forest mitigation initiatives; and challenges of baseline determination, additionality, permanence, and leakage.

Specifically, the report presents difficulties in securing the long-term investment needed for forest protection in the context of volatile market prices. It also highlights challenges arising from high administrative costs as well as from the lack of a crediting mechanism, with international oversight, that credits avoided deforestation or degradation. The authors find that some of the risks and challenges associated with crediting forest-related mitigation are common to other activities implemented under greenhouse gas crediting programmes while some are specific forest-related mitigation. [Report: Crediting Forest-related Mitigation under International Carbon Market Mechanisms]

The reports show that both carbon pricing strategies and mechanisms for trading emissions reductions still have a long way to go until they can achieve the emissions reductions necessary to prevent catastrophic climate change. Some challenges, such the carbon pricing gap, can be achieved through renewed political will and coordinated action. Other issues, such as various safeguards needed to ensure that carbon markets do not favor unsustainable solutions, will require more research and learning. On both fronts, negotiators can draw on a rich basis of lessons learned and analyses, such as the ones discussed here, to move carbon markets forward.

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