11.2 Carbon pricing and emissions trading

Carbon pricing is a powerful tool in the fight against climate change. It puts a cost on greenhouse gas emissions, making polluters pay for their environmental impact. This approach encourages businesses and individuals to reduce their carbon footprint through cleaner technologies and behavior changes.

There are two main types of carbon pricing: carbon taxes and cap-and-trade systems. Each has its pros and cons, but both aim to drive market-based solutions for emissions reduction. Real-world examples show that carbon pricing can be effective when implemented thoughtfully.

Carbon Pricing for Emissions Reduction

Concept and Purpose of Carbon Pricing

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• Carbon pricing assigns monetary value to greenhouse gas emissions measured in price per ton of carbon dioxide equivalent (CO2e)
• Internalizes external costs of carbon emissions making polluters pay for environmental damage
• Creates financial incentive for businesses and individuals to reduce carbon emissions
  • Encourages investment in cleaner technologies
  • Promotes changes in behavior
• Drives market-based solutions and innovations in low-carbon alternatives by increasing cost of carbon-intensive activities
• Implemented through various mechanisms (carbon taxes, emissions trading systems, hybrid approaches)
• Effectiveness depends on factors like price level, coverage of emissions sources, and complementary policies

Economic Principles and Market Dynamics

• Operates on principle that increasing cost of carbon-intensive activities will drive market-based solutions
• Stimulates innovation in clean technologies and energy efficiency
  • Examples: Solar panel efficiency improvements, electric vehicle advancements
• Pace of innovation may not always match urgency of emissions reduction targets
• Can generate revenue for governments
  • Revenue use impacts overall effectiveness and public acceptance
  • Examples: Green investments, tax rebates, climate adaptation projects
• Effectiveness influenced by price level
  • Higher price generally leads to greater emissions reductions
  • May face political and economic resistance at higher levels

Carbon Pricing Mechanisms: Taxes vs Cap-and-Trade

Carbon Tax Mechanism

• Directly sets price on carbon emissions per ton of CO2e emitted
• Provides certainty about cost of emissions but uncertainty about quantity reduced
• Generally simpler to implement and administer than cap-and-trade
• Examples of carbon tax implementation:
  • British Columbia's revenue-neutral carbon tax (implemented 2008)
  • Sweden's carbon tax (introduced 1991, highest carbon price globally)

Cap-and-Trade System Mechanism

• Sets limit on total emissions and allows trading of emission permits
• Provides certainty about quantity of emissions but allows price fluctuations based on market dynamics
• Requires more complex infrastructure for permit allocation and trading
• Can link different jurisdictions through international carbon markets
  • Potentially leads to more cost-effective global emissions reductions
• Examples of cap-and-trade systems:
  • European Union Emissions Trading System (EU ETS)
  • China's national emissions trading scheme (launched 2021)
  • Regional Greenhouse Gas Initiative (RGGI) in northeastern United States

Hybrid and Alternative Approaches

• Hybrid systems combine elements of both carbon taxes and cap-and-trade
  • Aim to balance price stability with emissions certainty
• Alternative approaches include:
  • Baseline and credit systems
  • Emissions intensity trading
  • Results-based climate finance

Effectiveness of Carbon Pricing

Factors Influencing Carbon Pricing Impact

• Price level significantly affects emissions reduction potential
• Coverage of emissions sources impacts overall effectiveness
  • Broader coverage generally leads to more comprehensive emissions reductions
• Complementary policies enhance carbon pricing impact
  • Examples: Renewable energy subsidies, energy efficiency standards
• Public acceptance and political feasibility often constrain implementation of high carbon prices
• Exemptions or free allocations to certain industries can limit effectiveness
  • Often implemented to address competitiveness concerns

Challenges and Limitations

• Leakage poses risk to overall effectiveness
  • Emissions-intensive activities may relocate to jurisdictions without carbon pricing
  • Can undermine global emissions reduction efforts
• Carbon pricing alone may not address all barriers to emissions reductions
  • Split incentives in building energy efficiency
  • Lack of alternatives in certain sectors (heavy industry, aviation)
• Political instability can threaten long-term success of carbon pricing initiatives
  • Example: Failure of Australia's short-lived carbon pricing mechanism (2012-2014)

Real-World Carbon Pricing Examples

European and North American Systems

• European Union Emissions Trading System (EU ETS)
  • World's largest cap-and-trade system
  • Covers about 45% of EU's greenhouse gas emissions across multiple sectors
• British Columbia's carbon tax
  • Revenue-neutral system implemented in 2008
  • Successfully reduced emissions while maintaining economic growth
• Regional Greenhouse Gas Initiative (RGGI)
  • Cooperative effort among northeastern US states
  • Caps and reduces CO2 emissions from power sector

Global and Innovative Approaches

• China's national emissions trading scheme
  • World's largest carbon market by volume
  • Initially covers power sector with plans for expansion
• New Zealand's Emissions Trading Scheme (NZ ETS)
  • World's only national all-sector all-greenhouse gas emissions trading program
• Sweden's carbon tax
  • Introduced in 1991
  • Highest carbon price globally
  • Contributed to significant emissions reductions in the country