Commodity markets will be transformed by high carbon prices

Understanding carbon pricing is vital as its role in incentivising emission cuts will grow internationally. Pricing emissions is one of the most effective ways to reduce emissions and will be central to many governments’ responses in mitigating climate change. Without carbon prices, the case for investing in decarbonisation is far more challenging. Policymakers will need broader and higher carbon pricing schemes to close the cost gap between traditional and green technologies.

Governments have various policy options – explicit carbon pricing, subsidies and mandated change

There are three broad policy options for promoting decarbonisation being used by governments today, each having advantages and disadvantages.

Explicit carbon pricing, as implemented in the EU, aims to increase the cost of traditional, fossil-based technologies such that low-carbon alternatives become economically viable. Explicit prices refer to direct charges levied on emissions per tonne, either through an emissions trading scheme (ETS) or a carbon tax.

By putting a price on carbon, companies and individuals are incentivised to invest in clean energy alternatives, adopt more efficient processes and reduce their overall emissions. Additionally, the revenue generated from carbon pricing can be used to fund clean energy development, environmental protection and other sustainable initiatives.

In the long term, this approach is likely the most efficient means of encouraging change, as the costs of decarbonisation are externalised and transparent. However, the full cost is borne by society directly, which can result in slow progress and reduced political appetite given the high cost of some low carbon options. The high upfront costs of some low carbon technologies can impact consumers uptake and political support. Without adequate support measures, carbon pricing can also create distribution issues, whereby the least advantaged in a society are proportionally the most impacted, hitting their political acceptability.

The second approach is through?subsidies, in the form of direct subsidy, tax breaks or feed-in-tariffs. This is a form of implicit carbon price that reduces the cost of green technologies to make them more cost competitive with fossil fuel-based processes.

Subsidies can encourage faster change but in the longer term they will hit viability issues and governments will be unable to subsidise entire markets indefinitely. However, subsidies are a good approach to kickstart markets and start building scale, which can bring about technology cost reduction prior to the market taking a leading role.

A good example of the subsidy approach is the recent US Inflation Reduction Act (IRA). The IRA will certainly support the rollout of low carbon energy, infrastructure and EVs, but it may struggle to incentivise widespread adoption of some emerging technologies, such as green hydrogen and CCS. For example, the tax credit available for captured CO2?is $85 /t, but CRU’s modelling suggests it would need to be at least $180 /t to encourage widespread use of CCS in power generation.

The third approach is?mandated change, where governments simply require low-carbon approaches or technologies to be adopted regardless of cost. This approach can drive change very quickly but, in globalised markets, it could put companies at a cost disadvantage. This approach must be backed up by strong support to ensure transitioning companies do not go out of business.

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