Money Talks: Decoding Carbon Markets and their Impact on Global Businesses

The symbiotic relationship between companies and money is universally understood - businesses are inherently driven by financial incentives. Therefore, the proposition of putting a price tag on carbon emissions to deter pollution seems plausible. Despite the seemingly straightforward nature of this concept, carbon markets, designed with this exact aim, have struggled to effectively reduce emissions. Here's why.

Back in the late 1980s, America was facing an ecological disaster. Power plants were liberally emitting Sulphur dioxide, causing acid rain that was damaging to plants, aquatic animals, and infrastructure. Without a financial incentive to halt their polluting activities, these power stations continued on their destructive course unabated.

A novel solution was proposed in 1990 when the American government established a new kind of market governed by a system called "cap-and-trade", essentially forcing polluters to pay for their emissions. This was an experiment that, by 1998, had led to a 20% reduction in acid-rain levels in large regions of eastern America. The success of this initiative led to the Kyoto protocol suggesting the application of the cap-and-trade concept to carbon in 1997. Consequently, various countries and regions started setting up their own carbon markets.

The mechanics of cap-and-trade are fairly straightforward. The government sets a cap on the amount of CO2 an industry can emit, divides this cap into permits, and then distributes these permits to firms. If a company doesn't exhaust its allowance, it can sell what it doesn't need. If it needs more permits, it can purchase them from entities with surplus. Each year, the cap becomes stricter, causing a contraction in the pool of permits and a rise in their cost. In theory, this market-based approach should lead to a reduction in carbon-dioxide emissions. But the reality has been quite different.

The crux of the problem is the inadequacy of the incentive. Carbon prices have remained too low to spark the necessary change to decarbonise the world economy. To meet the Paris Agreement's goal of limiting global warming to two degrees above pre-industrial levels, the worldwide price of carbon should range between $50-100 per tonne by 2030, according to economists Joseph Stiglitz and Nicholas Stern. However, the majority of carbon prices are far below this figure.

Moreover, fines for exceeding permitted emission levels are often too low to act as a deterrent. In the EU, for instance, a fine can be as low as €100 per excess tonne. The difficulty of enforcement and the complexity of the varied regulations across the world further exacerbate the problem. Additionally, the issue of “carbon leakage”, where industries relocate from areas with stringent environmental regulations to regions with lax rules to avoid paying for their carbon emissions, is a pressing concern.

Despite these challenges, potential solutions exist. Regulatory oversight can play a pivotal role. Governments need to strictly enforce rules, penalties, and carbon caps, increase the cost of permits, and introduce more stringent fines for rule-breakers. The introduction of a minimum price that rises over time would prevent prices from falling too low. Furthermore, establishing a border tax, as proposed by the EU, would deter carbon leakage by taxing carbon emitted in goods produced outside its market.

Significant strides towards improving carbon markets have been observed recently. The EU has started to reduce the number of permits it hands out since 2019, leading to record carbon prices of over €60 per tonne. With regulators across the world mulling ways to make their markets more effective, other countries might be incentivized to create their own markets.

These developments indicate an exciting time for proponents of carbon markets. If these prices are maintained and backed by governmental commitments, greener industrial processes could become more viable. Consequently, carbon markets may finally start to fulfill their original goal of helping to decarbonise the world. However, it requires a global effort with a harmonized approach towards carbon pricing and trading systems, coupled with robust regulatory mechanisms to ensure companies are held accountable for their carbon footprints. The world is watching, waiting for money to finally talk, loud enough to drive companies towards more sustainable practices.