Where do we stand on carbon pricing ?

What are we speaking about ?

Carbon pricing mechanisms, a central pillar in the fight against climate change, are increasingly adopted worldwide. While their primary target is greenhouse gas (GHG) emissions reduction, they also significantly impact businesses.

Carbon pricing, through instruments like carbon taxes and emission trading systems (ETS), puts a price tag on CO2 emissions. This creates a financial incentive for companies to reduce their emissions footprint. As the cost of emitting rises, companies are pushed to invest in cleaner technologies and optimize their energy efficiency. This can involve transitioning away from fossil fuels, adopting renewable energy sources, and implementing energy-saving measures in industrial processes.

In addition, governments can further incentivize decarbonization efforts by announcing future price hikes for CO2 emissions. This strengthens the "price signal" for companies, encouraging them to make long-term investments in clean technologies rather than short-term fixes. For instance, Norway's plan to triple its carbon price by 2030 sends a clear message, prompting companies to prioritize decarbonization strategies.

The financial burden of decarbonization can be significant for companies (eg.: Steel and aluminum industries where customer willingness to pay remains limited). To mitigate this impact, several measures are employed. Carbon Contracts for Difference (CCfDs) are one such example. Germany utilizes CCfDs to subsidize capital and operating expenses associated with decarbonization efforts, easing the financial pressure on companies within specific sectors.

Governments also employ various financial aid programs to support businesses during the transition. These include direct subsidies and the redistribution of carbon pricing revenues. In Switzerland, two-thirds of carbon tax revenues are redistributed to companies and households, helping them offset the additional costs triggered by carbon pricing.

A significant portion of the revenue generated by carbon pricing is reinvested in green projects. This creates a positive feedback loop, strengthening the environmental impact of the policy. Colombia is a prime example – 80% of its carbon tax revenue goes towards the Climate Sustainability and Resilience Fund, fostering long-term environmental benefits.

Another strategy for utilizing carbon pricing revenue involves direct and indirect transfers to businesses and households. This approach aims to ease the financial burden on companies while promoting public support for the policy. Canada demonstrates this approach – 90% of its carbon tax revenue is redistributed to households, while 10% is allocated to small and medium-sized enterprises.

In some cases, carbon pricing revenue is allocated to the general budget. While not directly targeted towards businesses, these funds still contribute to environmental initiatives. For example, the UK allocates its carbon pricing income to its general environmental budget, indirectly supporting the development and implementation of eco-friendly policies.

Let's focus some key countries in the carbon pricing approach ?

Europe stands out as a leader in carbon pricing. The European Union Emissions Trading System (EU ETS), launched in 2005, is the world's largest carbon market, covering a significant portion of European industrial emissions. In 2022 alone, the EU ETS generated a staggering €38.8 billion ($42.3 billion) in auctioning revenues.

North America also boasts established carbon pricing systems. Canada has a federal system with variations implemented by some provinces, while France operates a well-established carbon tax that generated an estimated $8.1 billion in 2022. Beyond Western nations, countries like Colombia and South Africa are implementing carbon taxes, with Colombia directing 80% of its revenue to a dedicated climate resilience fund.

However, significant regions remain without a national carbon market. The United States, despite some states taking initiative, lacks a comprehensive federal system. Australia repealed its carbon tax in 2014 and currently has no national carbon pricing mechanism. Large parts of Asia are also lagging behind, although some countries are exploring carbon pricing options.

But how is carbon perceived by populations?

France:

In France, carbon tax applies to electricity as a carbon component of the electricity tax. This component has been gradually rising since 2013 and currently sits at €44.6/tCO?.

In this country, the impact of carbon tax on electricity prices has been partially offset by other factors, like lower fossil fuel prices and the implementation of a tariff shield. However, carbon tax is expected to continue playing a role in increasing electricity prices as it rises in the coming years.

Generally, polls show some support for carbon tax, but it's conditional on how the revenue is used. A 2022 study by the DREES (Directorate for Research, Studies, Evaluation and Statistics) found that a third of respondents initially favored raising the carbon tax. However, when informed the increase would fund socio-economic or environmental policies, support rose to nearly two-thirds.

Nevertheless, lower-income households tend to spend a larger portion of their budget on energy, meaning they'd be more impacted by a carbon tax increase. In addition, people find it difficult to understand how carbon tax revenue is used. For information, taxes represented in 2022 app. 8'' euros when investments in conventional powerplant represented a quite similar amount in the country.

Despite these criticisms, carbon tax is seen as an important tool to fight climate change by:

• Encouraging behavioral changes: Carbon tax aims to make fossil fuels more expensive, incentivizing people to use less energy and switch to cleaner sources.
• Generating revenue: Carbon tax revenue can be used to fund climate change initiatives like renewable energy research and energy efficiency programs.

UK:

The United Kingdom employs a carbon pricing system known as the Carbon Price Support (CPS). This system acts similarly to a carbon tax, but instead of directly targeting consumers, it places the financial burden on electricity producers.

The core principle of the CPS is simple: the more CO2 a power plant emits during electricity generation, the more they have to pay under the CPS. This financial incentive encourages electricity producers to shift their reliance away from fossil fuels, like coal and natural gas, and towards cleaner energy sources like wind and solar power. As a result, the CPS aims to play a significant role in the UK's journey towards achieving net zero emissions.

Public acceptance of the CPS, like many carbon pricing mechanisms, is a balancing act. While there are clear advantages, concerns also exist:

Advantages:

• Incentivizing Clean Energy: By making fossil fuels more expensive to use in electricity generation, the CPS creates a financial incentive for producers to invest in cleaner alternatives. This fosters the growth of renewable energy sources like wind and solar power, contributing to the UK's environmental goals.

Concerns:

• Impact on Electricity Prices: Similar to a carbon tax, the CPS can lead to higher electricity bills for consumers. Electricity producers may pass on their increased costs under the CPS, potentially leading to higher prices for households and businesses.
• Fairness Concerns: A rise in electricity prices could disproportionately affect low-income households, who already face a larger energy burden. This raises concerns about fairness and the potential need for mitigating measures.

Germany:

Germany participates in the European Union's Emissions Trading Scheme (EU ETS), a market where companies trade CO? emission allowances. Electricity producers using fossil fuels, like coal and natural gas, must purchase these allowances to cover their emissions. This creates a double impact on electricity prices:

• Higher Costs for Fossil Fuels: The need to buy allowances increases the cost of producing electricity from fossil fuels. These additional costs are often passed on to consumers through higher electricity bills.
• Incentivizing Renewables: Renewable energy sources like solar and wind power don't emit CO? and therefore don't require allowances. This makes renewable energy production more competitive compared to fossil fuels, driving investment in cleaner electricity generation.

The overall impact of Germany's carbon pricing system on electricity prices depends on several factors:

• Emission Allowance Prices: Fluctuations in the price of CO? emission allowances directly affect the cost burden on fossil fuel producers, and consequently, electricity prices. Higher allowance prices lead to a more significant impact on electricity prices.
• Electricity Generation Mix: The more Germany relies on coal and gas for electricity generation, the greater the impact of the carbon pricing system on electricity prices will be. With a higher dependence on fossil fuels, the increased costs from needing to buy allowances translate more readily to consumer bills.
• Other Electricity Taxes and Subsidies: Germany has a complex energy market with additional taxes levied on electricity and subsidies provided for renewable energy sources. These factors can either mitigate or amplify the effect of the carbon pricing system on electricity prices. For instance, subsidies for renewables can offset the rise in electricity prices caused by the need for allowances.

Recent polls show some support, but it's conditional: Studies like the one conducted by the ifo Institute in February 2024 suggest a majority of Germans want the country to be a climate leader, but support for carbon pricing itself is weaker. However, support increases if the revenue is used for climate-friendly initiatives (e.g., renewable energy research).

In fact, Public acceptance of carbon pricing in Germany is a work in progress. While environmental benefits hold potential for support, concerns about affordability, fairness, and complexity remain. Clear communication from the government regarding revenue usage and potential mitigation strategies for price increases on low-income households will be crucial in gaining broader public acceptance.

Is a carbon market a good solution for developed economy in Asia?

Developed economies in Asia face a crucial challenge: accelerating the transition to cleaner energy sources while maintaining economic growth. Carbon pricing emerges as a promising tool as many economies like Japan, Korea or Australia are still using massively coal (eg.: 50% in Australia).

In fact, by putting a price on carbon emissions, carbon pricing makes fossil fuels more expensive, encouraging businesses and industries to invest in cleaner alternatives like renewables.

In addition, revenues generated from carbon pricing could be channeled into initiatives that support the energy transition. This could include funding for renewable energy research and development, energy efficiency programs, and infrastructure upgrades for a cleaner grid.

However, as shared on the French case, carbon pricing can disproportionately impact low-income households and energy-intensive industries. Measures like targeted subsidies or rebates can help mitigate these effects.

Also, a poorly designed carbon pricing system could lead to job losses in industries reliant on fossil fuels. Strategies like retraining programs and support for new clean energy industries can help ease the transition.

In fact, implementing a carbon pricing system requires strong political will from governments. Building public and industry consensus is crucial for successful implementation.

The question I keep open regarding all this carbon pricing topic is about the choice: Can we do it without?