It is the simplest of ideas, though perhaps too simple for our messy world: carbon pricing is the obvious response to the climate emergency.
Economists are more or less united on this point. In 2019, more than 3,600 of them signed a carbon tax declaration that “a carbon tax offers the most cost-effective lever to reduce carbon emissions at the speed and scale that is necessary.” The list included more than two dozen Nobel laureates as well as key figures like Treasury Secretary Janet Yellen, Lawrence Summers and Ben Bernanke.
In 2022, the U.S. Congress passed “the most significant climate legislation in U.S. history.” Yet, it featured no carbon taxes. Bowing to political reality, President Joe Biden made no attempt to put any kind of price on carbon.
Across the Atlantic, however, the picture looks quite different. Europe has a well-established cap and trade system for pricing carbon in place, known as the EU ETS (Emissions Trading System). The EU’s carbon price climbed above EUR 100 per tonne for the first time in February 2023.
To some extent, that rally was driven by a short-term surge in coal use following Russia’s invasion of Ukraine. As Europe shifts to cleaner energy, some leading market watchers now expect the rally to pull back. But there are long-term structural drivers at work. Under recent EU legislation, there are plans to phase out the so-called free allowances for heavy-polluting industries that have long acted as effective subsidies to polluters. In other words, emitting CO2 is set to get costly.
The fact that carbon carries a heavy price in one major market but no price in another is one of the complexities of this space. Another is that there are, in fact, at least five different types of carbon prices.
There are mandatory prices, including:
Then, there are voluntary prices:
Finally, there is a carbon price that doesn’t get discussed so much, but is perhaps the most important:
As carbon prices develop, their impact on portfolios will only grow. Therefore risk professionals, and everyone in business for that matter, need to understand how the transition to a low-carbon economy is progressing and how to help their companies transition efficiently.
This article was originally published on the GARP blog.
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