Pricing carbon to limit warming

Putting a price on carbon that makes firms pay for emitting greenhouse gases looks a good way to tackle climate change. But carbon taxes have been tried before, and haven’t worked.

Either schemes did not accurately monitor emissions, or the price wasn’t sufficient incentive to drive a much-needed change in behaviour. Though the economic slowdown caused by the coronavirus has led to a drop in greenhouse-gas emissions, they will most likely rise again as growth recovers.

Global warming is already evident through extreme weather causing floods, storms, droughts and wildfires. Emissions must ultimately be reduced to net-zero and even net-negative to stave off the most severe consequences of climate change.

Carbon pricing is a mechanism that tries to capture the external costs of emissions – such as healthcare, asset and property destruction or crop damage – even if these costs are not easy to quantify.

Carbon-pricing revenues could be used for climate-change mitigation or resilience

Pricing comes in various forms. A carbon tax is often considered the simplest way to price carbon and is relatively easy to implement. An emission trading system sets a cap on future emissions and allowances or ‘permissions to emit’ are issued – possibly at no charge.

Exceeding allowances requires buying extra permits, or paying a fine, but unused capacity can be sold or sometimes used later.

Carbon offset schemes try to put a price on the ability to reduce emissions. Carbon credits are awarded for activities deemed to have prevented a physical greenhouse gas from reaching the atmosphere. But accurate accounting and avoiding double-counting are essential.

Sustainable finance

HSBC is committed to supporting the transition to a low-carbon world.

And there are difficulties with definitions. An ‘absolute reduction’ means that emissions are down, but still adding to the atmospheric stock. A ‘relative reduction’ involves emitting less than a benchmark or baseline.

‘Zero emissions’ means putting no greenhouse gases into the atmosphere, though that is difficult to achieve over the entire life cycle of an activity.

‘Removing emissions’ actively cuts the atmospheric concentration of greenhouse gases by natural or man-made means, but it is imperative to ensure the removed emissions never reach the atmosphere again – even in the future.

The Clean Development Mechanism used to be the mainstay of carbon credits and offsetting but many issues seriously dented the credibility of this scheme. The 2015 Paris Agreement is trying to revamp carbon pricing through the climate pledges made by its signatories and the establishment of a new global carbon market – the Sustainable Development Mechanism.

To avoid perceptions of carbon pricing being ‘just another tax’ or a budget-increasing measure, we suggest using the revenues for sustainability purposes such as climate-change mitigation or resilience.

Companies engaging in carbon-intensive industries have been preparing for having to become more carbon-efficient as well as having to pay to emit. Many businesses are thus already employing internal carbon pricing. Indeed, the Task Force on Climate-related Financial Disclosures asks all sectors to provide the internal carbon prices used.

In mid-2019 the World Bank said almost 46 national and 28 sub-national jurisdictions had, or planned to implement, some carbon-pricing initiative. However, in total, these schemes cover only around 15 per cent of global greenhouse-gas emissions. This leaves a lot of room for more pricing in the future.

Analyst Certification

The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Wai-Shin Chan, CFA,

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