🛢💸 The real deal about Carbon Pricing

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Carbon Market Watch cement industry report cover, in 2016.

Despite the fact that carbon pricing has been the main and most ambitious undertaking to mitigate climate change since the beginning of our century; it is widely unknown or misunderstood. It must primary be due to both of its confusing different forms, but also its tremendous complexity that never stopped to evolve since it was first implemented in 2005 in the European Union (EU). What this page wishes to propose is not only an accessible description of what carbon pricing is, without getting lost in the economic gibberish; as our goal was to analyse the effects, both positive and negative, that carbon princing is said to have on citizens, companies, governments and of course, climate (through CO2 emissions cut).

To explore this topic, we answered the 3 simple following questions:

What is carbon pricing and what concepts stand behind it?

Everything has a cost, but not everything is paid.

Carbon pricing worldwide: use of revenues in 2018 (in million US$).

Because carbon is the atmospheric greenhouse gas that has the overall biggest impact on global warming[1], it has been considered as a good solution to tackle the emissions[2] of industries worldwide by giving a room and a price to carbon on public markets around the world. The economic theory behind this idea is that we should consider “externalities” in our economic system: the unexpected effects of any human activity should be taken into account in the value they create/destroy, despite the fact that it has no “direct” positive or negative impact on the activity: for example, an hotel or a coal-fired power plant opening next to a small town would have different effects on the baker’s like and business in this town; and this externality would be economically taken into account or not, depending on the political choices made in this town’s government. As carbon emissions would be considered as a negative externality that has a cost, in the long run to society, the emitter is levied from an amount of value that is indexed and proportionate to his emissions. To lower emissions with hope to mitigate global warming; carbon emissions cost never ceases to increase while permits to emit are gradually limited. You can get from the last sentence that there are 2 ways to monetize carbon: the carbon tax system and the carbon trading system.

  1. The carbon tax is as simple as it gets: you usually levy this tax on the carbon content of fuels[3], meaning that citizens and companies running cars, trucks, machines, etc. on fossil fuels would get it at an increasing price[4] — the same way it was done for tobacco in numerous countries. It will discourage fossil fuel use in favour of less emitting energy sources such as wind, solar, geothermal or nuclear fission; by making them more competitive.
  2. The carbon emission trading system, on the other hand, is trickier to get: a given government will first estimate the carbon emissions (in tons) of the whole emitting industries active in its territory during a given time (a year). Based on those datas, the government can create an Emissions Trading Scheme (ETS) by 2 ways:
- The government allocates each company with an annual emissions permit, where the sum of all permits account for less carbon emissions than the previous year, in order to reach their decreasing goals, year after year. In that case, what is call an allowance (permit to emit) would be freely distributed to companies, depending on their previous year emissions. If they decide to emit more that they were allowed to, they can buy allowances on the carbon market. Those allowances will be traded with companies who managed to lower emissions even more than the government expected.[5]
- We start with this same system of an allowance market which “size” is decided every year by the government, depending on its emissions decrease goals. However, the allowances are auctioned every year on a given platform. Allowances prices varies greatly depending on the market[6], but no extra permit to emit is given for free. This method gains more trust than free allowances, as it “puts into practice the principle that the polluter should pay”[7] Both options are now used by some governments, as free allowance is now seen by newcomers as a soft transition towards auctioned allowances.
Adoption of the Paris Agreement, Article 02, (c), UNFCC, 2015, p.22.

Carbon pricing continues to grow with new countries joining: as of 2019, 25 carbon taxes and 26 Emissions Trading Schemes were operating worldwide, generating $45B in revenues with respectively 52% from carbon taxes and 48% from ETS.[8] It is still considered today that one of the main efforts to mitigate climate change would come from finance mechanisms. “Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”[9] was one of the objectives of the 2015 Paris Agreement, following Kyoto Protocol.

What are the flaws of carbon pricing?

There are better ways of tackling climate change than by privatising the Earth's carbon-cycling capacity.” (Larry Lohmann, 2006)

Emissions Trading Schemes

Type of domestic use of auction revenues under EU ETS.

For a lot of economists, NGOs and politics, carbon pricing figures in number 1 position among solutions to mitigate climate change in a development-friendly way. But now that you know what is carbon pricing, and how successful it has been at generation money from polluting industries since years, you might ask yourself: “Great, now where did all this money go?” Well, in one of the earliest market, the European Union, the EU Directive announced in 2008 that half of its auctioning revenue should be used by Member States “for climate and energy related purposes”[10]. Still in EU, this money ends up in governments pockets, with fluctuating transparency about the way it is used[11], and no mandatory agreement to re-invest it in Green policies. Thankfully, according to European Commission report on auction revenues use, between 2013 and 2015, 82% of the revenues were used for climate and energy purposes, with a focus on support of renewable energy and energy efficiency programmes.[12] This was for carbon trading in EU, but if you consider carbon taxes that are levied nationally, it becomes more difficult to follow the revenues use.[13]

Despite the goodwill of governments, some frauds have been spotted, like the case of French cement producer Lafarge who benefited of an overestimated CO2 emissions permit, while shutting down plants; thus being able to sell its extra allowances on the carbon market for a total exceeding €1100M in 5 years. Between 2008 and 2014, the cement sector might have made €2,7B of windfall profit from this allowances surplus.[14] No surprise the EU decided to decrease the share of free allowances since 2013: some industries were literally paid to pollute!

To make it even harder to foresee, the carbon market is not only composed by allowances provided and auctioned by governments, but also allowances “created” by so-called “offsets”. An offset is basically a reduction of emissions made in order to compensate emissions made elsewhere. A polluting company would typically invest in a renewable energy project, reforestation or even de-pollution of environments, to get allowances in exchange, and emit more CO2 than they were “allowed” to. At least, The Kyoto Protocol (2007) has sanctioned offsets as a way to earn carbon credits that can be traded with other companies.[15] They also created an organisation for approval of offsets[16], which are very tricky to evaluate on the long run (a solar energy project or the renewal of a facility to emit less may not always be successful) and may benefit to developed countries getting “cheap” offsets from low-cost projects abroad. Moreover, the risk of fraud is high, in the form of “non-additional” credits: it means that the offset project will have taken place anyway, without the help from an interested carbon emitter. In this case, money is only going from hands to hands without financing anything else than pollution. This would even suggest that a wide part of carbon offsets do not represent actual emissions cuts, allowing companies to skew their emissions reduction easily.

Emission versus free allowances in the steel industry. Carbon-leakage evidence project, Ecorys, 2013, p.33.

Exaggerating the carbon benefits of an offset is a common practice too[17]; and same goes with what is called “carbon leakage” scam: companies are threatening governments, pretending they will close plants and delocalize in countries with no or less costly carbon pricing systems. Governments are then weakened when it comes to the negotiation of free allowances, but all this claim that carbon pricing could disadvantage companies dangerously has never been proven right in years. EU commissioned reports show no proof of carbon leakage[18], thanks to the EU financial compensations (free allowances for instance) given to sectors at risk. In the end, carbon market did not escape from the weakness of any young unregulated market, attracting so much scammers that Interpol, the international police, published a report about carbon trading crimes in 2013.[19]

Carbon taxes

Carbon intensities of connected grids in EU.
European Union planned electricity connection in 2020.

If we dive in the flaws from the more straightforward method, carbon tax, we can see how it compares to emissions trading. First, one could think that carbon taxes are less “citizen friendly” than emissions trading, because they directly impact goods price, but they are harder for companies to dodge, thus less expensive to governments and citizens, while generating more revenues worldwide. In fact, ecologists often favor carbon tax systems on emissions trading: James E. Hansen for instance, an influent former NASA scientist studying global warming since the 70s, advocated for a carbon tax in an open letter to the Obama presidential couple[20] in 2009, when emissions trading was not even implemented for long enough to discredit it. According to Hansen, emissions trading will allow “business as usual” for emitting industries, thanks to its ultra-liberal dimension; while a tax will appropriately affects all products that use fossile fuels, from cars to food. But as Hansen points out, “the public will support the tax if it is returned to them, equal shares on a per capita basis, deposited monthly in bank accounts”. He asks for absolutely no revenues of this tax to ends up in government pockets, and some says it could allow for a basic income to exist.

That is where the notion of “climate justice” comes into play: a carbon tax should be fairly levied and equally redistributed. But in 2020, the majority of carbon taxes accords diverse ranges of exemptions to economic sectors considered fragile due to international competition. Typically, exempted sectors would be road transporters, public transports, taxis, agricultural operators, air transports and fishery. Companies already subjected to an emissions trading scheme or considered to be exposed to a risk of carbon leakage are often exempted too.[21] This does not seem to meet Hansen’s advices, and as a result, some countries observed that poor people are the most heavily affected by the tax, because a bigger share of their income might be dedicated to fuel and heating. In France, in 2010 and in proportion to their income, 10% of the poorest people paid 4 times more carbon tax than the richest 10%[22]. French economist Thomas Piketty recommends a true progressive taxation, consisting on taxing only when individual emissions exceeds 5tCO2, where each additional ton of CO2 will cost more; so that the biggest emitters would be more levied — a system that will be complex but possible to establish, thanks to individual credit cards.[23] Other studies show the same problem of climate justice in Ireland and Mexico[24], and protests happen all over the world in response to carbon tax projects; but only in France did it act as a lever for people to rise against ultra-liberal policies: the “Yellow vests” movement. One of the reasons that made France carbon tax unacceptable was its redistribution: €3B of the €3,8B levied in 2016 were granted to finance the Competitiveness and employment tax credit (CICE)[25], a tax advantage accorded to companies employing workers, supposed to encourage employment and incomes growth. CICE was highly unpopular, since it was considered as a gift for companies with no mandatory results on employment, until it was discontinued in 2019.

To close the “carbon pricing flaw folder”, it appeared in Europe that there was a threat of high emissions electricity imports in countries applying a carbon price to fossil fuel energy. A few EU countries[26] are particularly exposed to imports of low-cost coal electricity, because they have a significant electricity interconnection or because their energy policy contrasts with that of their non-European neighbouring countries. This, for sure, is a carbon leakage profitable to energy companies, shaping possible “offshore carbon havens”. That is why the new European Commission President has put forward border carbon adjustments; that could start with the power sector. This means to apply a carbon price to electricity imports, making them less appealing to Member States. Since 2015, EU imports more electricity that it exports; with Russia and Ukraine as main sources. In 2019, 33TWh of electricity worth €1,6B was imported into EU. It is still marginal, since it accounts for approximately 1% of EU’s total production; but much more interconnections and coal plants are planned.[27]

What are the concrete effects of carbon pricing on climate?

Prove that Paris was more than paper promises.

Greenhouse gas emission future scenarios.

Global emissions are still increasing worldwide, from 35,21BtCO2 in 2013 to 36,15BtCO2 in 2017. Emissions tend to evolve towards stabilization, but the world is definitely not on-track to meet its agreed target of limiting global warming to 2°C. Under current policies, expected warming will be in te range of 3,1-3,7°C.[28] Yes, scientists agree to say that emissions rates are falling too slowly to meet Paris Agreement pledges. Moreover, now that the majority of progress has been made in advanced industrialized countries by switching coal for gas, the hardest cuts are the ones to come, and they ask for ambitious measures: construction of renewable energy and/or nuclear plants, transition towards less emitting transportation systems, reshaping of agriculture and forestry sectors, etc. Making an efficient system even more frugal will require massive efforts that already well involved countries are not determined to make. For instance, even the EU “star pupil” is confronted to the fact that 55% of its emissions fall outside of its ETS.[29]

Activist Greta Thunberg at Word Economic Forum in Davos, Switzerland, 2020.

Nevertheless, according to European Commission, the GHG emissions of all Member States were reduced by 23% between 1990 and 2018; and they might be on-track to reduce furthermore by at least 40% by 2030 and net-zero emissions by 2050 (2015 Paris Agreement commitment). From 2017 to 2018 for instance, emissions declined by 2%, most significantly in sectors covered by EU ETS.[30] However, a large amount of CO2 is embedded in traded goods, making countries able to consume more emissions that they actually produce.[31] But on the mean time, international aviation saw its emissions increase by 19% in only 5 years (2013-2008), while European flights (only) were covered by EU ETS.[32] This allows us to digress a bit on aviation, a sector that would be among the top 10 emitting countries if it was considered as such. In 2019, the International Civil Aviation Organisation (ICAO) approved a new offsetting scheme called CORSIA that would force EU to ditch EU ETS for this sector. CORSIA would essentially rely on “forest offsets” (or LULUCF[33] offsets), unlike EU ETS that never agreed on this kind of offsets, considering that they “cannot physically deliver permanent emissions reductions […and] would require a quality of monitoring and reporting” that is too hard to maintain. And again, unlike EU authorities, ICAO is considered by environmentalists as not rigorous enough to control the emissions trading of the whole aviation sector because they have too much shared interests. All this might end up with no emissions-cut and “tree-planting” greenwashing, that was shown close to ineffective since environmental threats and illegal logging make it impossible to measure the carbon sequestration of forests over time.[34] No surprise Swedish ecologist Greta Thunberg insisted on this during her speech at World Economics Forum in Davos, in January 2020.[35]

To conclude

Illustration (unknown author) published in New Scientist, 2006: “Carry on polluting”, Larry Lohmann.

The assumption that economic growth is always correlated to a minimum of CO2 emissions growth lays at the heart of carbon pricing, since it was never hidden that its goal is to mitigate climate change with the least negative effects on global markets. It seems obvious for European Commission to compare Europe’s reductions (-23%) with its economic growth (+61%); to show what “tour de force” it accomplished.[36] Accordingly, studies diverge about the effects of 2008-2009 global financial crisis (loss of economic growth) on carbon emissions. On one hand, emissions decrease in the US were believed to be caused by gas energy transition, but are suspected to be caused by the crisis.[37] On the other hand, global emissions might have grown faster worldwide following the crisis.[38] Glen P. Peters, a Norwegian scientist who participated to the later study, considers that in some ways the financial crisis was a missed opportunity to curb future emissions worldwide… A potential next question to open the scope of this carbon pricing series will be: “Will the 2020 economic crisis, that arise from the disastrous COVID19 virus, eventually put some governments on good tracks to Paris pledges, or is it a short minor break on carbon emissions?”

Notes

  1. Atmospheric CO2 is not the most impactful gas per ton in the air: methane, among others, has a global warming potential 84 times greater than CO2 for 20 years, but methane lowest concentration in the Earth’s atmosphere makes it contribute less to global warming (4-9% contribution). “Greenhouse gas”, Wikipedia Page, 2020. source: https://en.wikipedia.org/wiki/Greenhouse_gas#Global_warming_potential
  2. In 2013, industrial processes account for 6% of anthropogenic emissions, while manufacturing and construction account for 12,4% of emissions. As carbon market also applies to the energy sector in general, it could affect more than 80% of our emissions. source: Climate Analysis Indicators Tool from World Ressource Institute, 2017. https://www.c2es.org/content/international-emissions/
  3. In 2019, carbon taxes on fuel were of the following amount for those countries:
    • 124$/tCO2 in Sweden.
    • 51$/tCO2 in France.
    • 2,6$/tCO2 in Japan.
    source: Global Carbon Account 2019,Institute for Climate Economics (I4CE), 2019. https://www.i4ce.org/wp-core/wp-content/uploads/2019/05/i4ce-PrixCarbon-VA.pdf
  4. Only if the ressource price of extraction from the soil doesn’t drop for some reason: the price could stagnate or even decrease, regardless of taxes.
  5. But not only: the offset system makes it possible to create allowances that were not distributed by the government. We will come back to it later.
  6. In 2019, the price of a ton of carbon traded was of the following amount for those countries:
    • 17$/tCO2 for the European Union market.
    • 8,9$/tCO2 for Beijing pilot ETS.
    • 4$/tCO2 for the North-East states of USA (RGGI ETS).
    source: Global Carbon Account 2019, Institute for Climate Economics (I4CE), 2019. https://www.i4ce.org/wp-core/wp-content/uploads/2019/05/i4ce-PrixCarbon-VA.pdf
  7. Quote from EU ETS web page. It states the shifting for a bigger share of auctioned allowances, following scandals and market stabilisation. source: https://ec.europa.eu/clima/policies/ets/auctioning_en
  8. source: Global Carbon Account 2019, Institute for Climate Economics (I4CE), 2019. https://www.i4ce.org/wp-core/wp-content/uploads/2019/05/i4ce-PrixCarbon-VA.pdf
  9. Adoption of the Paris Agreement, Article 02, (c), UNFCC, 2015. source: https://unfccc.int/resource/docs/2015/cop21/eng/l09r01.pdf
  10. Quote from EU ETS web page. source: https://ec.europa.eu/clima/policies/ets/auctioning_en
  11. “In a number of Member States, revenues from auctioning of allowances are not allocated to specific uses […] generally pooled in the national budget and redistributed.” Analysis of the use of Auction Revenues by the Member States, European Commission, 2017. source: https://ec.europa.eu/clima/sites/clima/files/ets/auctioning/docs/auction_revenues_report_2017_en.pdf
  12. Analysis of the use of Auction Revenues by the Member States, European Commission, 2017. source: https://ec.europa.eu/clima/sites/clima/files/ets/auctioning/docs/auction_revenues_report_2017_en.pdf
  13. As citizens, nobody would like to learn that carbon pricing revenues are used to refund national debt or subsidy companies that are already thriving.
  14. Carbon Market Watch & Sandbag are 2 NGOs who contributed to unveil this scandal. source: https://carbonmarketwatch.org/wp-content/uploads/2016/11/Cement-windfall-from-the-ETS_4page_final.pdf
  15. Thanks to this measure, offsets cannot be a direct source of profit. “Carbon Offset” on Wikipedia, introduction, 2020. source: https://en.wikipedia.org/wiki/Carbon_offset
  16. It is the role of the Clean Development Mechanism, one of the Flexible Mechanism established by Kyoto Protocol. It provides help to offsets projects which generate Certified Emission Reduction units (CER). “Clean Development Mechanism” on Wikipedia, introduction, 2020. source: https://en.wikipedia.org/wiki/Clean_Development_Mechanism
  17. Take for instance the HFC-23 GHG destruction model that made China built 18 new refrigerant manufacturing plants equipped with HFC-23 incinerators for $100 millions, thus generating $5,7 billions in CDM offsets credits. This type of offset credit has since been eliminated by EU officials (in 2011). source: https://www.carbontax.org/carbon-tax-vs-the-alternatives/offsets/
  18. See those different documents:
    • EU Commission website provides a list of sectors at risk of carbon leakage.
    source: https://ec.europa.eu/clima/policies/ets/allowances/leakage_en#tab-0-0
    • Ecorys report commissioned by EU finds no evidence of carbon leakage.
    source: https://ec.europa.eu/clima/sites/clima/files/ets/allowances/leakage/docs/cl_evidence_factsheets_en.pdf
  19. See Interpol Environmental Crime Program: Guide to carbon trading crime, 2013. source: https://www.interpol.int/Crimes/Environmental-crime/Pollution-crime
  20. James Hansen, An open letter to the president and 1st lady from the nation’s top climate scientist, 2009, Grist website. source: https://grist.org/article/dear-barack-and-michelle/
  21. “Carbon Tax” and “Taxe carbone en France” (fr) on Wikipedia, 2020. source: https://en.wikipedia.org/wiki/Carbon_tax#Implementation source: https://fr.wikipedia.org/wiki/Taxe_carbone_en_France#Exon%C3%A9rations
  22. P. Malliet et A. Saussay, Impact redistributif de la taxe carbone, OFCE, Science Po school, 2017. source: https://www.ofce.sciences-po.fr/pdf/pbrief/2017/OFCE-Fiche7-Taxe-carbone-12-07.pdf
  23. “Taxe carbone”, Justice Climatique (fr) on Wikipedia, 2020. source: https://fr.wikipedia.org/wiki/Taxe_carbone#Justice_climatique
  24. “Carbon Tax”, Impact, on Wikipedia, 2020. source: https://en.wikipedia.org/wiki/Carbon_tax#Impact
  25. I did not find the exact source but it might come from Le Canard Enchainé French journal, from the 7th of November 2018. The first source state the numbers, and the second one from Mediapart refers to the journal, with no mention of those numbers. source 1: https://www.lafinancepourtous.com/decryptages/finance-et-societe/nouvelles-economies/finance-verte/taxe-carbone/ source 2: https://blogs.mediapart.fr/patrick-cahez/blog/111118/les-taxes-sur-les-carburants-financent-le-capital
  26. From Sandbag NGO datas:
    • Greece, connected with Turkey.
    • Finland, largest EU importer, connected with Russia (it appears that Finland tried to implement a border tax, but it was discontinued by the EU).
    • Spain, connected with Morocco.
    • Croatia, connected with Bosnia-Herzegovina.
    • Romania, connected with Ukraine.
    • Hungary, connected with Ukraine.
    source: https://sandbag.org.uk/wp-content/uploads/2020/01/2020-SB-Path-of-least-resistance-1.2b_DIGI.pdf
  27. Sandbag NGO, How Electricity generated from coal is leaking into the EU, 2020. source: https://sandbag.org.uk/wp-content/uploads/2020/01/2020-SB-Path-of-least-resistance-1.2b_DIGI.pdf
  28. Hannah Ritchie and Max Roser, CO2 and Greenhouse Gas Emissions, Our World in Data, 2019.
    • Datas from CDIAC/Global Carbon Project, projection to 2018 from Global Carbon Project (Le Quéré et al. 2018).
    • Consumption-based emissions evaluation is a good way to re-evaluate some low-emissions countries like Switzerland (205% of its domestic CO2 emissions are embedded in trade in 2016) or Sweden (65%); and on the contrary high-emissions countries like China (-13,9%) that have negative results because they export a lot of goods, meaning they “consume” less CO2 than they produce.
    source: https://ourworldindata.org/co2-and-other-greenhouse-gas-emissions
  29. Nature website, Prove paris was more than paper promises, several scientists, 2017. source: https://www.nature.com/news/prove-paris-was-more-than-paper-promises-1.22378
  30. EU Commission website, Progress made in cutting emissions, 2019. source: https://ec.europa.eu/clima/policies/strategies/progress_en
  31. Nature website, Prove paris was more than paper promises, several scientists, 2017. source: https://www.nature.com/news/prove-paris-was-more-than-paper-promises-1.22378
  32. EU Commission website, Progress made in cutting emissions, 2019. source: https://ec.europa.eu/clima/policies/strategies/progress_en
  33. LULUCF: “land use, land use change and forestry”. In EU commitments, the “no debit” rule ensures that land use emissions are compensated by an equivalent removal of CO2 in the same sector.
  34. EU Commission website, ETS FAQ n°21 “Will it be possible to use credits from carbon “sinks” like forests?”. source: https://ec.europa.eu/clima/policies/ets_en#tab-0-2 “CORSIA”, Crititicisms on Wikipedia, 2020. source: https://en.wikipedia.org/wiki/Carbon_Offsetting_and_Reduction_Scheme_for_International_Aviation
  35. “Planting trees is good, of course, but it’s nowhere near enough of what is needed, and it cannot replace real mitigation and rewilding nature.” REDD Monitor website, Greta Thunberg: “We are not telling you to offset your emissions”, January 2020. source: https://redd-monitor.org/2020/01/25/greta-thunberg-we-are-not-telling-you-to-offset-your-emissions/
  36. EU Commission website, Progress made in cutting emissions, 2019. source: https://ec.europa.eu/clima/policies/strategies/progress_en
  37. Climate Central Website, Recession caused U.S. emissions drop, study says, Bobby Magill, 2015. source 1: https://www.climatecentral.org/news/recession-caused-us-emissions-drop-19272 source 2: https://www.nature.com/articles/ncomms8714
  38. Independent UK website, Recession did not lower CO2 emissions, Steve Connor, 2011. source 1: https://www.independent.co.uk/environment/climate-change/recession-did-not-lower-c02-emissions-6272333.html source 2: https://www.nature.com/articles/nclimate1332