Carbon price

Carbon pricing is a way for governments to help fight climate change. It puts a cost on releasing gases that warm the planet, like those from burning fossil fuels. This makes it more expensive to pollute, so companies and people try to find cleaner ways to do things.

Right now, about 28% of the world's pollution is covered by carbon pricing. Many places in Europe and Canada use it, and China started a big program in 2021. But some big polluters, like India, Russia, and many US states, still don’t use this method. In 2020, carbon pricing made about $53 billion for governments.

Experts say the price needs to be much higher in the future to really cut down on pollution. For example, by 2050, it might need to be between $245 and $13,000 for each ton of carbon dioxide. Some places, like the European Union, already have prices above $100 per ton, while others are still below $10. This helps leaders make plans to keep the Earth’s temperature from rising too much.

Overview

Carbon pricing is seen by many experts as a smart way to cut down on pollution that harms our planet. By putting a cost on pollution, it encourages companies to find better ways to reduce the amount of harmful gases they release into the air. This is thought to work better than giving out money only to certain companies to use cleaner energy.

There are two main ways to put a price on pollution. One way is through a carbon tax, where companies pay a fee for the pollution they create. Another way is called cap-and-trade, where the government sets a limit on pollution and gives companies permits to pollute. Companies can buy and sell these permits. If they don’t have enough permits, they face a big fine. This system has been used in places like the EU ETS. It helped create a strong price for pollution for a while, but faced some problems before rising again in recent years.

Studies of different carbon pricing systems show that many of them have helped lower pollution. The amount of reduction varies, but it can be between 5% and 21% in some cases.

The exact cost of the damage caused by one ton of CO₂ is still being studied, but recent numbers show it is getting higher.

Implementation

Cap-and-trade systems can include rules to keep prices stable, with limits on how high or low they can go. These are often called hybrid designs. When the price is controlled by these limits, it acts like a tax.

Carbon emissions trading sets a limit on how much pollution companies can produce. The price changes based on this limit, which is an advantage over a fixed carbon tax. A carbon tax is easier to enforce widely. It has worked well in British Columbia, Canada, where it was put in place quickly. A hybrid cap-and-trade program can set limits on how much prices can go up and sometimes sets a minimum price too. For example, the Regional Greenhouse Gas Initiative sets a maximum price for pollution permits through its cost containment rule.

However, some industries might try to avoid paying a carbon tax. With emissions trading, polluters have a reason to reduce pollution, but if they avoid a carbon tax, they have no reason to cut pollution. Giving out pollution permits for free could also lead to unfair behavior.

Most cap-and-trade programs slowly lower the pollution limit each year, which helps make sure pollution goes down over time. With a tax, we can guess how much pollution will be cut, but it might not be enough to stop climate change. Lowering the cap each year sets clear goals for companies to reduce pollution and ways to check if they meet these goals. It also allows flexibility, unlike strict taxes. Giving out pollution permits is preferred when we need to be very sure about how much pollution will be cut.

Common ideas for using money from carbon pricing include

• returning the money to people equally, which can help if energy prices go up before clean energy like wind and solar is widely available. People who use more energy would pay more, while those who use less could benefit.
• supporting the switch to renewable energy
• funding research, public transport, car sharing, and other ways to reach carbon neutrality
• supporting technologies that remove carbon dioxide from the air, such as PyCCS or BECCS. The cost for removing carbon is about $150–165 per ton of CO₂. In theory, we could address past emissions by selling permits at prices higher than the cost of removal.

Price levels

About one third of carbon pricing systems are below $10 for each ton of carbon dioxide, and most are below $40. However, the price in the EU system reached $60 in September 2021. Sweden and Switzerland have prices above $100 for each ton of carbon dioxide.

Market price surge in fossil fuels

In 2021, prices for natural gas, oil, and coal went up suddenly. This caused a discussion about whether to delay increasing carbon prices to avoid putting more pressure on people. Helping poorer families, who use less energy, could ease this burden. The higher the carbon price, the more help is needed. However, some people, like those living in rural areas or in poorly insulated homes, still struggle because they can't easily switch to less polluting energy sources. Even with a carbon price, there is an incentive to use better technology, like advanced gas power plants, instead of polluting coal.

Scope and coverage

In countries that use special plans to manage pollution, about 40% to 80% of pollution is included. These plans can change a lot. Some include or exclude things like fuels, transport, heating, farming, or gases other than CO₂, such as methane or fluorinated gases. In places like France or Germany, there are two different systems. One system focuses on big power plants and industries, while another puts a price on fuels used by regular people.

Other taxes and price components

The price people pay for fuels and electricity depends on taxes and rules in each country. While carbon pricing is becoming more important, other taxes like energy taxes, VAT, and utility costs still make prices different between countries.

Impact on retail prices

The table shows how prices might change with a carbon price set at $100 or the same value in another currency. The food prices are calculated using CO₂ equivalents, which also includes the strong effect of methane emissions.

Economics

See also: Economics of climate change mitigation

Carbon pricing can work in different ways, like setting a limit on pollution or putting a tax on it. Both have their own ups and downs. Limits can change a lot, making it hard for businesses and governments to plan. Taxes, on the other hand, work better with other rules that help the environment, like paying for clean energy.

Sometimes, when one country tries to cut down on pollution, other countries might end up polluting more. This is called carbon leakage. It's tricky to know just how much this happens, but it can sometimes mean that the world ends up polluting more even if some places try to do less.

Studies show that putting a price on carbon doesn’t hurt the economy in rich countries. In fact, it can help make clean energy more affordable and attract more investment. This way, carbon pricing can support both the environment and the economy.

Advantages and disadvantages

See also: Carbon emission trading

Some experts believe that setting a price on carbon emissions can help countries work together to fight climate change. They think it would be easier to agree on a carbon price than on specific targets for each country. Famous economists have supported this idea, saying it is the best way to reduce climate change without costing too much.

There are different ways to put a price on carbon, like taxes or trading permits. Some say taxes are good because they let other policies, like supporting clean energy, still work. Others say that only setting a strict limit on emissions can truly guarantee that pollution will go down. These different methods can help make sure that the world tries its best to protect the environment.

Internal carbon pricing

Internal carbon pricing (ICP) is a way for companies to put a value on the pollution they create. This helps them understand the cost of harming the environment and encourages them to use fewer fossil fuels. Companies choose to use ICP on their own, even if they are not required to by law. As of 2024, over 1,700 companies in 56 countries have reported using ICP.

The goal of ICP is to make it more expensive for companies to pollute, helping them reduce emissions and prepare for future climate rules. It can also help companies plan for the future, find new ways to save energy, and spot areas where they can work more efficiently.

There are different ways companies can use ICP. Some methods focus on tracking pollution from specific activities, while others look at the whole company. The choice depends on the company’s size, its goals, and how much time and money it can spend.

One common method is an emissions trading system (ETS), where parts of a company trade permits to pollute. Those who pollute less can sell their permits to others. This helps spread the cost of cutting pollution but can be complex.

Another method is using a set price for pollution, called a carbon fee. This charges the company a fixed amount for each unit of pollution. The money collected can be used to fund projects that cut pollution.

Some companies also use a “proxy price,” which is a predicted future cost of pollution used to guide decisions. This is simpler but doesn’t change current pollution levels.

Studies show that companies using ICP often cut their pollution more than those that don’t. However, some companies might use ICP to avoid stricter rules from governments. Not all companies share how much they charge for pollution, making it hard to know how effective ICP really is.