Investors are united in their support for more explicit carbon pricing. But the underlying complexities mean there is no certainty of a global consensus at COP26.
A fixed minimum price for carbon emissions is the key to tackling climate change and the success or failure of November’s COP26 Summit in Glasgow rests on agreeing one. This is the view shared by many players in the financial services sector as they consider the chances of meeting targets set out in the Paris Climate Agreement.
Last December, the Global Financial Markets Association said governments need to take “swift action” on legally-enforceable carbon pricing mechanisms. In July, UN-convened Net-Zero Asset Owner Alliance (NZAOA) called for “effective, robust, reliable and fit-for-purpose carbon-pricing instruments”. And earlier this month, Zurich Insurance Group placed extension of carbon pricing at the top of its COP26 wish list.
Adam Matthews, Chief Responsible Investment Officer for the Church of England Pensions Board, recently told ESG Investor: “Ultimately we need a price on carbon; that is the clearest thing that will drive change at a level that will make the greatest impact [on climate change]. Governments committing to do setting carbon prices [at COP26] will be really important.”
Work on pricing carbon is being conducted and at pace. In June the International Monetary Fund (IMF) noted the proliferation of carbon pricing schemes with more than 60 implemented globally. The most notable national schemes include China’s national carbon market, introduced last month, preceded by Germany emissions trading scheme in January 2021.
The most established carbon market is the European Union’s Emissions Trading System, which is undergoing reform as part of the bloc’s ‘Fit for 55’ initiative, alongside the introduction of a Carbon Border Adjustment Mechanism (CBAM).
The World Bank State and Trends of Carbon Pricing Report reveals nearly half of the largest 500 companies in the world by market value already have an internal carbon price or intend to adopt one in the coming two years.
Yet, as the IMF says, “stronger and more coordinated action in the decade ahead is critical”.
A September report on carbon pricing from ratings agency Moody’s finds that while carbon pricing is an “effective tool to incentivise higher carbon efficiency and can boost government revenue” adoption so far has been low. Low take up, Moody’s says, reflects the “difficulty in achieving political consensus, given the costs for economies and sectors with high carbon intensity”.
Delegates at COP26 will have their work cut out then if they are to agree on global carbon-pricing systems.
Amy Bowe, head of carbon research at Wood McKenzie, says: “The future of carbon markets hinges on delegates working out a solution — agreement would help equalise prices across traded markets globally, while failure would place more importance on regional and voluntary markets.”
Never mind the price
The IMF reports that four-fifths of global emissions remain unpriced, and the global average emissions price is only US$3 per tonne. This is a long way from its calls for a global carbon price of US$75 or more per tonne by 2030 to meet the Paris Agreement targets. The Bank of England goes even further, stating that £150 (US$207) might be needed, while the International Energy Agency said in May advanced economies should set prices at US$130 a tonne by 2030 and US$250 by 2050.
For the biggest emitters, be they countries or companies, significant increases in carbon pricing will be an obvious concern. Some have argued that the introduction of transparent carbon pricing would radically alter investor perceptions and corporate profitability.
“Economies with carbon-intensive exports will bear a larger economic cost from carbon taxes implemented globally,” says Anushka Shah, a senior analyst at Moody’s. “The costs will also likely fall on hydrocarbon-consuming nations, depending on the elasticity of demand, and more carbon-intensive industries, including transportation, coal mining and oil refineries. Conversely, economies or sectors that supply low-carbon technologies stand to gain competitiveness over time.”
This kind of see-saw of benefit from one nation to another does not bode well for diplomatic success at COP26, particularly as delegates will also have to contend with the double counting of traded emissions reductions between the originating and purchasing country, and the carrying forward of Kyoto-era credits, reductions and allowances.
Such complexity and likely political friction mean COP26 is seen by some as an unsuitable stage on which to set carbon pricing.
Aviva Investors’ chief responsible investment officer, Steve Waygood, believes such expectations on achieving ‘unanimity or near unanimity’ on carbon pricing at the summit is unrealistic.
“Blaming the United Nations Framework Convention on Climate Change for not coming up with a global carbon price is unfair. It’s an inappropriate forum,” says Waygood.
Meanwhile those that have already made the running continue to fine-tune their existing approached. Ahead of the summit, decision makers in the EU have indicated their desire to advance plans to set carbon pricing across the bloc. As part of this effort, the aforementioned CBAM will target imports of carbon emitting products to protect low-emitting member nations.
Although the European Commission envisages a gradual phasing in of the CBAM, its proposals have been met with protest from those outside the EU. US Special Presidential Envoy for Climate John Kerry, for example, has said plans to hit importers with carbon taxes should only be used as a last resort while warning that such imposition could spark trade wars.
In response, the Organisation for Economic Cooperation and Development (OECD) is understood to be pushing the EU to set more nuanced levies based on importers’ explicit and implicit carbon taxes to avoid future conflicts. For example, including other carbon reducing measures such as bans on coal-fired power stations.
While the OECD has made nothing public on the issue, the FT reports that under the OECD plan, countries and economists would use a voluntary framework to agree on how to best price both carbon taxes and other forms of environmental regulation. That in turn could help drive consent for an international framework for carbon border taxes, and so avoid potential trade battles.
To the seasoned observer of disintegrating levels of political cooperation over the past decade, the effort needed to achieve agreed pricing carbon at COP26 might seem insurmountable. The IMF, however, reminds us that politics is the art of the possible.
“There is no time to waste in putting in place such an arrangement. Let us make sure that we will not look back at 2021 just to regret the missed opportunity for effective action. Let us instead look back with pride at global progress towards keeping global warming below the 2oC threshold. We need coordinated action now and it should be centred on an international carbon price floor.”