Putting a price on carbon emissions

1. Putting a price on carbon emissions Andrew Sentance Warwick University and Bank of England Climate Change Policy Seminar 15 May 2007

2. Climate Change Policy Seminars • Forum for discussing climate change research across University • Cross-disciplinary, and with strong focus on policy implications • Build a stronger research community and increase visibility of existing research • Platform for external speakers

3. Outline • Why price carbon emissions? • How to price carbon emissions? • Taxes vs emissions trading • Developing carbon pricing • Is carbon pricing enough? • Key conclusions and issues

4. Stabilising the global climate Source: Stern Review

5. UK carbon emissions

6. Stern Review: Policies • Carbon pricing • Accelerating technological change • Regulation, information and behaviour • Adaptation • International frameworks • Cost-effective action

7. “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Adam Smith, Wealth of Nations, 1776

8. Climate change as an externality • Externalities are costs (benefits) imposed on others which those who create the costs (benefits) do not take into account • The costs of climate change are potentially very large and irreversible but also uncertain • Pricing carbon emissions aims to ensure these costs are reflected in the decisions firms and individuals take

9. Pricing emissions • Regulation – command and control • Taxation – influence prices directly; quantity adjustment uncertain • Permits and trading – set quotas and allow markets to determine pricing • Possible hybrids – eg trading within price bands

10. Taxes vs trading - economics • Cost curve likely to be flatter over the long-term than in short-term • Benefit curve may steepen sharply if climate change reaches critical level • Trading likely to be more efficient over the longer-term • In short-term, taxes may have a bigger role to play in establishing a price signal

11. Emissions trading - requirements • Enforceable limits on emissions • Robust accounting and administration • Agreed mechanisms for distributing/allocating permits • Transparent and liquid markets, including futures markets • Participation of wide range of firms and sectors • Confidence in long-term viability

12. Carbon pricing – policy issues • Achieving consistent price signals across different activities • Long-term price signal needed to stimulate technology and investment • Wide international coverage strengthens the price signal • Institutional frameworks • Distributional issues

13. UK carbon “taxes” £/T of CO2, 2007 values

14. Carbon pricing in UK • Uneven pricing across transport and other activities • Uneven/inefficient pricing within transport (eg aviation, agriculture, public transport) • Domestic and industrial energy “underpriced” • Key issue is reconciling carbon pricing with other policy objectives, eg: • Cost of domestic energy for poorer households; • Competitiveness impact on business

15. Technical progress and emissions reductions

16. Long-term carbon price signals • Price impact on investment and technical change is a key channel for climate change policy • Outside private motor transport, price signals are still weak and short-term • EU Emissions Trading Scheme has short time horizon and allocation rules are still uncertain • Longer-term frameworks needed both nationally and internationally

17. Widening international scope • Broader international coverage: • Strengthens price signal for development of low-carbon technologies • Reduces concerns about competitive impacts on industry of national/regional policies • Emissions trading better suited to international co-operation than taxation • Potential approaches: • Global governance of carbon markets under “Kyoto 2” agreement • Linking together national/regional schemes • International agreements needed to underpin both approaches

18. Lessons from Kyoto • US support and involvement needed for a successful climate change agreement • Stronger engagement from emerging nations also needed • Longer term focus required to drive investment and technological change • Lack of effective compliance mechanisms has weakened credibility of emissions caps • More focus needed on developing delivery mechanisms – carbon markets and technology

19. Institutional frameworks • Stronger policy frameworks needed both domestically and internationally to underpin efficient carbon pricing • Compared to Kyoto, we need: • Longer-term focus • Better monitoring and compliance • Focus on actions/outcomes, not just targets • Better alignment with other policy objectives (eg development) • Potential lessons from other policy frameworks? • International trade • Monetary policy • Development of international standards

20. Distributional issues • Focus on pricing penalises countries with low per-capita emissions with large catch-up potential • Potential solutions: • Link climate change policy to technology transfer and development aid • Tougher targets for richer countries, supported by robust trading system • May also be distributional issues within countries, eg related to transport access and domestic energy prices

21. Technology: Is carbon pricing enough? • Comprehensive global carbon markets will take time to develop • Long-term carbon prices will depend on future policies which may be uncertain • Long time horizons, uncertainty and risk also justify additional policies to support low-carbon technologies • Technology support and carbon pricing are complementary, not alternatives

22. Conclusions • Efficient carbon pricing now and into the future is a key mechanism for incentivising emissions reductions • Current carbon pricing is very uneven across different activities, both nationally and internationally • Emissions trading looks the most promising mechanism, but will take time to develop and gain credibility • A long-term international framework is essential to underpin emissions trading • Tax-based approaches could be made more attractive if coupled with incentives for developing and embodying new technology

23. Key issues • Policy frameworks – national and international • Consistency of pricing and alignment with other policy objectives • Impact on technology and investment • Robust accounting and administration to underpin emissions trading

24. What next? • Buffet lunch served in S1.50 • Future seminars: • Dr Peter Newell (Warwick): “Climate for Change – the politics of global warming”, Tue 22 May, 11.30am • Michael Grubb (Cambridge and Carbon Trust) “Lessons and evolution of EU Emissions Trading Scheme”, Fri 8 June, 3pm • Professor Brian Thomas (Warwick HRI), Tue 19 June, 11.30am (tbc) • Continue in Autumn term, subject to demand. Suggestions for topics and speakers most welcome.