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Paying a fair price for carbon
Article first published in Agefi on 15 October 2020
The earth is now 1°C warmer than it was in 1850, mainly due to the emission of greenhouse gases, which have now reached their highest concentration in our atmosphere since at least 800,000 years. One important way to address this problem is to put a “true” price on emissions. One way of doing this is through carbon markets where emitters are obliged to purchase allowances to cover their emissions, thereby co-opting CO2 emitters into helping to finance the transition to a sustainable economic model.
Carbon markets can be divided into two kinds of systems: cap and trade systems and international credits. The former lets market participants exchange the right to pollute in future, while the latter allows emitters to trade their past reductions. One example is the European Union Emissions Trading Scheme (EU ETS), which will reduce the volume of credits in circulation by 2.2% per year from 2021, compared to 1.7% previously. This strategy will allow the EU to achieve its target of cutting emissions by 40% by 2030. It is interesting to note that in Europe, 43% of the available emission allowances are actually free of charge, which mainly benefits airlines and will continue to do so until 2026. The result is that the aviation sector only buys 15% of the carbon credits it needs, while Europe’s energy producers are forced to buy all of theirs.
Ultimately, all CO2 emissions enter the same atmosphere regardless of their geographical source. Likewise, atmospheric CO2 concentration decreases regardless of which country is cutting its emissions the most (all else being equal). Carbon markets are modelled on the principle of transferability – i.e. as long as the total volume of emissions falls, the climate benefits, no matter who is buying or selling in which market.
Article 6 of the Paris Agreement calls for the establishment of a robust accounting system to ensure the integrity of the emissions targets that countries commit to, as well as a framework to enable the international integration of national markets. This integrated market mechanism is vital for international cooperation. Other voluntary initiatives are also being developed by the private sector, including the working group initiated by the United Nations Special Envoy for Climate Action, Mark Carney, with the aim of boosting private-sector involvement in carbon markets.
The price of a product is always determined by the law of supply and demand. Since its creation, the supply of carbon allowances has constantly outstripped demand. The European Commission established a reserve fund in 2019 to absorb this surplus. This should lead to price increases over the coming years – which would be excellent news for the climate.
The current price for a quota permitting the emission of one metric ton of CO2 is around EUR 27. The World Bank believes that it would need to be USD 40 to USD 80 to achieve the goals of the Paris Agreement. Accelerating the move to make airlines pay for their emissions rights should be a priority, in order to ensure a market price that reflects the true social cost of carbon. The price of carbon will also progressively reflect its total cost to society as global carbon markets expand and mature. This is still a nascent field as only 20% of global emissions are traded on such platforms currently.
Important information
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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