A case and approach for a price for Carbon

There is already a price for Carbon in every country on earth. In most it is not explicit. However, the wider acceptance of at least partial responsibility for the unequivical and observed changes in the climate has provided changes in expectations that are impacting prices today. This maybe higher employment costs for organisations that do not explicitly incorporate climate change in their corporate social responsibility policies, lower yields from delayed adaptation effort raising food prices, or higher energy prices due to the integration of mitigation effort costs and a lack of response to demand signals due to uncertainty in explicit carbon pricing.

This could be considered a step forward, yet there is no design to this impact and as such whatever response it creates is not only unclear but unattributable. A lack of allocation blurs cause and effect and mires analysis in uncertainty. This is a worst of all outcomes as it fuels further inaction and delays purposeful response.

Clarity in the value of our actions will require the certainty provided by a price for Carbon.

The world is currently attempting to establish a common method to evaluate the scarcity of Carbon and thus form a price. Unfortunately the failure to achieve this may be more fundamental than a lack of will or a breakdown in the institutional processes. Instead, the failure maybe more directly attributable to the structural disimilarities in the Carbon intensity between nations and sectors of thier economies.

One sectors' ideal price to drive action may represent a microeconomic disaster for the government and society as it is applied unilaterally to all sectors. This inconsistency is all the more significant as it crosses borders and passes through the barriers of currency exchange, disimilar general tax regimes and potentially Carbon driven tariffs. It is therefore fairly clear that there is no one price for Carbon at least in terms of its application into an economy.

In traditional economics this doesn't appear to make sense. In what way can Carbon be all that different to any other globally trading commodity? The difference is twofold. The economy is already dependant upon this commodity based on a zero price and in most cases the demand is completely inelastic with no practical substitute. This difference is fundamental. The only practical approach to increasing the price from zero is to provide subsitution alternatives and the capacity for demand to become progressively elastic.

In the two hundred years since the industrial revolution began, economic development in each national economy as it has industrialised has been directly correlated to Carbon emissions. The nominally free cost of Carbon intrincally within our economy will not be de-coupled from economic prosperity without substantive change. This change is of a scale such that the destination beyond the change is likely to be just as different to our current economic and social fabric as we are to that of pre-industrial times. The difference is that we have only two generations to restructure what took eight to construct.

A clear long term price guide is paramount

The global economy and the less than hoped for progress in the Millenium Development Goals provides more than sufficient uncertainty to the lives of every man, woman and child. Planning to purposefully take the leaps of faith towards this contrasting future adds a layer of uncertainty that is surely insummountable and naturally causes a paralysis in our global institutions. Those called upon to lead must then strive to provide as much certainty as far into the future as possible.

The timescale of the response to climate change is in the order of several decades, yet many of our institutions are structured around periods not longer than five years with deregulated energy sectors having horizons measured in minutes. To provide long term certainty the solution, including a price for Carbon needs to be based on the long term levers and tools of our society. Therefore, a Carbon price cannot be solely dependant upon a market mechanism or defined by the political cycle.

Clearly the pricing of Carbon within any nation is defined by legislation within that nation. The law may also be a suitable place to define its price, but there are other examples of non-market centric long term pricing mechanisms. A Carbon price could be estabished in the same fashion as the price for money is in many economies, by a benchmark guided by political policy but set independantly. Whichever of these two or other methods to mark a price, this does not address the discontinuity of carbon intensity that our zero-Carbon-price economy has created.

Transitioning to a Carbon constrained economy will require sector specific transitional pricing for Carbon.

In every national economy there is a sector where it will take the highest Carbon price to achieve a behavioural response to lower the carbon intensity within that sector. At first glance in high petrol/gas taxing economies such as those of Europe and Australia the transport sector is a likely candidate. It may take a Carbon price beyond US$100 to reduce travel demand, drive modal shift and shift driving behaviour. If the much lower forecasted pricing were to occur, then the transport sector in these countries will not respond to price signals until sometime in the mid-2020s or beyond. This is clearly far too late for such a large, slow to change and signficant contributor to begin its shift. Certainly legislation and changing social values will move the sector's carbon intensity but price will not being playing its part.

An alternative approach is available. Set the price at the level of the highest price in the economy and define in law entry and transition rates of discount for the other sectors. In the high fuel tax economies with coal dependant electricity it is quite likely a price above 20% of that for petrol/gas for the energy sector will be high enough to drive behavioural change and foster the transition to renewables. However as the transition to renewables requires a small number of players to make signficant investment decisions, the nominal 80% discount should have a predetermined transition to no discount over perhaps a 20 or 25 year period providing investment certainty. It is also possible although counter productive to delay any application of the Carbon Price to a sector much in the same way that food or other 'essential'/'basic' products are justified not to have a goods and services tax applied in their supply.

Finally, it should be noted that this approach is not seeking to define the actual market price, but a certainty to the application of the market price to the economy of a suitable investment and decision making time frame. It is expected that as markets only function well with knowledgable market makers and market participants that in the initial stages a price floor would need to be defined in the Carbon pricing framework and that the 'initial stages' may be the entire period while discounts apply to any economic sector - that is, more than 20 years.

A low carbon future is about human behaviour

There are profound changes ahead for our way of life, the choices we have and the choices we don’t, in an affluent global community maintaining a CO2 concentration below 450ppm. A few of the changes are simply common sense efficiency for which there hasn’t been an excuse not to make for some time. Unfortunately, most are expensive risks that will cause inconvenience and at times distress to those whose lives are affected. The only incentive to tolerate this predicable impact on our lives being the precautionary argument which states that the incurred risk and investment embarks you along a path that is far less harmful than the cost and pain of the unplanned or unforeseen events that are spurred by inaction.

It is a good argument, but not one that reflects the reality of human behaviour. This point has not passed unnoticed, leading to policies that seek to steward and encourage the community and economy towards a low carbon pathway. In western democracies the policy responses focus on cap-and-trade market mechanisms to price carbon and in some cases a more direct method, a carbon tax. The IMF has made statements noting the preference for a carbon tax, citing the lack of certainty carbon trading markets provide industry and the dependency of the approach on the benchmarking of the cap.

The signals in the economy from the pricing of carbon are too haphazard to shift human behaviour onto the sustainable pathway.

A price for carbon, whether set by a market or a tax, does not provide clear pricing signals and thus behavioural changes in the use of carbon intensive products. Consider the consumption of petrol or gas for private vehicle use. In order to apply a 10% impost on the price of fuel via a carbon price in the United States, a US$34 per tonne carbon price would be sufficient. However, due to the existing dissimilar tax imposts and variations in supply chains between jurisdictions the carbon price in Australia would need a US$63 per tonne and in United Kingdom US$87.

To exacerbate the disparity, US citizens have higher demand elasticity for the price of gas or petrol than the United Kingdom meaning that the 10% impost created by only a US$34 carbon price would do more to the behaviour of the domestic consumers than the US$87 carbon price would in the United Kingdom!

Next, consider the effect these various domestic carbon prices would have on electricity prices in each of the jurisdictions noted above. Assumed the electricity has the carbon intensity of their respective national averages, US electricity receives a 19% impost from the US$34 carbon price or near double the impact, the United Kingdom 28% or nearly triple the impact and due to the high dependence upon coal, Australian electricity would increase by 44% or approaching five times the impact. This may reflect the carbon intensity of the consumption, but the uneven relative domestic impact and the need for unequal cross-border pricing to create the same signals and behavioural responses represents a significant challenge for policy makers.

It therefore clear that a global price for carbon is undesirable. Any price level would cause supportive price signals for some, destructive price impacts for others, and yet for many, no price signal at all (at least in terms of affecting behaviour). However in order to minimise the global cost of the transformation there must be a mechanism for shifting carbon abatement across borders and by implication shift capital to those least capable of responding. The two appear mutually exclusive – the key is not to convert the carbon emissions or abatement to money too early in the process.

Foreign Carbon Exchange & Carbon Import Duties

In developed economies, the only valid currency for domestic trade is the local currency and so it should be for carbon. The concept is a core component to preventing the leveraging of domestic market disparities and foreign currency fluctuations to evade the impost of any price on carbon. The approach has two significant implications: a foreign exchange in carbon; and the modification of the World Trading Organisations rules to allow an import duty to address carbon price disparities.

The internalisation of the environmental cost of excessive carbon dioxide and other greenhouse gases so as to have price signals is paramount in order to enact change on a broad scale. Nevertheless, it is clear that by simply pricing carbon, in isolation and without regard for the unintended consequences and complexities, will not by any means lead to a shift onto the low carbon pathway.

Price signals, even heavy ones, aren’t enough to shift behaviour.

The daily commute for many is in their car and for some this isn’t a choice. The lack of a viable alternative at any price provides for a very inelastic demand for car use and consequently the use of the petrol or gas. For this group the 10% impost isn’t a price signal, just a tax. However, if the receipt for the next tank of fuel wasn’t just 10% more, but also included the detail “123kg CO2” then behaviourally some would seek to do something about it – whether that entailed an inconvenient mode shift or an attempt to reduce their emission in private vehicle use.