Putting a price on carbon emissions Andrew Sentance

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

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

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

Stabilising the global climate Source: Stern Review

UK carbon emissions

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

“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

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

Pricing emissions • Regulation – command 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

Taxes vs trading - economics • Cost curve likely to be flatter over the longterm 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

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

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

UK carbon “taxes” £/T of CO 2, 2007 values

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

Technical progress and emissions reductions

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

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 cooperation 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

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

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

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

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 lowcarbon technologies • Technology support and carbon pricing are complementary, not alternatives

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

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

What next? • Buffet lunch served in S 1. 50 • Future seminars: – Dr Peter Newell (Warwick): “Climate for Change – the politics of global warming”, Tue 22 May, 11. 30 am – Michael Grubb (Cambridge and Carbon Trust) “Lessons and evolution of EU Emissions Trading Scheme”, Fri 8 June, 3 pm – Professor Brian Thomas (Warwick HRI), Tue 19 June, 11. 30 am (tbc) • Continue in Autumn term, subject to demand. Suggestions for topics and speakers most welcome.