Weak Carbon Pricing Stalls Energy Transition
Low and patchy carbon prices will delay the transition to a clean economy but present political advantages, says the Institute of International Finance.
The sluggish spread of carbon pricing around the world risks holding back the urgent transition to a low-carbon economy, a leading financial industry bodies has warned.
In a report co-authored with Pictet Asset Management, the Institute of International Finance (IIF) said the global cost of emitting carbon would remain stubbornly low well into the next decade.
While this will have a positive impact on the cost of living, keeping inflation to a relatively modest 3% in the coming decade, it will also take away incentives for polluting companies to clean up their operations, resulting in a slower shift to carbon-free energy sources, the report said.
This comes amid warnings from scientists that steep declines in greenhouse gas emissions are needed immediately to avoid the worst effects of climate change. With the current rates, the world could breach the key 1.5°C warming threshold within five years.
Speaking at a briefing on Monday ahead of the report’s release, IIF’s Head of Sustainable Finance Sonja Gibbs said a slower transition may prove to be “the only feasible way” to decarbonise, since higher carbon prices would lead to “unpopular inflation”.
“A very abrupt rise in inflation would produce so much political backlash, that it may be the case that [the energy transition] will have to proceed more gradually in order to have it happen at all,” she said.
Long favoured by economists for their market-based simplicity, carbon pricing regimes aim to push investment into low-carbon technologies by making it more expensive for businesses to emit CO2. The World Bank considers carbon pricing “critical to driving investment and behaviour change to lower emissions”.
However, legislating them has proven politically difficult due to their perceived inflationary effect. This has been a fatal stumbling block in jurisdictions such as the US, where attempts by the Obama administration in 2009 to legislate a federal emissions trading system (ETS) were scrapped after just two years.
In the report, the IIF also said that the real-world inflationary effect of carbon pricing in the coming decades would be modest due to a patchy uptake. It predicted that global inflation would reach around 3% through the 2030s, and rise slightly to above 3.3% thereafter – well below the scenarios modelled by the Network for Greening the Financial System (NGFS), which assume high and widespread carbon pricing.
“The IIF’s own forecasts differ from those of the NGFS because we expect the impact of carbon prices on overall price pressures to be more contained in the early stages of transition and align with historical averages,” the report said. “This primarily reflects our assumption of a slower uptake of carbon prices and a lower level of policy support to incentivise global decarbonisation.”
Slow expansion
The IIF’s projections are a stark reminder of the mismatch between ambitious emissions targets and real-world actions.
To keep global temperature rises below 1.5°C, a global weighted carbon price of at least US$170 per tonne would be needed by 2030 – which is seven times the current global average of US$23 per tonne. Carbon pricing would also need to be adopted across 100% of global emissions by 2030 to meet the 1.5°C target, up from 23% today – suggesting annual rate of adoption would have to triple.
Some form of carbon pricing currently exists in the EU, the UK, China, Canada, Japan, Australia, and a handful of US states including California, among other jurisdictions. But adoption so far has been slow. Since the EU launched its ETS nearly two decades ago, only 16 additional countries have taken it up.
The EU has the world’s most mature carbon-pricing system, with carbon credits trading at around €70 (US$76) per tonne at the time of writing. In the UK carbon was trading at about £37 (US$46) per tonne, while in California the price was around US$29 per tonne. Meanwhile, carbon-pricing in China’s ETS – which only applies to electricity generators – was around US$14 per tonne.
Not all bad
Not everyone, however, has such a negative outlook on carbon pricing. Josh Burke, a Senior Policy Fellow at the Grantham Research Institute on Climate Change and the Environment, was more upbeat on its prospects and on the general pace of transition.
“They are still too low by a mile, but having 23% of global emission covered by a carbon price isn’t that bad – and the number is growing,” he said. “There are always going to be economic winners and losers. But ultimately [it’s] a political choice, and governments have it in their means to protect those who they want. It doesn’t have to be painful.”
The EU’s adoption of the Carbon Border Adjustment Mechanism (CBAM), which imposes a price on imports into the bloc, has already prompted Taiwan to adopt a carbon-pricing scheme. He predicted others would follow.
Although the political polarisation of ESG- and climate-related topics in the US means it is unlikely to introduce a similar initiative soon, the decision by China – the world’s top polluter by far, making up nearly 30% of global emissions – to implement an ETS is an “important step”, Burke argued.
“Carbon pricing is an important element in pushing decarbonisation, but it’s not the only one,” he added. “Subsidies for low-carbon technologies are also key.”
The US Inflation Reduction Act (IRA), signed into law by President Biden in 2022, is a prime example of that – offering hundreds of billions of dollars in tax credits to a broad range of clean technologies.
“This differs from Europe’s regulation and market-based approach, and the region risks falling behind the US and China in the development of clean technology,” the IIF’s Director of Sustainable Research Emre Tiftik suggested during the Monday briefing, urging European governments to pour more money into renewable energy.
“If European governments don’t step up their spending for climate and don’t want to increase their government debt levels, this transition will fail,” he added.
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