Carbon pricing curbs greenhouse gas emissions by placing a fee on emitting and/or offering an incentive for emitting less. The price signal created shifts consumption and investment patterns, making economic development compatible with climate protection.

Carbon pricing is advancing rapidly as an approach to spur climate action. By 2020, 25 percent of global emissions are expected to be under some carbon pricing mechanism. A large and growing number of non-Annex I countries under the UNFCCC are pursuing carbon pricing: South Korea, China, Thailand, Singapore, Bangladesh, Kazakhstan, South Africa, Côte d’Ivoire, Colombia, Chile, Argentina, Brazil, Mexico, Panama, Trinidad and Tobago, others.

Recently, the V20, a group of 20 developing countries vulnerable to climate change, announced its intention to adopt carbon pricing by 2025.

Carbon pricing works by capturing the external costs of emitting carbon -  i.e. the costs that the public pays, such as loss of property due to rising sea levels, the damage to crops caused by changing rainfall patterns, or the health care costs associated with heat waves and droughts - and placing that cost back at its source.

Carbon Pricing effectively shifts the responsibility of paying for the damages of climate change from the public to the GHG emission producers.  This gives producers the option of either reducing their emissions to avoid paying a high price or continue emitting but having to pay for their emissions.   

Carbon Pricing also creates a price signal that reduces, or regulates, GHG emissions and at the same time provides a strong financial case for shifting investments away from high-emission fossil-fuels based technology towards cleaner technology.

Putting a price on carbon is widely seen as the most cost-effective and flexible way to achieve emission reduction.

Carbon Pricing can:

Help facilitate emission pathways compatible with keeping global temperature rise to well below 2°C above pre-industrial levels and pursuing efforts to hold the increase to 1.5°C, as per the Paris Agreement.  

Spur investment and innovation in clean technology by increasing the relative cost of using carbon-intensive technology. Businesses and individuals seeking cost-effective ways to lower their emissions will encourage the development of clean technology and channel financing towards green investments.

Promote the achievement of the Sustainable Development Goals by channelling financing to sustainable development projects.

Generate revenue which can be recycled into the green economy through government spending for research and development into green technology, helping vulnerable communities adapt to the effects of climate change, or managing the economic impacts of the transition to a low-carbon economy.

Create environmental, health, economic, and social co-benefits, ranging from public health benefits coming from reduced air pollution to green job creation.

Carbon pricing instruments can take on multiple forms. Ultimately, all approaches aim to create a price signal on GHG emissions.  The manner in which this is achieved differs across instruments.

An Emission Trading System (ETS) – also known as cap and trade – is a tradable-permit system for GHG emissions. It sets a limit (the cap) on the GHG emissions that can be emitted. Entities covered by the ETS need to hold one emission unit (allowance) for each tonne of GHG emitted, but entities have the flexibility of selling and buying emission units.

The total number of emission units reflects the size of the cap in the ETS. Under this approach, the price on carbon will depend on the balance between demand (the total emissions) and the supply (the emission units allocated and available).

Emission Reduction Funds are taxpayer funded schemes in which a government buys credits created by emission reduction projects.  Currently, an Emission Reduction Fund is operational in Australia.

A Carbon Tax on fossil fuel usage creates a price signal felt across an entire economy, thereby incentivizing a move away from carbon-intensive production. This results in a total reduction of emissions. Unlike an ETS, a carbon tax cannot guarantee a minimum level of GHG reductions, but instead ensures certainty around the size of the price signal on carbon.

Depending on the particular needs of the jurisdiction contemplating carbon pricing, a Hybrid Approach can also be considered, combining elements of an ETS and carbon tax. For example, a jurisdiction might set up an ETS with either a maximum or minimum price per allowance, or set up a carbon tax scheme that accepts emission reduction units to lower tax liability.

Momentum is building around the world for carbon pricing instruments:

• Currently 40 national and 25 sub-national jurisdictions put a price on carbon.
• These carbon pricing initiatives cover 8 gigatons of CO2e, which is equal to 15% of global GHG emissions.
• Of the 46 carbon pricing initiatives under way or planned for implementation, 23 are ETSs, applied mainly across subnational jurisdictions, and 23 are carbon taxes, primarily implemented on the national level.

Various carbon pricing approaches are being implemented. They tend to fall on the continuum between purely a price signal and purely an ETS. They are designed to benefit from both the predictable pricing of a price signal and the flexibility offered by an ETS. The emerging trend across carbon pricing approaches is a move towards international linkage of carbon markets.

Carbon Price Signal
In 2008, the Canadian province of British Columbia put in place a carbon tax on fossil fuels burned for transportation, home heating, and electricity.  The approach covers 70% of the province's total GHG emissions and is revenue neutral, implying that all the revenue earned via the carbon tax is returned to the citizens of British Columbia in the form of reductions to personal income tax, corporate income tax, and property tax, among others.

Emission Trading System
China is launching a national ETS. Once implemented, it will be the largest ETS in the world, covering approximately 40% of China’s GHG emissions. China has also signed a bilateral plan with New Zealand to cooperate on carbon markets and is working on identifying opportunities for collaboration or linking markets with other countries in the Asia-Pacific region.

Mixed Systems
In 2014, Mexico introduced a $3.50/tonne carbon price on fossil fuels and is currently preparing for a national ETS, planned for 2018.  The goal is to allow emitters to use certified emission reductions (CERs) from Clean Development Mechanism projects for compliance. Mexico has also signed an MoU with the US State of California to potentially link its ETS with the California cap-and-trade programme.

The South African carbon pricing approach allows for the cancellation of offsets to mitigate the tax liability of emitters. In other words, emitters will be able to purchase and cancel offsets to reduce their carbon tax liability up to a certain limit.

Two-thirds of all submitted Nationally Determined Contributions (NDCs) under the Paris Agreement consider the use of carbon pricing to achieve their emission reduction targets. This means 100 countries are looking into carbon pricing as a way to achieve their NDC through international trading of emissions, offsetting mechanisms, carbon taxes, and other approaches. According to the World Bank, using carbon pricing approaches on a large scale to meet the emission reduction targets set in NDCs could reduce the cost of climate change mitigation by 32% by 2030.

While putting a price on carbon is a low-cost, efficient way to achieve mitigation targets as expressed in NDCs, these approaches have to be coupled with complementary energy and environment policies to truly harness the potential that carbon pricing promises.

The Paris Agreement of 2015 marked a turning point for international climate action. For the first time, all nations came together in the common cause of combating climate change. The Agreement aims to keep global temperature rise to well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further, to 1.5 degrees Celsius. To achieve these ambitious goals the Agreement sets in place provisions for enhanced cooperation among nations on climate change mitigation, including through market-based approaches, such as carbon pricing.

These provisions are elaborated in the following articles of the Paris Agreement:

● Article 6.2: Establishes the potential of trading emission reduction credits across borders, between nations or jurisdictions. This can encourage the linking of carbon pricing approaches across countries and jurisdictions resulting in the reduction of emissions by a magnitude greater than what is possible solely domestically or nationally.

● Article 6.4: Creates a new international mitigation mechanism to help countries reduce emissions and promote sustainable development. The mitigation engendered under this mechanism can also be used by Parties other than the host Party to fulfil their NDC. In other words, this provision allows for offsetting through the trading of emission reduction credits.

● Article 6.5: Puts in place robust accounting measures to avoid double counting of emission reductions and increase transparency, thereby ensuring the integrity of the proposed market-based approaches.