Carbon price floors are now the single most important reform needed for global carbon markets.
These will increase market confidence and guide prices upward-over time. That, in turn, will deepen investment confidence.
This is the key to solving climate change. It’s second only to eliminating fossil fuel subsidies.
Over the long term, applying $40 carbon prices to the world’s 40 billion tonnes of carbon emissions will generate $1.6 trillion per year. Coupled with $5.3 trillion of eliminated fossil fuel subsidies will yield $6.9 trillion a year for reinvestment.
That $6.9 trillion represents almost nine percent of the global economy. That money can be invested in low emission energy technologies and the infrastructure needed to distribute it. An ironclad price floor will anchor expectations, speeding the process.
This crucial price floor can be achieved one of two ways.
The first, now being implemented by the UK and Germany, involves creating one by administrative edict. In the case of the UK, that floor is now set at $US35. If traded prices fall below that, additional levies are applied. Germany has introduced a different kind of measure. It requires particularly dirty coal fired power plants to get more permits than other plants, driving up the cost of carbon for them.
The second involves allowing market administrators to withdraw permits from the market in times of price weakness to keep them above a specified minimum price.
At present, benchmark carbon prices in the European Union Emissions Trading System (EU ETS) hover around US$10 per tonne. Under the market’s current structure, reforms may have to wait as long as 2020. This could leave traded price weak for several more years. The EU, however, may enact reforms before then.
The goods news is that –– despite currently weak carbon prices and the consensus need for reform — carbon markets are achieving their aim. Surveys of future carbon price expectations point to a rough consensus of $20 per tonne across various markets by 2020.
Given that only about 6.8 billion of the world’s roughly 40 billion tonnes of annual carbon emissions are now priced either through carbon trading or a carbon tax, a consolidated $20 price implies a current global carbon market of $136 billion.
If all global carbon is eventually priced at $40 by 2040, and global carbon emissions remain stable over that time, the global carbon markets measured by value should expand by 10% per year between now and then.
During this period, one big challenge will lie in more deeply integrating fragmented carbon markets and enabling means of arbitrage between them in order to move toward a more global price.
For instance, carbon prices in North America vary widely from roughly $8 per tonne in the US Northeast market to around $12 in California. In China, fledgling carbon markets now price carbon at $6-8 per tonne.
Another challenge for global carbon markets is that only about eight percent of global carbon emissions are now priced. This number needs to grow dramatically. In addition, roughly 20% of global carbon emissions come from non-energy sources, like forestry and agriculture. These will need to be integrated over time.
In 2016, developments to watch will be potential changes to the EU ETS, as well as any announcement by China to set ‘price floors’ in any of its various markets.
China plans to officially start up on a national carbon market by the end of this year, although the start date may be pushed back to 2017. However, the initial scheme is only expected to cover about 1.1 billion of China’s roughly 8.7 billion tonnes of carbon emissions, or about 13% of national emissions. That’s only slightly below the roughly 17% of global emissions now subject to carbon pricing.
While chaotic at present, these market mechanisms will mature. Given this, there’s reason for hope. This is particularly so since the pace of innovation and change can be expected to accelerate as time goes on.