Putting Price on Emissions: Why Carbon Credits are in Focus at COP28?

At COP28, the global focus on the stocktake underscores the stark reality that business-as-usual falls short in reducing greenhouse gas emissions adequately. Many nations grapple with the dilemma of choosing between both short- and long-term financial stability and the long-term health of the planet, exacerbated by constrained public finances and prolonged periods of elevated interest rates.

The dilemma is intensified by the fact that the impact of climate change is more visible than ever. Extreme weather patterns and losing land due to rising sea levels have told the story of climate change like never before.

Against this backdrop, an increasing number of countries are turning to carbon pricing as a strategic tool to meet financing need to meet its climate objectives. The fundamental idea is straightforward: impose a cost on polluters based on their emissions, creating a powerful incentive for them to adopt cleaner practices. This approach can manifest as a tax or an emissions trading scheme (ETS), compelling companies to acquire tradable offsets  for their emissions.

COP28 hosted a High-Level Roundtable on ‘Unlocking High-Integrity Carbon Markets,’ bringing together global leaders and institutions. Speakers emphasized the crucial role of carbon pricing schemes, compliance markets, and voluntary carbon markets (VCMs) in the net-zero transition.

The progress made by the Article 6.4 supervisory body and plans for the growth of global carbon markets, particularly in preserving forests, were highlighted. While acknowledging achievements in establishing guardrails for high-integrity credit supply, participants stressed ongoing capacity building and coordinated action among stakeholders for a cohesive global carbon market architecture by 2024-2025. This marked a significant stride towards effective climate mitigation.

Carbon Pricing

Carbon pricing, a pivotal tool in the fight against climate change, involves placing a monetary value on greenhouse gas emissions. The fundamental idea is to make industries and businesses accountable for the carbon dioxide they release into the atmosphere, turning environmental costs into a financial responsibility.

In essence, carbon pricing operates through mechanisms like carbon taxes or cap-and-trade systems. Carbon taxes set a direct price on each ton of emitted carbon, encouraging companies to reduce emissions to cut costs. On the other hand, cap-and-trade establishes a maximum limit (cap) on overall emissions, with companies buying or selling offsets to stay within this cap.

As countries grapple with the urgent need for emission reductions, carbon pricing emerges as a strategic solution, aligning economic incentives with environmental stewardship.

Why is Carbon Credit in focus at COP28?

The Appeal:

Carbon credit is emerging as a preferred choice for industries and governments across the world to offset their emissions. Carbon pricing’s appeal is rooted in three pivotal factors.

It proves effective as the centerpiece of a comprehensive emission reduction strategy, providing incentives for a transition to cleaner energy, decreased overall energy consumption, and increased investment in clean technology. Notably, sectors covered by the EU’s Emissions Trading System have witnessed a substantial 37% decline in emissions since 2005.

Carbon credit stands out as the most cost-efficient solution. Administering carbon pricing, especially when built on existing energy fuel taxes, minimizes administrative complexities. The EU scheme alone has generated revenues exceeding €175bn, turning the green transition into a financially sustainable endeavor. These funds can be directed towards tax reduction, funding public services, or developing clean energy infrastructure. Importantly, carbon pricing’s scalability over time mitigates abrupt disruptions.

Thirdly, with thoughtful design, carbon pricing ensures fairness. The principle is simple: those entities responsible for higher emissions bear a greater financial burden. This not only addresses any distributional concerns within and across countries but also provides a mechanism for managing these implications effectively.

The Reach

Domestically, the price impact on poor households can be offset with only a small portion of carbon tax income. According to the IMF, approximately 20% of these are required to compensate the poorest 30% of households, making the reform work for vulnerable consumers and small emitters.

Globally, revenues from carbon pricing can contribute to climate finance for developing nations, addressing equity concerns. Differentiated carbon price floors and net-zero trajectories aligned with countries’ historical emission-footprints offer additional fairness measures. African leaders have recently advocated for a comprehensive global carbon taxation regime encompassing fossil fuel trade, maritime transport, and aviation, with generated revenues directed towards climate investments in less affluent countries.

The momentum is evident, with 73 carbon pricing schemes in nearly 50 countries, covering a quarter of emissions—a doubling since the signing of the Paris Agreement in 2015. However, achieving emission reduction goals necessitates a significant increase in the global carbon price, reaching an average of $85 per tonne by 2030, a substantial leap from the current $5.

The Obstacle

Despite the numerous benefits of carbon markets, their wider adoption faces obstacles, with political will often cited as a primary challenge. The initial step into implementing carbon markets can be politically sensitive, requiring commitment and collaboration from various stakeholders. However, once initiated, countries often experience steady progress as the benefits become evident.

Another impediment to widespread adoption is the intricate nature of climate policy and the need for international cooperation. Negotiating and aligning policies among nations can be a complex process. Additionally, concerns about the distributional impact of carbon pricing may arise, with policymakers navigating ways to ensure fairness, especially for vulnerable populations.

Both factors are inter-related, which is why COP28 becomes a milestone amid the geopolitical storm and climate emergency more evident than ever.

COP28 – A Turning Point for Carbon Markets

Raising awareness and garnering support for carbon markets is crucial. Demonstrating the tangible outcomes, such as using revenues to enhance public investments or reduce other taxes, can build popular backing for these initiatives.

For a successful global transition towards carbon pricing, COP28 holds the key to establishing a robust benchmark for international cooperation in carbon markets. The coordination of efforts is essential to manage compliance costs, particularly for smaller companies in developing nations.

A widespread adoption of carbon pricing across countries can mitigate trade frictions and enhance competitiveness. The Paris Agreement provides a framework for exchanging carbon credits among nations moving at different speeds, but effective operation necessitates more ambitious climate goals and clear, credible standards. COP28 is an opportunity to ensure transparent carbon pricing as a tool for emission reduction, steering away from business-as-usual practices that fall short of preventing catastrophic consequences. The fair pricing of pollution is imperative for the future, aligning with global trade goals and securing a sustainable environment for generations to come.