Back to black - putting a price on climate change

Three months on from President Trump’s announcement of the US withdrawal from the Paris Climate Accord, progress in carbon markets points to renewed global resolve to tackle the challenge. We expect that progress will be reflected in part by the continued march towards placing a financial cost on carbon emissions through trading schemes and taxes¹. Carbon trading schemes are a cornerstone of climate policy and are spreading to cover more of the world’s emissions, while many of those already up and running are becoming more onerous.

Carbon pricing is one of the most important ways climate change will impact industries, businesses and investments. Price rises on the scale needed to meet long term climate goals will reshape industry cost structures, opening competitive opportunities for better placed companies.  We explored those impacts in our recent Carbon VAR report.

China is forging ahead with a scheme which will cover close to 10% of the world’s greenhouse gas (GHG) emissions². Whether it will initially cover the full range of 7-8 billion tonnes originally envisaged, or start with specific industries, remains unclear. However, even the 3.7 billion tonnes footprint of the country’s power sector would dwarf the 1.7 billion tonnes covered by the EU scheme.

In the US, the nine States behind the Regional Greenhouse Gas Initiative said in August that they plan to deepen cuts in carbon emissions to a 30% reduction between 2021 and 2030. As a State-led initiative, the scheme is relatively insulated from Federal decisions.

In Europe, which launched the largest scheme in 2005 but has struggled with excess supply of credits, politicians are working on tougher rules for phase IV of that scheme, which will start in 2020. In early September, France and Germany issued a joint press release stating they want an agreement on the European Emissions Trading System ahead of the UN-organised climate conference in Bonn in November. Our European Utilities analyst believes those negotiations are shaping up to deliver meaningful reform in the scheme, which will be supportive of significantly higher carbon prices. In particular the Council of Ministers’ proposals to reform the Market Stability Reserve are expected to reduce oversupply much more quickly than previously anticipated.

The next few months are likely to provide an important signal to the future of global climate policy and the strength of carbon pricing. Predictably, politics is a fraught exercise but the early signals are looking positive.

Source: Schroders, World Bank, March 2017

^{1. Carbon trading schemes limit the total emissions of participating companies and allow businesses to buy and sell emissions at prevailing market prices. Carbon taxes are simpler but considered less economically efficient: they impose a penalty proportionate to the emissions companies produce. Both have the effect of creating a financial penalty for emitting greenhouse gases.↩}

^{2. That scheme is currently scheduled to come into force in November 2017, although recent press reports indicate full implementation may begin in 2018.↩}