Why putting a price on carbon is becoming a business and economic reality.

PwC was among the businesses who signed the World Bank’s call to governments and business leaders to support putting a price on carbon. Jonathan Grant, director, PwC sustainability & climate change outlines the implications.

Finance was at the heart of the UN climate summit in New York this week. Indeed Ban Ki-moon’s action plans on cities, industry, energy, forests and agriculture all depend on it.  And it is widely agreed that the best way to mobilise the finance needed is by having a carbon price. 

At the Summit, the World Bank published details of governments and companies, including PwC, who expressed support for putting a price on carbon.  The 73 countries and 22 states, provinces and cities are together responsible for over half of global greenhouse gas emissions and 52 % of GDP. They were joined by over 1,000 businesses and investors across industry, energy and transportation, and institutional investors with more than $24 trillion in assets.

As the World Bank reminded us, there is no need to appeal to economic theory or mention internalising externalities.  The Bank said businesses see that carbon pricing is the most efficient and cost effective means of reducing emissions.

Working with CDP last year, we found that over 100 companies use carbon pricing to help them assess risks to their operations and new investments.  In a special report on carbon pricing published last week, CDP show this has risen to 150 major companies and highlight the rationale and prices used by some of them.

The focus on carbon pricing is great, and demonstrates the economic and business realities of the transition to a low carbon economy. But to many in the world of climate and energy policy and business, the level of attention the announcement got at the UN Summit may be a surprise.  Many in the business community were calling for it in the lead up to Kyoto in the nineties.  Having a price is the most obvious and direct way to force (or allow) companies to consider carbon in their investment decisions and consumers to think about it in their purchasing decisions.

And of course many companies have been participating in emissions trading schemes – such as the EU ETS which has been around since 2005 – or subject to carbon taxes for years.  Over the past year, carbon markets, and carbon pricing more broadly, have seen a number of steps forward. The Republic of Korea is set to launch the world’s second-largest carbon market in January 2015. Mexico has introduced a limited carbon tax, and Chile and South Africa have signalled their intention to do the same in the next few years. Indeed, many respondents (83%) to our recent carbon markets survey  think a global climate deal signed in Paris in 2015 will set the stage for national governments to create or link carbon markets. Four out of five believe China is likely to implement national carbon pricing following the ETS pilots it is currently running.

For companies covered by emissions trading, including a carbon price (or perhaps low, mid and high prices) in their big investment decisions should be routine. It helps teams assess the profitability of their projects in different scenarios and consider alternative mitigation options.  

But the current price of an EU carbon allowance is around €6 and the price of a CDM credit is €0.13.  So the mechanism is in place but the prices at these levels do almost nothing to incentivise low carbon investment or penalise higher carbon emissions. 

As an alternative, many companies use an ‘internal’ or ‘shadow’ carbon price in their investment decisions.  Some have disclosed these publicly.  BP uses $40/tCO2, Google uses $14/tCO2, Mars uses $20-30/tCO2 and Microsoft use $6-7/tCO2. 

As Rachel Kyte of the World Bank said earlier this week, having a carbon price is necessary but not sufficient.  The carbon price needs to be high enough to send a meaningful signal to investors and consumers. 

While the World Bank call is encouraging to galvanise support and profile around the issues of carbon pricing, it says little on what that price should be and is neutral on the mechanism to achieve it, whether a tax or a trading programme.  The price is critical because that it acts simply as an incentive to manage and reduce emissions, and incentivises long term investment in lower carbon options.

For an indication of what that level might be, we asked the members of the International Emissions Trading Association – experienced as they are in the roller coaster ride of the carbon markets in the EU and elsewhere – what carbon price is necessary to drive low carbon investment in line with a 2 degrees target.  The average price suggested was €47 – eight times its current level.  If governments and companies in New York this week were to operate on the basis of a carbon price at this level, then we would really see climate finance starting to flow.

Make no mistake, the signature of nations and companies to this commitment is significant. But like so many of the jigsaw parts that make up a global deal on climate change, turning aspiration into action has a distance to go on the road to the deal in Paris 2015.

Follow PwC’s updates on climate change and sustainable development @pwcclimateready. For more information on the World Bank Group Carbon Pricing initiative, visit: http://www.worldbank.org/en/programs/pricing-carbon.