Setting a market price for carbon

Setting a market price for carbon

Unchecked, energy use and hence emission levels are predicted to keep rising over time. Thus the number of companies needing to buy credits will increase, and the rules of supply and demand will push up the market price, encouraging more groups to undertake environmentally friendly activities that create carbon credits to sell.

An individual allowance, such as an Assigned amount unit (AAU) or its near-equivalent European Union Allowance (EUA), may have a different market value to an offset such as a CER. This is due to the lack of a developed secondary market for CERs, a lack of homogeneity between projects which causes difficulty in pricing, as well as questions due to the principle of supplementarity and its lifetime. Additionally, offsets generated by a carbon project under the Clean Development Mechanism are potentially limited in value because operators in the EU ETS are restricted as to what percentage of their allowance can be met through these flexible mechanisms.

Yale University economics professor William Nordhaus argues that the price of carbon needs to be high enough to motivate the changes in behavior and changes in economic production systems necessary to effectively limit emissions of greenhouse gases.

Raising the price of carbon will achieve four goals. First, it will provide signals to consumers about what goods and services are high-carbon ones and should therefore be used more sparingly. Second, it will provide signals to producers about which inputs use more carbon (such as coal and oil) and which use less or none (such as natural gas or nuclear power), thereby inducing firms to substitute low-carbon inputs. Third, it will give market incentives for inventors and innovators to develop and introduce low-carbon products and processes that can replace the current generation of technologies. Fourth, and most important, a high carbon price will economize on the information that is required to do all three of these tasks. Through the market mechanism, a high carbon price will raise the price of products according to their carbon content. Ethical consumers today, hoping to minimize their "carbon footprint," have little chance of making an accurate calculation of the relative carbon use in, say, driving 250 miles as compared with flying 250 miles. A harmonized carbon tax would raise the price of a good proportionately to exactly the amount of CO₂ that is emitted in all the stages of production that are involved in producing that good. If 0.01 of a ton of carbon emissions results from the wheat growing and the milling and the trucking and the baking of a loaf of bread, then a tax of $30 per ton carbon will raise the price of bread by $0.30. The "carbon footprint" is automatically calculated by the price system. Consumers would still not know how much of the price is due to carbon emissions, but they could make their decisions confident that they are paying for the social cost of their carbon footprint.^[20]

Nordhaus has suggested, based on the social cost of carbon emissions, that an optimal price of carbon is around $30(US) per ton and will need to increase with inflation.

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