On Nov. 30, the world will descend on the deserts of Dubai for an annual climate summit with much fanfare, protest and policy. Debates will be held over fossil fuel phase-outs, building this novel loss and damage fund, and what our first global stocktake means for the Paris Agreement.
At COP28, the dueling “carbon pricing” and “carbon trading” will be thrown around in negotiation texts as case studies for the merit of market-based climate mechanisms. But as Earth continues to warm, the seas encroaching ever so slowly inland, the use of these programs will have to evolve and take on a new life, much like they have in the past.
By 1990, the ecosystems of the northeastern United States were severely degraded, with rocks weathering and forests shedding. More than 1,000 surveyed streams were found to be chronically acidic, a product of decades of acid rain fueled by extractive coal power plants. The region had been the U.S.’ economic engine, now hollowed by the dangerous, unknown impacts of unbridled nitrogen oxide and sulfur oxide emissions. Led by C. Boyden Gray, a lawyer in the Bush EPA, and rooted in neoclassical economics, the U.S. amended its monumental Clean Air Act to add a novel idea — a “cap-and-trade” system where emissions levels would be capped with allocated — and tradable — permits to pollute. The result was a 66% reduction in NOx levels and 94% reduction in SOx levels since 1980, saving billions in ecosystem services and improved quality of life. It was the first time a major environmental concern was mitigated through emissions trading, setting the stage for expansion around the globe.
The U.S.’ pioneering cap-and-trade system was effective for a number of reasons: its strong oversight, few point sources and streamlined trading systems. Most important, however, was its ability to reduce air pollution without slowing economic growth, without curbing emissions that warm our planet, a much more complicated task. To begin reducing carbon emissions, cap-and-trade needed to adapt.
Under the 1997 Kyoto Protocol, European nations took the lead in working toward a 5% global reduction in greenhouse gas emissions between 2008 and 2012, but needed to act unified. In 2003, the European Parliament passed a bill outlining a two-phased emissions trading scheme that initially gave freedom to member states before tightening rules and allowances. The mechanisms were simple: make nations purchase tradable allowances for a fee and penalize states that emitted past their share at a higher cost than an individual permit. This early version of carbon pricing was meant to realign national incentives to reduce emissions alongside a strengthening cap, with revenue generated from permit sales put toward sustainable investments.
The laws of supply and demand govern this scheme. As EUAs become more scarce, their price should grow, causing a more rapid shift toward renewables as polluters find it less economical to pollute than invest in clean energy. Interestingly, however, the price of a EUA cratered as the world fell into a global recession and optimism over a watershed climate accord froze in the Copenhagen winter. By December 2010, allocation prices had fallen 8.7% to just 12.40 euros, sustaining polluting activities across the continent. The shift challenged traditional ideas of how carbon was priced, beyond its literal impact on our planet, now seen as fully dependent on present economic and social conditions. To stimulate growth as Europe welcomed a new decade, leaders refused to tighten the cap, worrying allowance prices would become prohibitive and stem economic activity.
Although EUA prices rose again after the recession — now at more than 88 euros — policy momentum gathered for a different alternative: a true carbon pricing scheme to ensure incentives to turn green are maintained no matter fiscal and social conditions. An emissions trading scheme, in theory, controls the level of emissions reduced, but a price collapse like the one in Europe can reform economic signals and confuse markets. A stable, high price of carbon under a pricing scheme provides clear signals to the private sector about how to optimize profits, providing a strong economic green hand.
The prices for allowances under the EU carbon trading scheme cratered after 2009 and only recently began rising — a failure of the system to spur a green transition. Source: tradingeconomics.com
The benefit of a pure carbon pricing scheme — a tax — is its limited market impact and ability to generate revenues for governments to reinvest in clean energy or back to citizens directly. Many micro-level taxes have been implemented globally, from fuel taxes on every gallon of gasoline to nationwide CO2 taxes, which was implemented in France. These policies have raised the pain of polluting, making it economical to become green. The opposite of a carbon tax — a renewable credit — works within the market to lower the costs of renewable alternatives and was at the core of last year’s Inflation Reduction Act. Home and business owners now see investing in solar panels and greening their operations as cheaper, reducing the barrier of upfront switching costs.
It seems the world has turned a corner, readily adopting market-based policies — now mainly pricing schemes — to incentivize the private sector and citizens to curb their emissions. By June 2023, more than 61 jurisdictions had implemented more than 3000 environmental incentives covering 90% of global GDP. But as emissions continue to rise and the cost of climate change worsens, the future of carbon markets will be increasingly challenged. While they control how far emissions will be reduced — and at what prices — carbon markets fail to align the speed of reductions with the speed needed to maintain 1.5℃. Civil society and Indigenous groups stand against assigning nature a price, allowing it to be traded. It is in the Navajo people’s bahane (creation story) that the animals of the world were created first, meant to give life to human inhabitants as equals. They now advocate for an ethic that sees the trees, bats, birds and beetles on equal footing with humans. That human pricing of the natural world has forever altered the landscape, upsetting the balance between people and their planet.
Carbon pricing mechanisms have proliferated at both the local and national level, the preferred choice today to mitigate emissions. Source: EY Green Tax Tracker
The phoenix of carbon markets may need to be reborn again out of the ashes of an effective system incapable of meeting the climate demands of today. We began with carbon trading, concerned over lowering emissions, but failed to control its prices, its incentives, and ultimately its success. Carbon pricing has proliferated, providing stable incentives to businesses and homeowners, but has failed to curb emissions as quickly as our planet needs. May a solution lie within the market? Or may we step outside of it, mandating cuts with urgency and dive deep beyond a price tag on all that we can see?