COP21 and carbon pricing: Is there a climate for change?

Later this month, global leaders will descend on Paris for the 21st Session of the Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC); more snappily COP21.

Will this meeting see a significant step forward for emissions reduction? Is the climate for change big enough to bring a global price for carbon?

Clearly a major aspect of these negotiations is around agreeing emissions targets and commitments. However, the perpetual challenge is how governments achieve those commitments. In particular, leaders will again be challenged to put a higher price on carbon. This means putting a financial cost on the release of greenhouse gases (primarily carbon dioxide) and/or a financial incentive on activities that either capture these gases or generate energy from “climate friendly” sources.

Sounds simple. In comparison to the tangled web of existing international tax legislation the OECD BEPS project has spent 2 years trying to straighten out (and I’m more than aware that there are still plenty on knots), surely pricing carbon must be simple.

Well, not quite.

There are 4 real options open to policy makers:

Carbon taxation – Impose a tax on those emitting carbon dioxide. In some cases these costs may be passed on to consumers to encourage behavioural change. By sending a transparent carbon price signal, consumers and producers are encouraged to reduce their emissions. 

Carbon trading scheme – Imposes a cap on the amount of carbon emissions in a given geographic region, with emissions under the scheme managed using a credit mechanism, allowing a market to form where those with excess credits sell them to those with too few. This has the advantage of setting a limited cap on emissions, but requires the market to be large enough for effective trading. There is also the political challenge associated with reducing the cap over time.

Incentives – Financial support in the form of subsidies/grants, tax incentives or other methods, designed to encourage behavioural change. They can be effective where specific, targeted behavioural changes are desired, and are particularly good at encouraging long-term investment in research or infrastructure.

Standards – The introduction of new rules for energy efficiency of buildings or vehicle emissions. Hmmm. Moving swiftly on…

Much has been written on the flaws in the EU Emissions Trading Scheme, launched in 2005 with the aim that it would be a $2 trillion global scheme by 2020.

Elsewhere, a carbon tax was introduced in Australia, only to be repealed soon afterwards. South Africa has spent several years slowly moving towards a carbon tax. There are some success stories from the USA and elsewhere, and clearly fuel duties are a common tax on carbon (even if they often pre-date the climate change debate and have been rebadged as green taxes more recently).

And although the UK government has this week committed to the phasing out of coal, Natalie Bennett, Leader of Green Party in England and Wales has been highly critical of the winding back of incentives for renewables. The global track record for pricing carbon is not looking that good.

So why are we seemingly still having the same discussion 10 or more years later?

Well, one reason appears to be that the climate change agenda took a back seat for several years during and after the global financial crisis. Although governments were keen to find new revenue sources (with taxes from company profits falling as the profits of those companies fell), the political momentum behind the climate change agenda was waning. Tackling tax avoidance and evasion was a much more politically valuable debate to be involved in.

However, the combination of ever increasing concerns about rising temperatures, sea levels, and the other effects of climate change, have brought this back onto the agenda, at least in some countries.

As Jonathan Grant, PwC Sustainability & Climate Change Director has put it, “If there's any silver bullet to tackle emissions growth, it's probably carbon pricing.”

Antoine Frérot, Chairman of French environmental services company Veolia recently pledged Veolia’s support for wide-scale deployment of a carbon tax. “COP 21 is a unique, potentially last chance, opportunity to cap global warming at 2 degrees Celsius. This can be best achieved through a carbon tax to be implemented on a large scale.”

Indeed, the six biggest U.S. banking institutions (JP Morgan Chase Bank, Bank of America Corp., Wells Fargo, and Citibank) have called for a “strong global climate agreement” and policies that “recognize the cost of carbon”.

Despite that, it would appear that we are unlikely to see this coming out of COP21. Christiana Figueres, executive secretary of UNFCCC has already admitted that COP21 will not come up with a global carbon price, saying that “life is much more complex than that”.

As Jim Yong Kim, President of the World Bank recent wrote, “The transition to a cleaner future will require both government action and the right incentives for the private sector. At the center should be a strong public policy that puts a price on carbon pollution. Placing a higher price on carbon-based fuels, electricity, and industrial activities will create incentives for the use of cleaner fuels, save energy, and promote a shift to greener investments.”

So we may not be about to see global solution to what is very clearly a global problem. But that doesn't mean we won't see a resurgence in national or regional environmental fiscal reform.

As with any new or expanded tax regime, it is vital to consider it as part of the overall tax collected by government and borne by taxpayers, and the balance of risk and reward between investor, company, government and society.

As well as keeping an eye on COP21, EU businesses should also be aware of the new Renewable Energy Directive on which the EU is consulting at the moment.

So what do companies need to be doing now?

• Engage with your businesses to understand how a price on carbon might impact on you, whether it is taxes or incentives. That might mean energy prices, supply chain risk, or perhaps a commercial opportunity.

• Develop a climate change policy, if you don’t have one.

• Build a carbon pricing policy on top of that, and understand your position in relation to the debate.

• Engage in the debate. Carbon pricing is not just an issue for energy companies.

Some while back we were saying "'tax' is where 'the environment' was 5 years ago". Perhaps now we should be saying "'the environment' is where 'tax' was 5 years ago".

The climate for change may not be sufficient to bring about a global price for carbon just yet, but COP21 will put pressure on governments to take the next step.

For more information contact Engaged Consulting here.

See here for an excellent summary of the previous climate change negotiations from the Rio Earth Summit in 1992 to COP20 in Peru last year.