Across the world, policy makers are evaluating strategies to mitigate climate change. The UN Climate Change Conference of the Parties (COP26) opened an opportunity for parties to the Paris Agreement to collaborate on achieving their shared goals. The direction of travel is becoming increasingly clear, so financial markets participants would be well advised to plan accordingly.
Discussions on carbon pricing mechanisms were on the agenda. The European Union, for example, has proposed that Carbon border taxes be applied to goods manufactured in countries with higher carbon footprints, aiming to force importers to confront some of the costs of Co2 emissions. This year, the Biden administration announced an interim update to the social cost of carbon, essentially restoring the values to what they were prior to the Trump administration. It is expected these values will be updated by early 2022 to reflect the latest science and economics.
Our Research analysts argue that efforts like these are essential to achieving the goals of the Paris Agreement. Only by attaching direct and explicit costs to greenhouse-gas emissions, will governments and companies incentivise changes in behaviour and investment in greener technologies and practices.
Here, our Research analysts highlight some of the most important carbon pricing mechanisms (CPMs) currently in play.
Carbon credit schemes
Carbon credit schemes evaluate investment projects on the basis of their emissions reduction, removal or avoidance. The EU, UK, California and a group of northeastern US states have mandatory carbon credit schemes in place today. Credits can be purchased by investing in green projects to offset carbon emissions, through recognised crediting mechanisms, or internationally through the likes of the Clean Development Mechanism developed under the Kyoto Protocol.
Voluntary carbon markets enable businesses, governments, non-profit organizations, and individuals to offset their emissions outside a regulatory regime, thus enabling companies to support decarbonisation beyond their own carbon footprint, and accelerating the broader transition to a lower-carbon future. This flexibility may accelerate adoption of such schemes. A range of private schemes in Brazil, for example, made the country the seventh largest seller of carbon credits in the world in 2019, while accounting for just 1% of global Co2 emissions.1
1"Como funciona o mercado de créditos de carbono no Brasil," Revista Exame, 11 February 2021.
Emissions trading systems
Emissions trading systems (ETSs) come in two main forms. In cap-and-trade systems, governments determine limits on greenhouse-gas emission volumes for entities covered by the scheme, and then auction off credits or allocate them. Under baseline-and-credit systems, entities with emissions above a certain level are required to surrender allowances, while emitters below their baseline receive credits for the reductions achieved. In both cases, credits can be sold to other market participants.
One advantage of such schemes is their dynamism: the European Commission, for example, which launched the world’s first international ETS in 2005, has proposed a gradual withdrawal of free allowances for the aviation sector and a move to full auctioning by 2027. Whatever the features, though, ETSs tend to drive in the same direction: providing long-term price signals for industry and power sectors, giving them a pathway to meet carbon reduction goals.
EU and UK ETS prices (Futures prices, EUR/tonnes)
Internal carbon pricing schemes
Internal schemes vary by design. Some businesses and organisations use “taxes,” applying them to all responsible units within the organisation on the basis of their Co2 emitted. Funds collected are then invested in low-carbon and energy-efficient technologies. Others adopt “shadow” carbon prices – normally linked to external sources such as the UK Green Book, the CDP-Carbon Pricing Corridors, or the EU-ETS – and then assign them to targeted investments, with the aim of incentivising energy-efficient investments. A third category of businesses uses “implicit” carbon prices to assess their footprints and to evaluate the economic costs of carbon-related regulations.
Such carbon pricing initiatives are on the rise. According to the Carbon Disclosure Project, an international non-profit, more than 2,000 companies representing over US$27tn in market capitalisation are currently using internal carbon pricing, or planning to do so within the next two years.
Growth of internal carbon pricing by region: 2018-2020
Figures show the number of companies operating in each region, using internal carbon pricing. Source: CDP April 2021 report: Putting a price on Carbon
Increasing use of carbon pricing mechanisms will likely create winners and losers, and could have profound effects on the prices of many goods and services, as well as stoking geopolitical uncertainties.
Our analysts see the success of COP26 hinging, in part, on developed countries fulfilling commitments to transfer financing and technologies to developing countries, for whom the costs of mitigation are likely to be especially acute.
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Marie Freier is Global Head of Cross Asset ESG Research at Barclays. Marie leads the integration of ESG into Barclays fundamental research products, driving collaboration and a coherent and consistent approach across regions and asset classes. Marie and her team of dedicated ESG subject matter experts support credit and equity analysts in assessing how ESG attributes affect financial risks and valuations across sectors and companies, ultimately driving security pricing. Marie joined Barclays from Sanford C. Bernstein, where she served as Head of European Product Management and, most recently, as both co-Head of European Sales and Global Head of ESG, spending more than 13 years at the firm. She previously worked for Aon and Willis Re, now part of Willis Tower Watson. Marie holds an M.A. in Mental Philosophy from the University of Edinburgh.
Francois Cabau is a Director and Senior European Economist based in London. He is responsible for macroeconomic coverage for France and Greece. He also oversees the analysis and forecasting of the euro area’s business cycle. Mr Cabau joined Barclays in 2010 from Société Générale, where he was a research associate within the Global Economics Research team from 2007. Mr Cabau graduated with an MSc in International Economics from Dauphine University.
Fabrice Montagné is Chief UK Economist at Barclays. Previously, he was a senior European economist responsible for French, Greek and euro area macroeconomics. Mr. Montagné joined Barclays in January 2012 from the Dutch Central Bank where he was responsible for balance sheet, asset/liability management and strategic asset allocation decisions in the Financial Market division. Prior to that, he worked at the French Treasury and Fonds de Reserves pour les Retraites. Mr. Montagné graduated from Ecole Polytechnique, has an MSc in Economics and Statistics from ENSAE, and an MSc in Economic Analysis and Policy from the Paris School of Economics.
Shawn PM Golhar is a Managing Director and the Head of Public Policy Research at Barclays. Shawn analyses and publishes commentary on major public policy issues, as well as advises the firm’s global institutional investor and corporate client base. Shawn works with the firm’s investment banking teams, particularly the Sustainable Banking Group, to help corporate clients understand the impact of public policy issues. Shawn also serves on the boards of BOMANI Cold Buzz and the Millennial Action Project, is a member of the Council on Foreign Relations, is a Truman National Security Fellow, and serves as an advisor to start-ups in the Barclays Accelerator. Active in the community, Shawn was awarded the Barclays Global Citizenship Award and co-founded America Needs You, a non-profit that provides economic mobility for ambitious, first-generation college students through transformative mentorship and intensive career development for hundreds of students each year across four regions. Previously at Barclays, Shawn developed and led client outreach in the Public Policy Group in New York and Washington, DC, and was a public finance investment banker in California, where he worked on nearly $30 billion of senior and co-senior managed deals. He began his career as a consultant with Deloitte & Touche LLP. In addition, Shawn volunteered for over a decade with a civics education non-profit (IDIA), ultimately serving as the chairman, and was an advisor to Global PACT International, Inc., an international activism non-profit with programs in Europe, Asia, Africa, and South America. Shawn co-founded Global PACT while teaching their inaugural programs in Mongolia (2002) and Croatia (2004). He completed his undergraduate studies at Rutgers University and the London School of Economics and received his Master’s degree in Public Policy from the Harvard Kennedy School. Shawn is a frequent contributor to Bloomberg, CNBC, and other media outlets.