As the 21st century unfolds, climate change stands as a defining threat to global economies. The current generation is experiencing its consequences firsthand, despite decades of international efforts to address the issue. These efforts have included multilateral summits, intergovernmental conferences, protocols, and agreements, most recently embodied by the COP (Conference of the Parties) and the Paris Agreement. One such event is UN Climate Summit COP 26 in Glasgow, where Prime Minister Narendra Modi had announced that India would achieve the net zero emission target by 2070. It’s a cumbersome task as India is the third largest emitter of greenhouse gasses after China and the US and  would require some real action on the ground to achieve the target. Policies will play a crucial role in initiating the transition. One such policy intervention to address the issue is Carbon Pricing.

Wondering what carbon pricing really entails? Here’s a brief.

Carbon pricing is a market-based strategy that aims to reduce greenhouse gas emissions by putting a monetary value on carbon emissions. About 23% of global greenhouse gas emissions were covered by a direct carbon pricing regime as of 2023, almost double the 13% coverage in 2020.

Why Do We Need Carbon Pricing System?

To limit warming to 1.5 degrees Celsius, the global average price for carbon would need to rise to at least $170/tCO2e by 2030.The world’s direct carbon price averaged about $23/tCO2e as of 2023. At current emission levels, the Indian economy loses USD 210 annually, the country level SCC for India alone is USD 86 per ton of CO2. These concealed expenses reign a toll on economies, manifesting in unprecedented challenges such as escalating food prices, agricultural failures, resource conflicts, forest fires, natural disasters, and extreme weather events.

What Should Be Our Approach To Carbon Pricing?

1. In a ‘cap and trade’ system the carbon price changes over time. A maximum level of pollution (a ‘cap’) is defined and manufacturers need licenses to emit carbon. How expensive these licenses are is determined by a trading system. The price of a license increases as emissions approach the cap.
2. A carbon tax is simply a levy that is applied to all goods and services which lead to carbon emissions in their production. Carbon taxes are a type of Pigouvian tax. Governments set a price per ton of carbon dioxide emissions, usually determined by the social cost of carbon, which reflects the environmental and economic damages caused by each ton of CO2 emitted.   

What Is The Global Scenario?

The European Union’s Emission Trading Scheme (EU ETS) is a cap-and-trade system aimed at reducing greenhouse gas emissions. Currently, there are 36 ETSs in force around the world. By late 2023, the global carbon permit market reached $950 billion, with EU ETS accounting for 87%. The program, now in its fourth phase, sets emission limits that decrease over time towards net zero. 

Companies receive allowances to emit CO2, which they can trade. Each allowance permits the emission of one ton of CO2. The EU’s carbon border adjustment mechanism (CBAM) is expected to significantly impact India’s exports, especially in industries like steel, by increasing costs. To mitigate these effects and maintain international competitiveness, India is in need of setting-up a carbon market through its Carbon Credit Trading Scheme (CCTS), aligning with global carbon pricing norms.

Sweden’s Polluters Pay Principle

Sweden is often depicted as a pioneer in environmental and climate governance, hailed as a success for being effective in reducing carbon emissions while decoupling continued economic growth from national emissions. The carbon tax was introduced in 1991 at a rate corresponding to SEK 250 (EUR 25) per ton of fossil carbon dioxide emitted, and has gradually been increased to SEK 1 330 (EUR 122) in 2023. Since its introduction in 1991, the tax has been raised and redesigned step by step. The costs of pollution are borne by those who cause it. This ensures that emissions are reduced in the most cost-effective way, while stimulating the development and deployment of new, clean technologies.

What Are Some Lessons for India? 

The West being at the forefront of Emission reduction practices through Carbon markets, India needs to kick start its indigenous market. With the recent notification from the Ministry of Power in June 2023 on the Carbon Credit Trading Scheme (CCTS), India has signaled its intent to establish a carbon market. As we embark on this journey with hopeful anticipation and cautious optimism, it is crucial for India to learn from the experiences of others. A critical lesson emerges: restricting the number of offsets allowed to a small share of the compliance market. It is imperative to implement robust monitoring, reporting, and verification policies to ensure that carbon offsets deliver genuine, additional, measurable, verifiable, unique, and permanent reductions in greenhouse gas emissions. Recent scandals underscore the importance of conducting regular audits to uphold the integrity of carbon credits. By heeding these lessons, India can pave a path towards a credible and effective carbon market, aligning environmental goals with sustainable economic development.

What Is The Influence Of Carbon Pricing On Choice?

Carbon pricing changes the relative prices between carbon-intensive and low-carbon intensive products and this changes consumption choices towards a low-carbon lifestyle: Carbon prices make it more likely that we rely on low-carbon electricity rather than fossil fuels, that we take the bicycle rather than the car, that we buy the smaller car rather than the bigger one. The incentive for consumers and entrepreneurs is to reduce their emissions whenever doing so costs them less than paying the carbon price.

The Law of Demand – if the price of something goes up, consumption goes down – also holds in this case. Places that have implemented a substantial carbon price are achieving the intended effect, the consumption of carbon-intensive products declines and emissions fall.

Conclusion

The reason our societies are powered by fossil fuels is that they provide energy at the cheapest monetary price. If we want to transition away from fossil fuels and build a world that is powered by their alternatives we can rely on the price mechanism as well.

What makes carbon pricing so powerful is that it is a policy that changes the entire system. No decision about any carbon-intensive activity escapes its influence: it changes the choices of consumers, producers, investors, entrepreneurs and innovators in all relevant sectors at once. Also, we need to make sure we do not limit ourselves to a single policy, we also need to diversify our arsenal for fight against climate change and achieving net zero by R&D, policy intervention, and awareness. 

Learning from the challenges faced by other countries, even if circumstances were different, could also help India implement an effective and credible institutional structure for its carbon market that will complement the country’s broader decarbonization strategy.