Determining a Carbon Price

The price of carbon in a tax or emissions trading system (ETS) drives the level of greenhouse gas (GHG) abatement – the more expensive it is to emit, the more emissions will be reduced.

One approach to pricing is to assign a  ‘social cost of carbon’, an economic estimate of the damages associated with emitting one additional ton of carbon. The Biden Administration recently put the social cost of carbon at $200/ton. But there is not a clear consensus as to what this price is or should be. As calculating the social cost of carbon gives such a wide price-range, this can be of limited use to policy makers setting specific CO2 prices.

Estimating the carbon prices necessary to reduce emissions in line with net zero targets and allocated carbon budgets avoids some of this uncertainty. In its 2017 report, the High-Level Commission on Carbon Prices recommended direct carbon price levels of at least $50-$100 per tCO2e (in 2017 USD) by 2030 to limit global warming to 2°C.  The IMF recently suggested that a global average carbon price of at least $85 per ton by 2030 is needed to stay on track with the goals of the Paris Agreement.

Taking emissions trading as an example, under a targets-based approach a government would seek to influence the market price of carbon through the issuing of allowance permits. The total number of allowances issued over time would align with the amount of CO2 emissions permissible under its national climate targets. To ensure that emissive practices become progressively less viable, the price of carbon will normally increase over time through reducing the supply of allowances.