Tackling Climate Change with a Robust Carbon Price

Even as the first generation of the carbon market stutters, a robust price on carbon has never been more important if we are to avert dangerous climate change.  

Current greenhouse gas emission pledges place the world on a trajectory for warming of well over 2°C, even if they are fully met. We know now that the goal adopted by the international community, to keep the average global temperature increase to 2° C – brings serious risks. A disastrously warming planet is not just an environmental challenge – it is a fundamental threat to any effort to end poverty and threatens to put prosperity out of the reach of millions.

In order to better understand the impact of climate change on development, the World Bank commissioned a scientific report, Turn Down the Heat: Why a 4°C Warmer World Must Be Avoided.  The report concluded that the world will warm by 4°C, on average, by the end of this century with devastating consequences if we don’t take concerted action now.

Inside the World Bank Group, we are stepping up our mitigation, adaptation and disaster risk management work, and immediately ramping up our work with others to:

i) build low-carbon, climate-resilient cities by mobilising direct finance and expertise, and by helping fast-growing cities avoid locking in carbon-intensive infrastructure;

ii) move forward on climate-smart agriculture through building an action alliance to realise the triple win of increased yields and income, making farms more resilient to climate change, and helping to sequester carbon in the soil; and

iii) work with others to accelerate energy efficiency, investment in renewables and universal access to modern energy.

But we recognise that our work, alone, is not enough. We need a global response that will drive mitigation action in top emitting countries, get incentives and prices right, and get finance flowing to drive low-carbon growth. We need a response equal to the scale of the climate problem, a response that puts us on a new path to ending poverty and building shared prosperity. 

In our view, that global response should include supporting the removal of harmful fossil fuel subsidies and placing a robust and predictable value on carbon. We are committed to continue working with others to pursue both ideas.

Carbon pricing 

Let’s be clear: as a first step towards climate action, we need high-level political commitment and ambitious national emission reduction targets. 

A strong price signal in major economies is essential to establish the right incentives and to direct financial flows away from carbon-intensive growth to low-carbon investments.

A carbon price can be achieved through markets or taxes, and different instruments will be appropriate in different countries for different sectors of the economy.  But market-based mechanisms are likely to deliver large-scale emission reductions more efficiently and quickly – and with the climate problem, time is not our friend.

A larger and liquid global market will also support the necessary level of ambition for reducing emissions as it would drive down the cost of mitigation, catalyse innovation and mobilise investment in low-carbon technology worldwide.   

Working towards global carbon trading

The good news is that an increasing number of countries, provinces and cities around the globe are developing and building schemes to reduce emissions and trade the resulting carbon reductions.  

Supporting national or subnational governments to put in place these mechanisms must be a priority. Many will want to participate in some level of trading across markets and  some are already entering into formal bilateral negotiations to that effect. Adoption of common approaches and frameworks will facilitate linking and significant efforts to share experience and ideas are ongoing. However, recognising that countries will choose the most appropriate approach for their national circumstances and that the result is likely to be some level of heterogeneity across markets, a flexible approach is needed. We need an approach that recognises and accommodates differences across counties and that will support efficient trading across current and yet-to-emerge heterogeneous domestic and regional carbon markets and a range of asset types. 

As these developments unfold, we believe it is worth exploring  the idea of a globally-networked carbon market with: pricing and exchange rates to support fungibility across asset classes; a reserve carbon “currency” for conversion and trading of emission reduction assets; and services and institutions to support a market of global scale.  Of course, the principle of environmental integrity would need to underpin any effort of this sort.

Possible elements could include independent carbon asset rating systems to provide information to the market and domestic regulators on relative risk and environmental integrity or an International Carbon Reserve supporting, as needed, domestic and regional reserves to help avoid extreme price swings. It could have a clearing-house function to establish exchange rates and possibly act as market-maker for new assets. It could also oversee a cross-border settlement platform to track cross-border trades and holdings of various carbon asset classes.

But there are those who doubt that any form of carbon market could still work. What gives us confidence is the level of innovation in countries exploring domestic market mechanisms. There is evidence that carbon pricing can work if it is flexible and aligned with national policy initiatives, in particular economic priorities.

While prices in major existing carbon markets like the EU Emissions Trading System flounder, many new national carbon pricing initiatives are emerging. And, not surprisingly, among the new carbon pricing initiatives, many include design features to manage extreme price volatility. 

The Partnership for Market Readiness  

In March, the Bank hosted a meeting of the Partnership for Market Readiness (PMR) – a growing coalition of over 30 developed and developing countries working on various solutions to carbon pricing. The World Bank acts as secretariat, trustee and principle delivery partner for the initiative.  We are seeing more and more countries taking innovative domestic action.

China is showing extraordinary leadership in this field. China’s seven pilot programmes – capturing between them five cities and two provinces with a total population of 246 million and accounting for a cumulative GDP of $1.6 trillion – are planned to launch this year.  Shenzhen will launch its pilot in June 2013; Beijing and Shanghai will follow shortly thereafter.  These pilots will pave the way for establishing a national carbon market, and China is already looking ahead to how it might link its ETS with others.

The PMR is also supporting Chile, which is putting in place the necessary building blocks for an emissions trading system in its energy sector, including building a greenhouse gas registry system to track emission permits.

South Africa is spearheading a carbon tax, which will be implemented in 2015. The design of the system includes a carbon offset scheme that helps companies meet their liabilities.

Outside of the PMR, South Korea is preparing the first phase of its ETS, to start in 2015. And in California, compliance obligations came into force at the start of this year for its cap-and-trade programme which, when it expands in 2015 to fuel providers, will cover 85% of the state’s emissions.

Innovation generating action

It is progress at the country level that gives hope – the innovation, energy and farsightedness among the people developing these national and sub-national systems that convinces us at the World Bank that carbon pricing is emerging and carbon markets have a future.

We hope to jumpstart a fresh debate.  We don’t know if these are the right answers, and they are certainly not the only answers, but we do know that we need to work with everyone – policy-makers, the private sector and civil society – to develop our ideas, learn from others, and together decide how best we can move ahead on catalysing stronger political ambition and translating ambition into robust, predictable carbon prices.

At the World Bank Group, we will continue to support innovation and offer technical analysis to countries as they explore their carbon options, and investigate mechanisms that can bring markets to a scale commensurate with the challenges we face.

We cannot afford to fail in our efforts to limit climate change.