Countries Are Signing Up for Sizeable Carbon Prices

IMF Blog, April 21, 2016

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With global leaders set to start signing the Paris Agreement on climate change on April 22 (Earth Day), countries will face the issue of setting prices for greenhouse gas emissions, most importantly carbon dioxide (CO2).
Back-of-the-envelope calculations indicate most large emitters will need to charge anywhere from $50 to $100 per ton or more (in current prices) by 2030 to meet their commitments to reduce carbon emissions.
Example impacts of such carbon prices:
- A $50 per ton CO2 charge would add $0.12 cents per litre to the pump price for gasoline.
- It would almost triple world coal prices.
A typical national commitment is to cut greenhouse gas emissions by around 30 percent by 2030 relative to emissions in some baseline year.
Not all countries need the same price level; for example, prices needed in Russia are lower because Russia’s emissions have already fallen substantially relative to 1990, the benchmark year for its emissions pledge.
Currently only 12 percent of global emissions are covered by pricing systems and typically with prices below $10 per ton.

Potential revenues from carbon pricing at the indicated price levels are typically well above 1 percent of GDP.
These large revenues could allow substantial cuts in burdensome taxes on labor and capital.
Fiscal and domestic health benefits (from cleaner air) can be substantial even before counting benefits for the global climate.

Step 1: Project a country’s future use of coal, natural gas, and petroleum products in the absence of new mitigation policies to determine ‘business as usual’ (BAU) CO2 emissions. This projection depends on:
- income growth,
- trends in energy efficiency,
- possible shifts in the future fuel mix from technological and price changes.
Step 2: Infer the relation between CO2 prices and emissions using assumptions about the responsiveness of fuel use to CO2 pricing, drawing on a large empirical literature about fuel price responses.

There is substantial uncertainty in price estimates; countries need transparent and predictable rules for periodically adjusting CO2 pricing trajectories if energy systems evolve in unexpected ways.
Emissions prices should be phased in progressively to allow firms and households time to adjust and to limit risks of scrapping existing capital well before the end of its useful life.
- Illustrative example: a country requiring an estimated CO2 price of $75 per ton by 2030 might plan to increase the emissions price by $5 per ton each year starting this year.

There is growing recognition among policymakers, business, and finance that CO2 reduction pledges are best met through a robust and predictable emissions price.
The Paris Agreement creates peer pressure on governments to demonstrate progress, which could create important momentum for adopting carbon pricing.

Source: Ian Parry, April 21, 2016.

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