Andrew Sentance Warwick University and Bank of England Climate Change Policy Seminar 15 May 2007 Putting a price on carbon emissions

Climate Change Policy Seminars Forum for discussing climate change research across University Cross-disciplinary, and with strong focus on policy implications Build a stronger research community and increase visibility of existing research Platform for external speakers

Outline Why price carbon emissions? How to price carbon emissions? Taxes vs emissions trading Developing carbon pricing Is carbon pricing enough? Key conclusions and issues

Stabilising the global climate Source: Stern Review

UK carbon emissions

Stern Review: Policies Carbon pricing Accelerating technological change Regulation, information and behaviour Adaptation International frameworks Cost-effective action

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Adam Smith, Wealth of Nations, 1776

Climate change as an externality Externalities are costs (benefits) imposed on others which those who create the costs (benefits) do not take into account The costs of climate change are potentially very large and irreversible but also uncertain Pricing carbon emissions aims to ensure these costs are reflected in the decisions firms and individuals take

Pricing emissions Regulation – command and control Taxation – influence prices directly; quantity adjustment uncertain Permits and trading – set quotas and allow markets to determine pricing Possible hybrids – eg trading within price bands

The efficiency of taxes and tradable allowances in the short term

The efficiency of taxes and tradable allowances in the long term

Taxes vs trading - economics Cost curve likely to be flatter over the long- term than in short-term Benefit curve may steepen sharply if climate change reaches critical level Trading likely to be more efficient over the longer-term In short-term, taxes may have a bigger role to play in establishing a price signal

Emissions trading - requirements Enforceable limits on emissions Robust accounting and administration Agreed mechanisms for distributing/allocating permits Transparent and liquid markets, including futures markets Participation of wide range of firms and sectors Confidence in long-term viability

Carbon pricing – policy issues Achieving consistent price signals across different activities Long-term price signal needed to stimulate technology and investment Wide international coverage strengthens the price signal Institutional frameworks Distributional issues

UK carbon “taxes” £/T of CO2, 2007 values

Carbon pricing in UK Uneven pricing across transport and other activities Uneven/inefficient pricing within transport (eg aviation, agriculture, public transport) Domestic and industrial energy “underpriced” Key issue is reconciling carbon pricing with other policy objectives, eg: –Cost of domestic energy for poorer households; –Competitiveness impact on business

Technical progress and emissions reductions

Long-term carbon price signals Price impact on investment and technical change is a key channel for climate change policy Outside private motor transport, price signals are still weak and short-term EU Emissions Trading Scheme has short time horizon and allocation rules are still uncertain Longer-term frameworks needed both nationally and internationally

Widening international scope Broader international coverage: –Strengthens price signal for development of low-carbon technologies –Reduces concerns about competitive impacts on industry of national/regional policies Emissions trading better suited to international co- operation than taxation Potential approaches: –Global governance of carbon markets under “Kyoto 2” agreement –Linking together national/regional schemes International agreements needed to underpin both approaches

Potential size of global carbon markets Extending EU ETS to power and industrial sectors in Top 20 countries would create a market of US$ bn

Lessons from Kyoto US support and involvement needed for a successful climate change agreement Stronger engagement from emerging nations also needed Longer term focus required to drive investment and technological change Lack of effective compliance mechanisms has weakened credibility of emissions caps More focus needed on developing delivery mechanisms – carbon markets and technology

Institutional frameworks Stronger policy frameworks needed both domestically and internationally to underpin efficient carbon pricing Compared to Kyoto, we need: –Longer-term focus –Better monitoring and compliance –Focus on actions/outcomes, not just targets –Better alignment with other policy objectives (eg development) Potential lessons from other policy frameworks? –International trade –Monetary policy –Development of international standards

Distributional issues Focus on pricing penalises countries with low per-capita emissions with large catch-up potential Potential solutions: –Link climate change policy to technology transfer and development aid –Tougher targets for richer countries, supported by robust trading system May also be distributional issues within countries, eg related to transport access and domestic energy prices

Technology: Is carbon pricing enough? Comprehensive global carbon markets will take time to develop Long-term carbon prices will depend on future policies which may be uncertain Long time horizons, uncertainty and risk also justify additional policies to support low- carbon technologies Technology support and carbon pricing are complementary, not alternatives

Conclusions Efficient carbon pricing now and into the future is a key mechanism for incentivising emissions reductions Current carbon pricing is very uneven across different activities, both nationally and internationally Emissions trading looks the most promising mechanism, but will take time to develop and gain credibility A long-term international framework is essential to underpin emissions trading Tax-based approaches could be made more attractive if coupled with incentives for developing and embodying new technology

Key issues Policy frameworks – national and international Consistency of pricing and alignment with other policy objectives Impact on technology and investment Robust accounting and administration to underpin emissions trading

What next? Buffet lunch served in S1.50 Future seminars: –Dr Peter Newell (Warwick): “Climate for Change – the politics of global warming”, Tue 22 May, 11.30am –Michael Grubb (Cambridge and Carbon Trust) “Lessons and evolution of EU Emissions Trading Scheme”, Fri 8 June, 3pm –Professor Brian Thomas (Warwick HRI), Tue 19 June, 11.30am (tbc) Continue in Autumn term, subject to demand. Suggestions for topics and speakers most welcome.