Carbon pricing – tool for implementing climate targets

Carbon pricing is a key element of a sustainable global climate solution. The more market driven the mechanism is, the better.

According to The Confederation of Finnish Industries (EK), the aim of the Paris climate negotiations (COP21) needs to be a global, legally-binding, ambitious and balanced climate agreement that has a significant impact on reducing emissions.

Once the reduction targets are set, we need mechanisms which enable to implement them in practice. For that end, EK is strongly advocates carbon pricing.

Carbon pricing on a global scale

Through carbon pricing, the emitter (a consumer or a company) pays a price for the carbon dioxide emissions. This encourages the emitter to reduce emissions, for example by increasing energy efficiency and the use of renewable energy.

Ideally, carbon pricing would be implemented globally and the cost effect of emissions would be the same everywhere in the world. This would reduce the risk of carbon leakage (i.e. production and emissions being moved to countries with lower climate costs). In a global carbon market, emission reductions would take place where they can be achieved with the lowest costs.

Tools for carbon pricing: Carbon taxes and emissions trading

Different pricing systems have been developed for carbon dioxide emissions. The most common systems are carbon taxes and emissions trading. According to the World Bank, there are 40 national and 20 regional carbon pricing systems in use at the moment, covering 12% of the world’s emissions.

• Carbon dioxide tax is in use, for example, in the Nordic countries, in some other European countries and in Japan. In Finland carbon dioxide tax was introduced in 1990, being probably the first of its kind in the world.

• Emissions trading, on the other hand, is used for example in the EU (including Finland), California and South Korea. China has announced that it will start a nationwide emissions trading system in 2017. At the moment there are seven regional pilots ongoing.

In addition to creating new emissions trading systems, existing ones can be developed further and combined to make bigger entities. There are, however, some challenges in combining existing systems: they are linked to nationally important issues such as energy production and industry, the existing systems function in different ways and it may be difficult to find a solution on how to organise governance systems. As an example on these difficulties, the EU and Switzerland have been negotiating the possible combination of their emissions trading systems for quite a long time already, without being able to find a solution.

Background on key concepts

Carbon leakage

The fact that there are tighter emission targets in the EU than in other parts of the world means that companies operating in Europe have higher operating costs, as they have to, for example, buy emission allowances or pay a higher price for electricity. The additional costs compromise the competitiveness of the companies operating in Europe, when they also operate in global markets.

The phenomenon, where industrial production and therefore emissions are moved to countries with lower climate costs is called carbon leakage. As a result of carbon leakage, global emissions typically grow.

The higher climate costs reduces the willingness to invest in Europe, which means that for example Asia and the USA become even more appealing for industrial activities while Europe is in danger of losing industry, investments and jobs. As a result, the emissions in the EU become lower, but the global emissions may actually grow.

The risk of carbon leakage can be minimized by agreeing on comparable climate targets and measures. Until these are in place, the carbon leakage sector in the EU (= European energy intensive companies which compete on global markets) need compensation for the burden put on their competitiveness. Both direct compensation in the form of free allocation as well as indirect compensation such as partial compensation for rising electricity costs according to EU rules are needed.

Emissions trading
In the European Union, emissions trading system functions according to the following principles (covering energy production, energy intensive industry, aviation):

• The yearly lowering emissions ceiling leads towards the targets that have been set for 2020 and 2030
• A price is given for the carbon dioxide emissions. The price is based on market terms according to demand and supply:
  • Supply is based on climate targets; EU sets the ceiling for emissions.
  • Demand depends on the energy choices made by companies and on the economic situation; in an economic downturn emissions are typically lower and in an economic boom emissions usually grow as production levels grow.
• Emissions trading system steers toward the most cost-efficient way of reaching lower emissions while at the same time guaranteeing that the climate targets are met.
  • Companies choose themselves whether it makes more sense to buy allowances or invest in, for example, new technology.