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While limits on carbon emissions are becoming more common, the pace of government regulatory support for carbon pricing varies dramatically from country to country.
For investors, it means this additional cost of doing business from emitting carbon, should be taken into account.
Ratified by close to 200 nations, the Paris Agreement’s goal is to keep mean global warming well below 2 degrees Celsius.
Putting a price on carbon emissions makes polluting energy sources expensive and provides an incentive for emitters to reduce them.
An important feature of the mandatory carbon pricing is that carbon emissions must not only be priced but also become increasingly costly over time.
Cap and trade is not a new approach, having been used to tackle environmental problems in the past.
Cap and trade has grown in importance, albeit slowly.
Beyond this, a number of countries, provinces, states, and cities operate a cap-and-trade programme.
All cap-and-trade programmes set emissions limits compatible with their nation’s CO2 reduction targets and calculated by governments and policymakers.
Carbon allowances or units totalling up to this maximum are then allocated or auctioned to companies in high-emission sectors, such as power generation, oil and gas refining, steel making, and chemical manufacturing.
But if the company generates less than its allowance, it can sell any excess units in the market to a company that hasn’t successfully reduced emissions.
By contrast, the price of a similar amount within the California/Quebec cap-and-trade programme was less than $28 at the same time.
It estimates that at global level, a price of $75 per ton or more is needed by 2030 to restrict global warming to below the Paris Agreement’s well below 2°C threshold.
Proponents of cap and trade point out that it gives companies flexibility by allowing them to hold allowances into future compliance periods.
Governments set a price per tonne of carbon emissions high enough to provide an incentive to switch to clean energy technology such as wind, solar, or other non-carbon-emitting power sources.
In Canada, the carbon tax is set at CA$40 per tonne of CO2 equivalent for 2021.
A carbon tax differs from a cap-and-trade scheme in that a tax provides a high level of certainty about future prices — as those are set by the government in advance — but not about emissions.
President Joe Biden’s proposal of a carbon tax was vehemently opposed, causing him to opt for a payment scheme for emission reductions.
Cap and trade and carbon taxes need not be mutually exclusive.
Regardless of government mandated-schemes, an increasing number of companies wish to reduce their carbon footprint or accelerate the process of achieving net-zero emissions.
They are certificates that represent one metric ton of CO2 equivalent that is either prevented from being emitted into the atmosphere or removed from the atmosphere as the result of energy efficiency projects such as reforestation or production of renewable energy.
Reforestation is a common offset, as trees absorb CO2, they grow and store it, and makes up half the voluntary market.
McKinsey, a consulting firm, points out that though the voluntary carbon credit market is currently experiencing significant growth, it is still relatively small.
Critics claim many of these projects are ineffective, and do not reduce emissions as they claim to.
As a result, offsets are cheap compared to the price of carbon on cap-and-trade schemes, at a lowly $3 per tonne.
RBC Europe’s energy analyst Al Stanton thinks that to slow down and ultimately reverse climate change, technologies and solutions that actively remove CO2 directly from the atmosphere need to be deployed.
Whether a country has a legally binding cap-and-trade programme in place or not, more and more companies are incorporating a cost to emitting CO2 as a way to measure their climate change risk and to put their businesses in a better position to manage the transition to a lower carbon business model.
In 2020, the Grantham Research Institute at the London School of Economics counted close to 2,000 pieces of climate legislation across the world, of which two thirds were enacted since 2010.
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