Policy Corner | June 22, 2022

Pricing carbon could succeed where Scope 3 falls short in accounting for emissions

Amy Cortese
ImpactAlpha Editor

Amy Cortese

ImpactAlpha, June 22 – As the Securities and Exchange Commission mulls new rules for climate disclosure, investors are weighing in on what could be a more simple and efficient solution to achieving net-zero emissions: carbon pricing. 

A group of 72 institutional investors representing more than $10 trillion in assets is urging governments to institute carbon pricing policies to provide predictable price signals and ensure a just transition. The Net Zero Asset Owners Alliance, or NZAOA, has laid out five principles to guide an overhaul of carbon-pricing mechanisms, which include cap-and-trade systems, carbon markets and carbon taxes. 

Among the recommendations: minimizing competitive distortions and carbon “leakage,” raising prices, and using the proceeds from carbon pricing to ensure an equitable transition. 

“Carbon pricing provides a broad incentive for decarbonisation, driving emissions reductions where they are most cost-effective,” the NZAOA writes in a new paper (note: the Net Zero Asset Owners Alliance is distinct from the Net Zero Asset Management initiative, which last week reported on investors’ progress, or lack thereof, on net-zero pledges)

Some 68 countries, regions and states have or are planning carbon taxes or emission trading schemes. Europe’s ETS has helped lower the bloc’s emissions by 35% between 2005 and 2019, and more so since then as carbon prices on the market have soared. In the U.K., carbon pricing has helped cut power sector emissions almost in half between 2013 and 2017. 

Still, many carbon pricing schemes are held back by low pricing and loose allocations of free credits. Government policies such as fossil fuel subsidies also undercut their effectiveness, says NZAOA. 

Less than 5% of global greenhouse gas emissions in 2021 were covered by carbon pricing consistent with limiting warming to 1.5 degrees Celsius, the target for avoiding worst-case climate outcomes. A price of $40 to $80 per ton of CO2 by 2020, and as much as $150 by 2030, are needed to meet that goal, according to experts. Only Sweden has a price above $100 (its current price is around $130). Carbon is trading around $90 on Europe’s ETS after breaching $100 last year. 

China, which accounts for 7.4% of global emissions, has a price of $7. 

The asset owners’ paper comes as rising energy costs and inflation are hitting consumers and low-income communities, and ahead of a G7 summit kicking off in Berlin on Sunday, where climate action will be part of a discussion dominated by the war in Ukraine. 

NZAOA recommends five design principles to ensure more effective carbon pricing:

  • Ensuring appropriate coverage and ambition. That means broadening the number of sectors covered by carbon pricing schemes and tightening pricing policies, including making them legally binding..
  • Delivering a just transition. More than 40% of carbon pricing revenues flow into general government budgets. A portion of that should be used to support disadvantaged citizens. In California, for example, 35% of revenues from the state’s cap-and-trade system are required to go towards projects that benefit disadvantaged and low-income communities and households. British Columbia redistributes all carbon revenues back to households and businesses.
  • Providing a predictable price signal. Price stability ensures an orderly transition. NZAOA recommends that carbon taxes rise steadily and are signaled well in advance. Emission trading schemes should have price floors and ceilings to avoid excessive volatility. 
  • Minimizing competitive distortions. Uneven implementation of carbon pricing can put companies at a comp[etitve disadvantage or spure them to move to jurisdictions with lower or no carbon prices. Carbon “border adjustment mechanisms” can help address such “leakage.” 
  • Promoting international cooperation. Linking emission trading schemes, sharing knowledge and setting up international ‘climate clubs’ that encourage high levels of climate ambition. Germany, which holds the current G7 presidency, has said it will set up an international climate club. 

Climate rules

Investors are also pushing carbon pricing in comments submitted to the S.E.C. as the U.S. financial watchdog considers rules that would require mandatory climate disclosure for listed companies. The comment period wrapped up last week. 

Inclusive Capital’s Jeffrey Ubben, a member of ExxonMobil’s board of directors, urged the S.E.C. to require companies to adopt an “assumed price on carbon” in near-, mid-, and long-term planning. The assumed price would be reported in their annual reports and financial statements the way commodity prices, interest rates and other risk factors are, and would prepare companies for an eventual price on carbon.

“This price, even if it is considered to be zero, would give investors a meaningful way to analyze the thinking of management towards the physical, transition and liability risks of the company,” wrote Ubben. 

Stanford University’s Alicia Seiger, Marc Roston and Thomas Heller said carbon pricing may be a simpler way to force a full accounting for carbon footprints than so-called Scope 3 reporting, which attempts to quantify companies’ downstream and upstream carbon emissions (see, “How the SEC’s rules will – and won’t – solve climate change”). In their comments, the authors urge the S.E.C. to make Scope 3 reporting voluntary, not mandatory. 

“Supply chain emissions are more effectively managed through carbon pricing, efficiency standards, and mandates,” they argue.