Fully emerging from the mist of decades-long cynicism, carbon pricing is now widely accepted as a must-have mechanism in the push for net zero by 2050. However, implementation is still a mixed bag. About 23% of global greenhouse gas (GHG) emissions were covered by carbon pricing initiatives last year, at 11.86 GtCO₂e, according to the World Bank. That figure can be read two ways.

One, it is laudable considering that the world’s first carbon trading market – the EU Emissions Trading Scheme (ETS) – launched 18 years ago in 2005. Some bruises undoubtedly blot the EU ETS’ track record. But it has been pivotal in working out the kinks of carbon pricing and galvanising nervy stakeholders as they entered the uncharted territory. The $84bn in revenue from global carbon markets in 2021, a 60% year-on-year climb, reflects the mounting appetite.

Some 70 carbon pricing initiatives are in play today – versus just two in 1990. These are an invaluable accelerant towards a global carbon price at some point in the move towards net zero in the next 27 years.

Another interpretation is that we are dangerously behind. The tracking, offsetting or removal of 76.83% of the world’s GHG emissions are largely loose in the wind, despite the rallying cries to tackle climate change from the UN Framework Convention on Climate Change (UNFCCC), the Intergovernmental Panel on Climate Change (IPCC), the International Energy Agency (IEA) and many others.

There are also big gaps in international verifications, accountability and linkages for today’s menu of choice – ETS, carbon tax, carbon fee, voluntary carbon markets (VCM), internal carbon pricing (ICP) and others – risks that create a fragmented and contradictory space long-term. Not only could this feed ambiguity today, but a lack of fungibility now could derail hopes for a global carbon price later.

The answer lies somewhere in the middle. Variety has been integral for enticing stakeholders into the market, especially those less comfortable or able to embrace mandatory efforts. Equally, the red flags of ‘greenwashing’, even if unintentional, must be addressed. As the rules on carbon pricing inevitably tighten in years, more parameters, education and guidance will be needed to shepherd companies towards a more unified, global approach.

Time to shine
Clearly there is great potential. Trading in carbon credits could reduce the cost of implementing Nationally Determined Contributions (NDCs) under the Paris Agreement by as much as $250bn by 2030, for example, according to World Bank figures.  Plus, public and corporate buy-in has rocketed in the last three years, underpinned by the fact that 92% of global GDP (gross domestic product) based on purchasing power parity (PPP) is now covered by net zero targets, reports the Net Zero Tracker.

The worrying spread of climate change on the proverbial doorsteps of 8 billion people worldwide means that customers increasingly want to know companies’ carbon strategy. According to the World Meteorological Organisation, a disaster related to a weather, climate or water hazard killed 115 people and caused $202mn every single day for the last 50 years. This cause-and-effect is affecting wealthier economies more and more, as well as less developed nations. All this, plus the impact of the Russia-Ukraine war, soaring energy prices and inflation means carbon markets are more relevant and dynamic than ever.

In a world first, the European Union (EU) agreed to impose a CO₂ emissions tariff, also known as a carbon border adjustment mechanism (CBAM), on imports of polluting goods in carbon intensive sectors such as steel and cement to help European industries shrink their carbon footprints. As part of the ‘Fit for 55 in 2030’ package, the EU’s plan to reduce GHG emissions by at least 55% by 2030 compared to 1990, the CBAM will start operating in October 2023 and fully kick in from 2026.

There are concerns around this landmark tool which aims to help reduce the risk of carbon emissions by encouraging producers in non-EU countries to green their production processes. However, it simply highlights the complexity of pricing carbon.

For example, some worry that the CBAM places a carbon charge on companies from countries that did not primarily cause climate change. The GDP of Mozambique – in the top 10 of the world’s poorest nations – would fall by 1.5% due to the tariffs on aluminium exports alone, according to the Center for Global Development. One route is for revenue from the sale of CBAM certificates to be ring-fenced to support climate action in less developed countries. 

There are also questions over the consistency of CBAM with international trade law, although advocates say the CBAM has been designed in full compliance with the rules of the World Trade Organisation (WTO) and international climate law.

Plans are gaining momentum elsewhere across the globe, too. China’s national ETS is the world’s largest in terms of covered emissions, estimated to cover more than 4bn tCO₂ and accounting for more than 40% of the carbon emissions (according to the World Economic Forum) from the world’s most populated nation of 1.4 billion people. A total of 179mn tonnes of China Emission Allowances (CEAs) changed hands over the 114 trading days in 2021, with a 99.5% compliance rate versus the EU ETS’ sub-80% compliance rate in 2005 (albeit in a very different macro climate environment), according to Refinitiv data.

As the rules on carbon pricing inevitably tighten in years, more parameters, education and guidance will be needed to shepherd companies towards a more unified, global approach. 

Making a choice
The VCM is growing at a rapid pace, reaching $2bn in 2021 – four times its value in 2020. By 2030, the market is expected to hit between $10bn and $40bn, according to the Boston Consulting Group. Amid this surge, having verifiable and reputable monitoring, reporting and accountability frameworks increasingly decides whether a purchase proceeds. Demand for such visibility has always been a pinch point in VCMs, with concerns over double counting of offsets, a lack of unified international regulation on credit quality and the risk of projects with little impact on climate change. Yet, it is intensifying as more players enter the space.

The Integrity Council for the Voluntary Carbon Market (ICVCM) launched its Core Carbon Principles and Program-level Assessment Framework this year, setting rigorous thresholds on disclosure and sustainable development for high-integrity carbon credits, establishing a pathway towards even higher ambition. Developed with input from hundreds of organisations throughout the VCM, the Core Carbon Principles (CCPs) set out fundamental principles for high-quality credits that create real, verifiable climate impact.

ICP is also gaining major traction. Companies use ICP to get a head start on understanding and reacting to how regulations that may increase the cost of CO₂ emissions will affect their bottom line. The most comprehensive recent data showed an 80% increase in the number of companies planning or using an ICP from 2015–2020, with more than 2,000 companies disclosing current or planned used of ICP.

The combined market capitalisation of these companies exceeded $27tn, a significant increase from $7tn in 2017, according to CDP – and notably, before the flow of net zero targets were announced. Japan, the UK and the US had the highest percentage of companies using ICP as of 2021, with 24%, 20% and 15%, respectively, according to McKinsey analysis.

A ‘menu’ of ICP gives companies more choice. There are three types, with the most effective being an ‘actual price’. This can be implemented using an internal trade system, with the revenues earmarked for measurable and accountable carbon-cutting efforts. There is an ‘implicit price’, which means companies can see the impact abating and/or offsetting their emissions would have, but it does not change their financial model. And a ‘shadow price’ that helps modelling and managing financial and regulatory risks, but is purely theoretical. While they differ in effectiveness, all force decision makers to be more alert to how a company’s environmental footprint affects strategic readiness.

In addition, those with ICP have a springboard when doing the ‘environment’ section of their environmental, social and governance (ESG) reports, as they have already gathered and analysed data along the way. This is what Microsoft, the world’s second largest company by capitalisation, has done for more than a decade. Microsoft’s internal carbon tax is paid by each division across its business, based on the carbon emissions, with the funds paying for sustainability improvements – aimed at helping make Microsoft carbon negative by 2030.

Mid-century should see Microsoft remove all the carbon the company has emitted directly or by electrical consumption since it was founded in 1975. The tech giant recently raised the bar again by redesigning and increasing its carbon fee to accelerate Scope 3 emissions. For example, the Scope 3 business travel fee will increase to $100/t of CO₂ equivalent to better support the purchase of sustainable aviation fuel (SAF), with this fee increasing thereafter at an accelerated rate up to 2030.

Overall, efforts must accelerate dramatically. For we are on the brink of putting so much CO₂ into the atmosphere that it will take thousands of years to fix it. Undoubtedly, the more entry points into some form of carbon price management, the more the players will be in the market. However, the degree of market collaboration today must be viewed as chapter one – not the endgame.