Positive Pricing of Carbon Reduction: A Low Hanging Fruit

A new UN Climate agreement will probably be signed by the end of this year with some incremental progress but even inveterate optimists like myself don’t believe it will be capable of ‘bridging the gap’ between the maximum that 196 governments can agree upon by consensus and the minimum the IPCC[1] states as needed to keep greenhouse gas concentrations below 450 ppm and the average temperature below 2 degrees Celsius. So how to address something that is fast becoming implausible? 

It is high time to think out of the box and take the UN climate process for what it is: the lowest possible common denominator among 196 governments and their own domestic political and economic circumstances. It remains very important as a baseline and an expression of international will to deal with the problem, but it is insufficient as a tool for a 450ppm/2 degree paradigm. Two additional actions are needed: a specific and concentrated effort by a select group largest greenhouse gas (GEE) emitters --both governments and corporations-- and building a friendlier framework for low carbon economies in the global financial system.

The first one is quite obvious: a small group of countries accounts for the vast majority of emissions, China and the US together sum up to 40%. These governments can negotiate specific bilateral or multilateral arrangements like, for example, a China, US and EU agreement on a common effort to help decommission Chinese and Indian coal plants. A similar effort involving directly the largest private emitters should follow. This concept of Climate Clubs is being currently developed parallel to the UNFCCC[2] actions. Working these additional arrangements is a common sense and realistic way for additional action. It makes more sense than working out a solution based exclusively upon ‘burden sharing’ and international command and control treaty commitments that just won’t fly for well known political reasons.

The other fundamental aspect concerns the global financial system. 450ppm/2 degree paradigm will not be achieved in the present global economic/financial context both indifferent and ineffective to deal with the financial demands generated by the huge climate crisis challenging humanity in the 21^st Century. Most governments struggle with large debts and persistent deficits, their resources are limited. There are no appropriated scale mechanisms or adequate incentives to mobilize enough capitals from the global financial markets for productive low carbon investments. De-carbonization demands strong upfront and slower return financing that is hard to obtain under current financial system criteria, more prone to speculative stakes. Carbon reduction has an intrinsic social/economic value to be recognized and incorporated to both global and national accounting.

Pricing Carbon Reduction

The pricing of carbon for taxation purposes makes a lot of sense but faces internal political resistance in most countries, enough to keep it blocked in the consensus dependent UNFCCC. It is an uphill battle that will eventually be won, internally in each and every country, one by one, since taxation systems are national.

‘Positive pricing’ of carbon reduction is both an alternative and complementary approach. Politically it is “carrots” rather than” sticks”. It is based upon the recognition of the social and economic value of carbon reduction and envisions mechanisms to establish it as convertible financial value. It is basically a reward for duly certified mitigation. It does not replace carbon taxation but offers an easier path. In fact, it can be complementary to carbon taxation and carbon markets. All three mechanisms have their specific role in the transition process towards low carbon economies.

In 2014, Brazil submitted to the UNFCCC, within the COP20 that took place in Lima, a proposal to recognize “the social and economic value of emissions reduction and the need to consider them as units of convertible financial value.” This was meant to be an initial step towards the creation of this new instrument for financing transition to low carbon economies. The rational for carbon reduction being source of true value --not a ‘bitcoin’ kind of device!-- is based upon quantifying the loss inflicted to the global economy by climate change. In the Stern Report it has been estimated as of at least five percent of the global GDP.

Of course there can be various ways of estimating this (the report itself considers figures from five percent to twenty percent of the global GDP). Nevertheless, a consensual quantification can be agreed upon diplomatically. Once this is officially established the value of a ton of carbon equivalent reduction can be priced. To establish mechanisms and criteria enables ‘positive pricing’ to operate as a tool to boost mitigation investments and helpes achieve more ambitious results.

The Brazilian proposal in Lima was an intended first step:  the recognition, in principle, that carbon reduction equals value. The proposition was not submitted to vote at that time but remains on the table. This recognition by 196 governments once approved in the UNFCCC would require further research, lots of theoretical and practical work, and political/diplomatic will endorsed in a post-Paris agenda to establish implementation mechanisms.

Translating this eventual recognition carbon reduction value into workable financial tools will need a different kind of forum, most likely the G20. The governments of the largest economies, articulated to central banks, Bretton Woods institutions and the new multilateral Asian and BRICs based development banks, would eventually create a Climate Club to establish the guaranties for these carbon reduction assets and eventually an ad hoc institution. Government backed guaranties will enable a subsequent mobilization of resources from the private financial system. It can also produce positive macroeconomic repercussions by offering a productive low carbon framework for the quantitative easing operations of the kind being currently implemented by the European Central Bank.

A low carbon Bretton Woods

There are several possible mechanisms for the implementation of positive pricing of carbon reduction. We have acknowledged with great interest ideas developed by professors Jean-Charles Hourcade, Michel Aglietta, Étienne Espagne and Baptiste Perrissin-Fabert who are working on an innovative path that has recently been publicished by France Stratégie.[3] Avoiding detailed explanations, at this time, let us just imagine: a group of willing governments provides guaranties for a specific quantity of carbon reduction assets. Bank loans for duly certified carbon reduction projects can be reimbursed up to ten percent in “carbon reduction certificates”. These certificates are handed to the suggested institution that cashes them in --thus becoming a sort of “Fort Knox of carbon reduction certificates”-- and pays back the banks in their currencies.

The willing governments offer guaranties for theses certificates and eventually use carbon taxation to cover their exposure. This new value, covering up to ten percent of these carbon reduction investments, can become a tipping point for low carbon finance. Along with carbon markets and carbon taxation positive pricing of carbon reduction will help establish a more stimulating worldwide financial environment for a new era of low carbon economies and a path to net zero emissions in the second half of the century. We need a low carbon Bretton Woods. In fact, a major but not that complicated adjustment in the global financial system, on a globally agreed upon premise: carbon reduction recognized as a convertible unit of value.