How Companies Can Win with Carbon Pricing

by

The carbon conversation is shifting. It’s no longer about whether to put a price on carbon; it is about how to do it. Know what to expect from cap-and-trade or a carbon tax.

In Canada, Ontario is gearing up to join Quebec as the second province to implement a cap-and-trade system. Alberta is increasing the stringency of its existing carbon pricing policy and potentially considering expanding it – even oil executives are speaking up.

What are the changes likely to occur? And what do they mean for business?  Here, we review the most common policy approaches and describe how businesses can adapt — and thrive.

Two Strategies

Carbon pricing is a financial instrument that businesses and governments are using to reduce carbon emissions. Carbon pricing is generally done in one of two ways (although combinations are possible):

  • Cap-and-Trade: Through cap-and-trade systems, governments cap total carbon emissions and then give or sell companies carbon permits that add up to the cap. Companies can then trade permits with each other. Those who can reduce emissions cheaply and easily sell permits to those who cannot. The price of the permits is variable, depending on the market.  But generally, the lower the cap, the higher the price.
  • Carbon Tax: Here, governments impose a fee on carbon: the more a company emits, the more they pay. The price determines how effective the policy will be at lowering emissions—the higher the price, the greater the reductions.

Similarities & Differences

While each strategy has its advocates, carbon taxes and cap-and-trade are “more similar than different.” For example:

  • Both put a price on carbon — a price that can be adjusted over time.
  • Both create economic incentives for companies to reduce emissions and increase green technology.
  • Both generate revenue that can be used to create other economic benefits (like lowering other taxes or investing in research and development, for example).
  • Both can reduce emissions, and do so more cost-effectively than regulations.

Differences remain, and result in specific benefits and drawbacks, shown below.

CAP-AND-TRADE CARBON TAX
Predictable emission reductions

Emissions are capped: amount of carbon emitted is set by policy.

Emission reductions depend on consumer sensitivities to carbon prices.

Predictable pricing

Price of carbon varies depending on demand. Smart policy design can mitigate this variation and uncertainty.

Price of carbon is set by policy.

Ease of implementation for business and government

Generally requires more bureaucracy. 

A carbon tax functions within tax systems already in place.

Potential for broader system

Can easily link with other cap-and-trade systems (e.g. Quebec, California).

Jurisdictions can adopt the same carbon price to harmonize different policies.

For both, success lies in the details.  A cap-and-trade system introduces a ‘cap’ on emissions that should result in meaningful reductions. Such a cap should steadily and predictably decline over time. For a carbon tax, policy designers should choose a price that leads to meaningful reductions, and that slowly and predictably rises over time.  Both approaches should be done in a way that does not undermine the economy.

Lessons for Business

Take innovation opportunities.

Carbon pricing increases the cost of doing business — especially for carbon-intensive industries. But business can also benefit. Companies are encouraged to find ways to cut fuel use and reduce emissions, which can be easier than executives or managers realize.

In Norway, for example, the R&D sector has pooled resources to address carbon emissions. Projects consider different approaches to carbon capture and storage and several have already shown promise for managing emissions and for producing new forms of cleaner energy. As ScienceDaily observes, “on this technological front, there is room for not just one but many winners.”

Act early.

The first businesses to develop new technology have a first-mover advantage. In 2005, China set a target of supplying 15% of their electricity from renewable sources by 2010. Today, China is a major exporter of solar panels.

Other countries are already pricing carbon, as are some U.S. states: California, for instance, implemented a cap-and-trade system in 2012. Lining up at the end of the carbon-pricing queue isn’t the best economic approach.

Answer these guiding questions:

  1. Can your organization act ahead of policy action?
  2. How is your organization preparing to adapt and innovate, once policies are in place?
  3. Is your organization informed and prepared to work with policy makers on the details of carbon-pricing policy?

The Bottom Line

Yes, a carbon tax or cap-and-trade system can create a competitive disadvantage for companies that have to compete against businesses in jurisdictions that don’t price carbon.

But this effect is a small, short-term disadvantage that can be overcome by strategic business decisions that produce real innovation, as well as good policy design.

The technology, products, and processes companies develop in response to carbon pricing will ultimately reveal new opportunities. As a practitioner, will you produce them or pay for them?

  • Thomas Webler

    One pretty big difference is where in the commodity chain the tax is placed. Cap and Trade is usually at the corporate level of large polluters (mainly power plants). Carbon Tax can be placed on the carbon when it comes out of the ground, when it is burned by the consumer, or anywhere inbetween. In the first linked article embedded in the posting above, it says: “Suncor’s Williams repeatedly noted that since 80 per cent of emissions come at the point of combustion, any strategy trying to take on climate change must include end users — people turning ignition switches and flipping on lights at home.” Economic and environmental costs and benefits will differ depending on these details.
    We need a careful analysis and discussion about where to place any carbon tax. In BC, the tax is charged when carbon fuels are imported into the province, not at the point of consumption.

    • Carbon Conversations

      I thought that the BC tax was applied at the pump. Thanks for the clarification.

      What about fuels produced in BC? Tax applied at the wellhead?
      How does the carbon tax, or how WILL the carbon tax, affect LNG in BC?

    • http://www.ecofiscal.ca Dale Beugin

      Cap-and-trade needn’t necessarily be applied downstream on emitters. Quebec’s system, for example, includes both upstream (fuel distributers) as well as downstream (big emitters) points of regulation. See here for more details: http://ecofiscal.ca/2015/04/22/carbon-policy-broader-coverage-is-better/