Lecture 24

Climate Change II: Carbon Pricing

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

November 4, 2024

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Climate Change II: Carbon Pricing

Introduction

Sources of Greenhouse Gas Emissions

Source: Total U.S. Greenhouse Gas Emissions by Economic Sector in 2022, EPA

The Need for Comprehensive Policies

  • Carbon pricing offers a more comprehensive emission reduction strategy.
    • Controls greenhouse gas (GHG) emissions beyond the energy sector.
  • Benefits of carbon pricing:
    1. Fuel Switching: Encourages shift to lower-carbon fuels.
    2. Energy Efficiency: Increases cost savings per unit of emissions reduced.
    3. Non-Energy GHG Reduction: Targets emissions from various sources.
    4. Technological Innovation: Stimulates development of new fuels and emission-reducing technologies.

The Equimarginal Principle

  • Definition:
    • Achieve cost-effectiveness when the marginal cost (MC) of reducing the last ton of emissions is equal across all reduction opportunities.
  • Explanation:
    • Cost-effectiveness is achieved by allocating emission reductions where they are cheapest.
    • No further cost savings can be made by reallocating efforts among sources.

The Equimarginal Principle

  • Example:
    • Both Company A and Company B have non-constant MC.
    • If Company A can reduce emissions at $50/ton and Company B at $100/ton:
      • Allocate more reduction to Company A until MCs equalize.
  • Implication:
    • Equalizing MCs across all emitters minimizes the total cost of achieving emission targets.

Cost-Effectiveness of Carbon Pricing

  • Equimarginal Principle
    • Achieve cost-effectiveness when the MC of reducing the last ton of emissions is equal across all reduction opportunities.
  • Carbon pricing inherently promotes this by:
    • Imposing a uniform price on CO2e emissions.
    • Leading emitters to abate until their marginal cost equals the carbon price.
  • Result:
    • Equalized marginal costs among all emitters.
    • Satisfaction of cost-effectiveness conditions.

Necessary Conditions for Cost-Effectiveness

  1. Comprehensive Coverage:
    • Price applied to all GHGs (via CO2e), not just CO2.
    • Inclusion of all emission sources.
  2. Uniform Pricing:
    • All emitters face the same CO2e price.
    • Prevents violation of equal-marginal cost condition.
  • Current Challenges:
    • Existing programs often exclude certain gases or sources.
    • Different carbon pricing programs impose varying prices.

Forms of Carbon Pricing

  • Two primary approaches:
    1. Carbon Taxes:
      • Government sets the price.
      • Market determines the resulting emissions level.
    2. Emissions Trading Programs (Cap-and-Trade/Cap-and-Invest):
      • Government sets the allowed emissions level.
      • Market determines the price to achieve that level.
  • Interchangeability:
    • For any emissions level, there’s a corresponding price and vice versa.

Global Adoption of Carbon Pricing

  • Early Negotiations:
    • Europe favored carbon taxes.
    • United States preferred cap-and-trade.
  • Current Landscape (World Bank, 2021):
    • 64 carbon pricing initiatives implemented or scheduled.
    • Involves 45 national jurisdictions.
    • Covers 21.5% of global GHG emissions.
    • Breakdown:
      • 74% of covered emissions from emissions trading programs.
      • Remaining from carbon tax programs.

Global Adoption of Carbon Pricing

Selected Emissions Trading and Carbon Tax Programs