CO2 Tax: An Emerging Market Opportunity for Climate Change?

The idea of putting a price on carbon dioxide emissions to help tackle climate change has been slowly spreading around the globe over the past two decades.

Economists have long suggested that raising the cost of burning coal, oil and gas could be a cost-effective way to curb emissions. But, in practice, most countries have found it politically difficult to set prices that are high enough to spur truly deep reductions. Many carbon pricing programs today are fairly modest. In France and Australia, efforts to increase carbon taxes were shelved after a backlash from voters who were angry about rising energy prices.

Partly for that reason, carbon pricing has, so far, played only a supporting role in efforts to mitigate global warming.

Figure 1: Countries with Carbon Taxes - Source: “State and Trends of Carbon Pricing 2019” State and Trends of Carbon Pricing (June), World Bank, Washington, DC

What Is Carbon Pricing?

The phrase put a price on carbon has now become well known with momentum growing among countries and businesses to put a price on carbon pollution as a means of bringing down emissions and drive investment into cleaner options.

So, what does it mean to put a price on carbon, and why do many government and business leaders support it?

There are several paths governments can take to price carbon, all leading to the same result. They begin to capture what are known as the external costs of carbon emissions – costs that the public pays for in other ways, such as damage to crops and health care costs from heat waves and droughts or to properties from flooding and sea level rise – and tie them to their sources of emission through a price on carbon.

A price on carbon helps shift the burden of the damage back to those who are responsible for it, and who can reduce it. Instead of dictating who should reduce emissions where and how, a carbon price gives an economic signal and polluters decide for themselves whether to discontinue their polluting activity, reduce emissions, or continue polluting and pay for it. In this way, the overall environmental goal is achieved in the most flexible and least-expensive way to society. The carbon price also stimulates clean technology and market innovation, fuelling new, low-carbon drivers of economic growth.

There are two main types of carbon pricing: emission trading systems (ETS) and carbon taxes.

An ETS – sometimes referred to as a cap-and-trade system – caps the total level of greenhouse gas emissions and allows those industries with low emissions to sell their extra allowances to larger emitters. By creating supply and demand for emissions allowances, an ETS establishes a market price for greenhouse gas emissions. The cap helps ensure that the required emission reductions will take place to keep the emitters (in aggregate) within their pre-allocated carbon budget.

A carbon tax directly sets a price on carbon by defining a tax rate on greenhouse gas emissions or – more commonly – on the carbon content of fossil fuels. It is different from an ETS in that the emission reduction outcome of a carbon tax is not pre-defined but the carbon price is.

The choice of the instrument will depend on national and economic circumstances. There are also more indirect ways of more accurately pricing carbon, such as through fuel taxes, the removal of fossil fuel subsidies, and regulations that may incorporate a “social cost of carbon.” Greenhouse gas emissions can also be priced through payments for emission reductions. Private entities or sovereigns can purchase emission reductions to compensate for their own emissions (so-called offsets) or to support mitigation activities through results-based finance.

Some 40 countries and more than 20 cities, states and provinces already use carbon pricing mechanisms, with more planning to implement them in the future.  Together the carbon pricing schemes now in place cover about half their emissions, which translates to about 13 percent of annual global greenhouse gas emissions. 

In recent years, several countries have taken measures to reduce carbon emissions using environmental regulations, emissions trading systems (ETS), and carbon taxes. In 1990, Finland was the world’s first country to introduce a carbon tax. Since then, 15 European countries have followed, implementing carbon taxes that range from less than €1 per ton of carbon emissions in Ukraine and Poland to over €100 in Sweden.

Figure 2: Carbon Taxes in Europe, 2019

Sweden levies the highest carbon tax rate at €112.08 (US$ 132.17) per ton of carbon emissions, followed by Switzerland (€83.17, $98.08) and Finland (€62.00, $73.11). You’ll find the lowest carbon tax rates in Poland (€0.07, $0.08), Ukraine (€0.33, $0.39), and Estonia (€2.00, $2.36).

Carbon taxes can be levied on different types of greenhouse gases, such as carbon dioxide, methane, nitrous oxide, and fluorinated gases. The scope of each country’s carbon tax differs, resulting in varying shares of greenhouse gas emissions covered by the tax. For example, Spain’s carbon tax only applies to fluorinated gases, taxing only 3 percent of the country’s total greenhouse gas emissions. Norway, by contrast, recently abolished most exemptions and reduced rates, now covering over 60 percent of its emissions.

All member states of the European Union (plus Iceland, Liechtenstein, and Norway) are part of the EU Emissions Trading System (EU ETS), a market created to trade a capped number of greenhouse gas emission allowances. With the exception of Switzerland and Ukraine, all European countries that levy a carbon tax are also part of the EU ETS (Switzerland has its own emissions trading system).

The Spanish region Catalonia and the Netherlands are currently considering a carbon tax, and Turkey and the Ukraine are considering an ETS.

A carbon tax in South Africa went into effect on 1st June 2019, making South Africa one of about 40 countries worldwide to adopt a carbon-pricing program.

Proponents of the carbon tax say the true cost of carbon emissions, a key contributor to climate change, is not reflected in the price of fossil fuels. Many economists have argued that taxing carbon would result in a shift toward cleaner sources of energy.

The tax will be introduced in phases: The first phase will run until December 2022 and will tax carbon at a rate of about $8.34 per ton of CO2 equivalent. But according to a statement from the National Treasury, tax breaks will significantly reduce the effective rate of the tax.

Goverment's treasury will assess the impact of the tax and the country's progress toward emissions goals before the second phase of the policy, which will start in 2023 and end in 2030.

Is carbon pricing working?

Carbon pricing is a regulatory instrument in order to reduce CO2 emissions. As most decisions nowadays are commercially driven carbon prices are a successful instrument to shift a fossil fuel based society to a more renewable way of using our resources. On a worldwide basis:

• 57 country implemented or scheduled a CO2 carbon price implementation,

• covering 11 GtCO2e=20% of worldwide emissions,

• with a range of prices in existing initiatives of US$ 1 - 127/tCO2e,

• whereas 51% of the emissions cover a price lower than US$10/tCO2e,

• but in total US$44 billion have been raised in carbon pricing revenues in 2018

Example: Sweden

Sweden has had a carbon tax since 1991. It started at €25 per tonne of greenhouse gases and is now €120 per tonne, the highest carbon tax in the world. Since implementing carbon pricing, Sweden’s economy has grown well above the European average.

How it worked: Businesses and homes started using less coal, gas and oil for heating, and started using biofuels instead. Sweden has reduced its greenhouse gas emissions by 25 per cent since 1995. Its carbon tax was a key contributor.

Key fact: Sweden wants to be carbon neutral by 2045 and will use pricing to help get there.

Example: United Kingdom

The United Kingdom has had a bipartisan consensus on climate change for a long time. They introduced a carbon price in 2001 and gradually ramped it up over time.

How it worked: The carbon price completely transformed how the U.K. generates and uses electricity. Its emissions haven’t been this low since 1890, and studies point to carbon pricing as a key contributor.

Key fact: The U.K. got serious about carbon pricing in 2013. In 2012, the U.K. got 36 per cent of its electricity from coal. In 2018, it got six per cent of its electricity from coal.

Pollution pricing works. It is working around the world. However, these efforts are insufficient, as less than five percent of global emissions covered under carbon pricing initiatives are priced at a level consistent with achieving the goals of the Paris Agreement.Half of the emissions covered by carbon pricing initiatives are still priced below US$10/tCO2e. Carbon prices of at least US$40 - 80/tCO2e by 2020 and US$50-100 /tCO2e by 2030 are required to cost-effectively meet the temporary targets of the Paris Agreement.These prices are suggested under the condition that a sufficiently ambitious climate policy is in place.

Could the ROW or South Africa be a raw model for the African Continent?

South Africa already has a longer history in promoting Green Energy despite huge own coal resources and controversial debates against it. Countries such as Namibia, South Africa or Morocco established at a very early stage a proper regulator and a political framework that supports the reduction of CO2 emissions and promotes green energy. All these countries have huge green resources: Wind, water or (mostly) the sun. These resources are mainly underutilized on the African continent.

Detailed example Botswana: Let´s have a look at what further coal extraction would mean to a country such as Botswana, which alternative energy resources could be established and what are the commercial impacts of a possible CO2 emission tax:

If Botswana´s Government is following its strategy, Vision 2036, and the NPD 11, which means that Botswana wants to utilise more of its coal resources and want to become a net exporter of power, it needs to consider the commissioning of an additional 300 MW coal fired power plant in 2023. This plant will work as a base load facility and will increase emissions further by 23% up to 10,593 tonnes per year in 2031.

Figure 2: Future CO2 increase in Botswana with an additional 300 MW coal block - Source: KANTRAS calculation

Following the actual strategy, outlined in Vision 2036, means that Botswana, despite their initial effort to participate in the Paris Climate Change Agreement and its climate action plan, will not achieve its objective to reduce CO2 emissions within the next 13 years. CO2emissions will rise, if the energy policy is not changed urgently. As a result, Botswana will contribute to the global warming in the Southern African region and the average yearly temperature will rise in the long run.

The recent publication and analysis by Dr Keith Jefferis, the former Deputy Governor of the Bank of Botswana and KANTRAS, show that the investment into green energy is not only feasible, but commercially viable as well. Of course Botswana needs to consider, that the country has only limited resources for green energy. There is rarely wind, water is rare as well and nuclear power plants would technically be hard to establish due to the lack of cooling water. However, was 350 sunny days per year it is an excellent alternative to replace coal.

But even if Botswana is not commissioning a new 300 MW coal fired power block the CO2emission will be high and not in line with the Paris Climate Change Agreement objective. In order to achieve that, Botswana would need to decommission MBPS and replace it within the next 5 years by a CSP solar power plant, which provides enough 24/7 storage capacity. A 24/7 renewable energy power plant is highly competitive to coal fired power plants, and the demolishment of Morupule B could be compensated by a tariff increase of 1%.

In addition to that solar PV panels need to be compulsory on every house that would be newly built. Furthermore, small solar power plants need to established next to villages plus a storage facility. As Botswana has all the mineral resources on hand to produce their own battery storage facilities, the country should invest into such technologies.Botswana needs to balance the objective of low costs of power, reduction of CO2 and high security of supply.

Figure 3: Power Generation Choices

So how could the Government of Botswana encourage everybody involved in the domestic energy sector to fulfil the Climate Change mandate: by introducing a CO2 emission tax.

As most decisions nowadays are commercially driven, a CO2 tax would drive the country to a greener footprint.

KANTRAS evaluated a possible CO2 tax impact on the electricity price as well as the fuel/diesel price. If Botswana would like to be like the best in class - Sweden - the country would need to introduce a Co2 tax of US$110/tCO2e which would increase the end consumer energy price from actually US$0.097/kWh to US$0.123/kWh. If Botswana would choose a lower CO2tax, such as the United Kingdom, the CO2 tax would be US$22/tCO2e and the end consumer energy price would increase up to US$0.102/kWh. As Botswana´s power tariffs are quite moderate compared to neighbouring countries a CO2 tax of US$22/tCO2e still sounds affordable. Doing nothing will cost future generations much more.

The IPCC in its Global Warming Report of 2018 recommended a US$24-35/tCO2e by 2020 and US$38-100/tCO2e by 2035.

Figure 4: Possible Tarif impact on a CO2 Tax for coal fired power plants- Source: KANTRAS calculation

As coal is not the only source of CO2 emissions, the possible CO2 tax would need to be applied on fuel and diesel as well.

Under the previous discussed scenarios of the compared countries such as Sweden or the United Kingdom the petrol would need to go up to US$1.033/l (United Kingdom CO2 tax) or US$0.8269/l (Sweden CO2 tax).

Figure 5: Possible pricing for diesel & petrol with a CO2 tax - Source: KANTRAS calculation

But when discussing CO2 emissions one needs to look at it more holistically, rather than only looking into replacing coal fired power plants or introducing more electric vehicles. Botwana´s CO2 emissions have been growing constantly for the past 20 to 30 years. This increase was not only caused by a growth of population (2,159,927 in 2016 versus 1,504,730 in 1996), but also an increase of CO2 emissions per capita from 2.10 in 1996 to 2.98 in 2016 of 42%. This increase was mainly caused by "Transport" and "Buildings" as well as "Other industrial combustions". The wealthier the populations, the more they spend on cars as well as Air-cons. In addition to that electricity is used for heating and is replacing the traditional way of heating houses (wood).

Figure 6: Botswana´s CO2 emissions by year Possible pricing for diesel & petrol with a CO2 tax - Source: Emission Database for Global Atmospheric Research (EDGAR)

As the Power Industry is only responsible for 14% of the CO2 emissions a CO2 tax only targeting coal fired power plants would be too shortsighted. A CO2 tax in petrol and diesel would have a much higher impact as one would address 45.3% of the all CO2 emissions. As the "Other industrial combustions" are mainly using coal and diesel a combined CO2 tax for coal and fuel would increase the pressure on this sector (mainly mining) to invest into sustainable energy production.

Figure 7: Botwana´s fossil CO2 emissions b y sector - Source: Emission Database for Global Atmospheric Research (EDGAR)

Conclusion

Many countries have proven in the recent years that a CO2 tax is a proper tool to enforce green energy in order to reduce CO2 emissions. Germany just introduced a program to shut down all coal fired power plants until 2035. Nevertheless, the introduced CO2 tax in Germany is much too low to achieve the Climate Change objectives. Emerging Countries should use best practise right from the beginning and should at least start with US$40/tCO2e.

Countries on the African continent, such as South Africa, Namibia or Morocco, have proven that Green Energy can be implemented and Green Energy today builds a major pillar of the energy mix.

Climate Change comes with a price, which means the price for electricity and fuel will go up. But if Africa or any other Emerging Markets are not acting now, they will make the same mistakes other developed countries have done in the past and the price we will need to pay in the end will be much higher.

In order to implement CO2 reduction Governments in the Emerging Markets needs to establish at the least the following:

• An Energy policy that encourages Green Energy with a clear commitment to targets and a roadmap when to chain which coal.

• Governments need to establish a clear and professional communication strategy in order to communicate the Green Energy Policy to the public, the end consumer and the utilities.

• Goverments need to develop an integrated resource plan, approve it and publish it.

• The national energy regulators need to establish take off and IPP policies for power plants on a utility scale as well as small roof top power plants feeding back into the grid.

• Governments also need to invest into the Transmission and Distribution network in order to balance the new green energy resources.

• Goverments need to define their role in the future financing of the Energy Sector and the Goverment Support Agreement they are willing to countersign for possible IPPs.

Countries such as Sweden and the United Kingdom have shown that a CO2 tax can not only be implemented successfully, but that a CO2 tax is a proven tool to reduce its countries CO2 footprint.

Furthermore, people need to be encouraged to consume less fossil fuel by using different technologies. Diesel cars can be replaced step by step by electric vehicles, street and traffic lights can be feed by solar pv plants, private and Goverment buildings could use more solar power and utilities could implement more solar power plants.

Some energy producing technologies especially on a utility scale still have not reached a mature state with a proven track record over the last 10 years. On the other hand when the first man flew to the moon, there was no previous experience to build upon.

In order to reduce CO2 emission one needs the following: A strong will to do the right thing and not getting derailed by details. Secondly, implementing a strong project management that covers all areas and departments of Goverment.