Carbon Pricing: An Economic Solution to an Environmental Problem

Marjan Aslani
December 15, 2012

Submitted as coursework for PH240, Stanford University, Fall 2012

Carbon Dioxide and other greenhouse gases in the atmosphere are causing severe climate changes. Pollution heats the planet which has a cost on our natural environment and our way of life. Instead of being able to pollute for free and passing the overwhelming cost of pollution to the future generations, big polluters must pay a price for every ton of greenhouse gas they create. A carbon price is a cost applied to the right to emit CO2 to encourage polluters to reduce the amount of carbon pollution they emit into the atmosphere. Establishing a carbon price is one of the most powerful mechanisms available to curb greenhouse gas emissions. [1] Once included in the energy legislation, industry must factor in the cost of carbon pollution in their business, just as they factor in materials and labor. To serve its purpose, and prevent industries to get around this cost by simply increasing the final price of their product, the carbon price must be sufficiently high to encourage polluters to change behavior and transition to low carbon economy in accordance with national targets through switching to low emission energy sources as well as innovation in energy efficiency. This creates a competitive advantage for businesses, investors, researchers and innovators who find cleaner ways of doing business. With a carbon price in place, the costs of stopping climate change are distributed across generations. Without that price signal, it will be difficult to get sustained investment in clean power technologies.

The types of changes a carbon price can deliver are: [2]

Establishing Carbon Price

There are two ways for a government to establish a carbon price. First, it can impose tax on the distribution and consumption of fossil fuels in direct proportion to their carbon content. This could encourage business and people to transition to greener fuel, such as substituting coal with natural gas.

In the second approach, the maximum allowable emission in a country or region is determined by a regulatory authority and permits to pollute are created for this emission budget. Permits are allocated or auctioned to companies and the companies can trade them between one another, introducing a market for pollution that should ensure that the carbon savings are made as cheaply as possible. [1] Putting an appropriate price on carbon; explicitly through tax or trading, or implicitly through regulation, means that people are faced with the full social cost of their actions. [3]

Currently carbon price varies by regions and countries, and are not established in many regions as well. In the United States although carbon pricing exists in some areas under regional and state based systems, a consistent national approach has yet to be developed. Ideally, there should be a uniform carbon price across the world, reflecting the fact that greenhouse gases have the same impact wherever they are emitted. Uniform pricing would also remove the risk that polluting businesses flee to "pollution havens"'- unregulated economies that are open to international trade. [4]

In 2013, the floor price for California carbon allowances sold at state-run auctions will be at $10.09 per ton. Prices for European Union emissions, currently set at 6 euros a ton, is expected to drop bellow 5 euros for that year. Many analysts believe minimum price of at least 20 euros is necessary to convince industry and utilities to adopt cleaner forms of energy over coal and gas. Large energy companies including Shell, BP and Dong Energy say that prices of between 20 and 50 euros are needed to justify investment in clean technologies such as carbon capture and storage. [5]

Global Task of Managing Carbon Emissions

Carbon pollution is not confined to national borders. It affects the whole planet. To establish a clear,ambitious and cost effective global energy policy framework that includes emissions management, requires that major current consumers of energy and emitters such as the USA, EU, China, Canada, Russia and Australia to partner up and implement regulations than ensures substantial CO2 emission reduction. Not only global participation has to be encourage, but also through administrating and reviewing the rules, appropriate accountabilities for uncontrolled CO2 emission has to be established. [3]

In 2009, president Obama pledged to cut U.S. emissions by 17 percent below 2005 levels by 2020. The Climate Action Tracker report for 2012, announced that major emitters China, the US, the European Union and Russia all got "inadequate" ratings for their plans to help limit global warming by 2020. Among the biggest emitters, only Japan and South Korea had formal policies for cuts that were "sufficient". India, Brazil and Indonesia got a "medium" rating, according to the scorecard. [6]

In long term, development, demonstration and deployment of new technologies will be critical to the management of emissions. In addition to increase use of currently available cleaner technologies, such as wind, biofuels, natural gas and nuclear, new energy technologies such as solar will require to develop. This necessitates advance planning to ensure that the technical skill base for the new technologies are grown and investment decisions are made to support this endeavor.

© Marjan Aslani. The author grants permission to copy, distribute and display this work in unaltered form, with attribution to the author, for noncommercial purposes only. All other rights, including commercial rights, are reserved to the author.


[1] H. Saddler and F. Muller, "Competitiveness and Carbon Pricing: Border Adjustments for Greenhouse Policies," The Australia Institute, Discussion Paper 86, April 2006.

[2] "Securing a Clean Energy Future: the Australian Government's Climate Change Plan," Department of Climate Change and Energy Efficiency, Commonwealth of Australia, 2011.

[3] N. Stern, The Economics of Climate Change: The Stern Review (Cambridge U. Press, 2007).

[4] D. Clark, "What Is a Carbon Price and Why Do We Need One?," The Guardian, 16 July 12.

[5] N. Chestney, "EU Climate Fight Hit by New Record Low Carbon Price," Reuters, 30 Nov 12.

[6] A. Doyle and M. Kruppa, "Pledges to Fight Global Warming Inadequate, U.S. Off Track," Reuters, 30 Nov 12.