• Economic Research
  • Environmental Sustainability
  • Environmental Sustainability

Pricing carbon

Taxing polluters is the only way forward

Nearly three decades after it first agreed to tackle climate change, the world has failed miserably to curb the growth in CO2 emissions. To succeed, it urgently needs to establish an effective price for carbon.

In the 1820s, French mathematician Joseph Fourier calculated an object the size of Earth, and at its distance from the Sun, should be considerably colder than the planet is if warmed only by the effects of incoming solar radiation. His consideration of the possibility the Earth's atmosphere might act as an insulator is widely recognised as the first proposal of what came to be known as the greenhouse effect.

It took over a century, however, for the dangers of burning fossil fuels to be better understood. Edward Teller, a Hungarian-American theoretical physicist, sometimes referred to as ‘the father of the hydrogen bomb’, was among the first to sound the warning. At an address to the membership of the American Chemical Society in December 1957, Teller warned the large amount of fuel that had been burnt since the mid-19th century was increasing the concentration of carbon dioxide (CO2) in the atmosphere and would “act in the same way as a greenhouse by raising the temperature at the surface”.

By 1992, with evidence of the perils of man-made climate change mounting, 154 countries agreed to begin to address the problem. Signatories to the United Nations Framework Convention on Climate Change (UNFCCC) in Rio de Janeiro committed to reduce atmospheric concentrations of greenhouse gases with the goal of “preventing dangerous anthropogenic interference with Earth's climate system”. Nearly three decades and countless international conferences on, efforts to curb climate emissions have failed miserably.

Figure 1: Annual total CO2 emissions, by world region (billion tonnes)1
Annual total CO₂ emissions, by world region
Note: This measures CO₂ emissions from fossil fuels and cement production only – land use change is not included.
Source: Our World in Data based on the Global Carbon Project, data as of August 2020

Commons problem

Five years after Rio, the first international treaty to cut emissions was signed amid scenes of jubilation. The Kyoto Protocol, in which several developed countries agreed concrete steps to limit emissions, was hailed as a breakthrough to set the world on a new low-carbon path.

The Kyoto Protocol never looked likely to succeed

However, although the protocol entered into force in February 2005, it never really got off the ground. Four years earlier, the US had effectively withdrawn, having never even got as far as formally ratifying the treaty – the Byrd–Hagel Resolution, effectively rejecting it, was passed 95-0 in the Senate in 1997. Kyoto died a death on 31 December 2012, when Canada, Japan, New Zealand, and Russia withdrew.

Despite the acclaim that greeted Kyoto, the agreement never looked likely to succeed. To see why, ones needs to understand the nature of the problem policymakers are trying to confront.

Climate change is a problem of the ‘commons’. The atmosphere is shared between countries and while a CO2-abating country incurs the full cost of its abatement, it receives only a small fraction of the benefits. Moreover, most of those accrue to future generations, some in the distant future. As with any such public good, the self-interested response is to ‘free ride’ in the hope others will foot the bill. That is especially true in a globalised economy where energy costs affect competitiveness and there is an ever-present danger of ‘carbon leakage’.

Taxing or imposing limits on emissions must be negotiated among sovereign nations

Even within nations, resolving public goods problems such as road congestion or the provision of railway tracks can be problematic, especially for federated systems of government. But the global nature of the problem makes it that much more intractable since there is no government to prevent free riding. Instead, ways of addressing the problem by either taxing or imposing limits on emissions must be negotiated among sovereign nations.

Global cap and trade

The Kyoto negotiations tried to create a global cap-and-trade system, whereby a limit on emissions was set at a global level, following which individual countries would commit to cutting emissions beneath 1990 levels to varying degrees to meet that cap. The protocol assigned international emissions permits – ‘assigned amount units’ (AAUs) – and set up a system for trading them. The result was a patchwork of weak and unenforceable commitments that failed to address the free-rider problem.

Kyoto produced a patchwork of weak and unenforceable commitments that failed to address the free-rider problem

The AAU market proved so illiquid and secretive there was no effective market price and the price of few transactions was known; meanwhile, no carbon pricing policies resulted. To the extent Kyoto made any difference, it was via command-and-control policies such as subsidies and requirements for clean energy like wind and solar, as well as energy-efficiency improvements.

Nations have since stumbled through a series of summits and conferences to find a replacement without success. Although the UN Conference of the Parties (COP21) meeting in Paris received the usual victory statements – UN Secretary General Ban Ki-moon hailed it as “a monumental triumph for people and our planet”2 – the agreement was seen by some as a step back from Kyoto.

There was no longer any serious discussion of a common commitment to reduce the quantity of carbon emissions by negotiating a global cap. Countries merely agreed to non-binding, non-enforceable, incomparable ‘intended nationally determined contributions’ (INDCs).

Under a so-called pledge-and-review approach adopted at Paris, INDCs will be registered without any coordination of the method or the metric of measurement of the ambition of these actions. Reporting on, and verification of, the pledges was not decided, despite being crucial to the credibility of the system. In effect, there was no serious effort to confront the free-rider issue. Although the hope is for an upward spiral of ambition over time, history suggests this could be wishful thinking.

How not to negotiate

According to Dr Stephen Stoft, co-editor of the 2017 book Global Carbon Pricing, the failure of successive negotiations is telling. To see where things have gone wrong, he says game theory, particularly the work of political scientist Elinor Ostrom, is instructive. She was awarded the Nobel Prize in economics for her innovative work which, against the grain, argued that common-pool resource over usage was not inevitable, or subject to a ‘Tragedy of the Commons’ as the ecologist Garrett Hardin suggested in 1968. Drawing on both the science of game theory and real-world examples, Ostrom showed cooperation could be maintained by the interaction of reciprocity, reputation, and trust.

Ostrom’s work suggests Kyoto and Paris were doomed from the start

Stoft, who has consulted for the World Bank, the US Department of Energy, and the UK’s Department of Energy & Climate Change, says Ostrom’s work suggests the way negotiators went about trying to solve the problem at Kyoto and Paris meant the talks were doomed from the start.

Kyoto’s failure to deliver an agreement on curbing emissions is partly explained by the complexities involved in reaching a cap-and-trade deal at a global level with multiple countries involved, each with an incentive to negotiate a high cap for itself and free ride off others. At Kyoto, for example, negotiators unsuccessfully proposed at least ten formulae for establishing individual commitments. In the end, however, countries were merely asked to provide their final numbers for insertion into the draft.

As for the ‘pledge and review’ approach, not only was there nothing to prevent countries setting themselves unambitious targets, there was no agreed penalty for not meeting them.

Time for a change

Stoft says what Ostrom and others show is that to promote cooperation, a collective goal must be translated into a reciprocal accord: an agreement to abide by rules that specify ambitious behaviour, provided others abide by the same rules. Moreover, penalties for breaking the rules are needed to discipline free riders.  

Success requires a common commitment, not a patchwork of individual actions

“Success requires a common commitment, not a patchwork of individual actions. After 20 years of pretending to do what is right for the climate and doing almost nothing, it is time for a change of direction,” he says.

Yale professor William Nordhaus says if there is a single lesson to be learnt from economics, it is that “economic participants – thousands of governments, millions of firms, billions of people, all taking trillions of decisions each year – face a market price of carbon that reflects the social costs of their consumption, investment, and innovation”.

While Stoft agrees a uniform price would be economically efficient, he argues establishing a global minimum carbon price as a starting point would give the negotiations a much better chance of success. By providing a salient focal point for discussions, talks would likely be much more straightforward than those over a global cap-and-trade deal proved to be. It was Thomas Schelling, another American economist awarded the Nobel Prize for his work on game theory, who argued cooperation can be enhanced when participants’ actions converge on a focal point.

The idea of trying to establish a global carbon price appears to be gaining currency beyond academia. The Intergovernmental Panel on Climate Change, the UN’s own body for assessing the science related to climate change, recommends a “single global carbon price” high enough to create the necessary incentives to limit global warming to about 2C above pre-industrial levels.

In May 2019, over 75 businesses, including eBay, Nike, Mars, Microsoft, and PepsiCo, called on Congress to pass meaningful climate legislation. Placing a price on carbon was high up their agenda.3 In November 2020, a number of UK businesses called on their government to do likewise.4 The corporate world’s call for action has been echoed by various international bodies such as the World Bank, International Monetary Fund (IMF) and Organization for Economic Cooperation and Development. UN Secretary-General António Guterres has called for “much more progress on carbon pricing”.5

Leading policymakers are beginning to chime in too. In January, US Treasury Secretary Janet Yellen said the climate crisis cannot be solved “without effective carbon pricing”. Moreover, Yellen, who Stoft describes as the “best person to move the issue forward”, said US President Joe Biden supported an “enforcement mechanism that requires polluters to bear the full cost of the carbon pollution they are emitting".6 Just days later, European Central Bank chief Christine Lagarde talked of the need for an effective carbon price if “the EU's targets for reducing emissions are to be reached”.7

Skirting around the issue

The increasing calls for action make it hard to understand why successive UN climate change conferences have tended to skirt around the issue.

We’re running out of time and urgently need a concrete plan of action

“Go all the way back to Rio, they talked about internalising the externality. It just hasn’t happened. We’re running out of time and urgently need a concrete plan of action,” says Tom Tayler, senior manager in Aviva Investors’ Sustainable Finance Centre for Excellence.

Although the Paris Agreement talked about the need for a global carbon market, negotiators essentially kicked the can down the road. Article 6 is central to the integrity of the accord and negotiators have warned weak rules could undermine the entire agreement. Yet few appear to have much idea how the rules governing this mechanism could be made to work. Many doubt they ever can.

Article 6 is just two pages long. Perhaps in a deliberate effort to obfuscate, the wording is complex; tellingly, it fails to describe how the system will work, and what rules will ensure it leads to real emissions cuts, in anything other than the vaguest terms.

While some say resolving the article could make or break COP26, both Tayler and Aviva Investors’ chief responsible investment officer Steve Waygood believe such expectations are unrealistic.

Intensive lobbying by the fossil fuel industry has in the past been an obstacle to reaching agreement on carbon pricing at UN summits – for example, COP25 in Madrid was criticised because it was sponsored by some of Spain’s biggest polluters. However, the main impediment is that unanimity, or near unanimity, is required for agreement to be reached.

“Blaming the UNFCCC for not coming up with a global carbon price is unfair. It's an inappropriate forum,” says Waygood.

It is easy to conclude that international cooperation is doomed to failure. This is the wrong conclusion

Nordhaus, who has been dubbed the father of climate change economics and in 2018 received the Nobel Prize for his ground-breaking work modelling the interplay between climate change and the economy, says the requirement for unanimity is in reality “a recipe for inaction”, particularly where there are strong asymmetries in the costs and benefits.

“In light of the failure of the Kyoto Protocol, it is easy to conclude that international cooperation is doomed to failure. This is the wrong conclusion,” he argues.

Join the club

In April 2021, IMF chief Kristalina Georgieva said a “focus on a minimum carbon price floor among large emitters, such as the G20, could facilitate an agreement covering up to 80 per cent of global emissions”.8

She appears to have taken her cue from Nordhaus, who in 2015 advanced the idea of establishing a ‘climate club’ as a means of breaking the deadlock.

If the EU and China agree to impose a uniform price on all their carbon emissions, you could then envisage the US wanting to join

Luca Taschini, associate professorial research fellow at the London School of Economics’ Grantham Research Institute, agrees this may offer the best prospect of meaningful progress. While establishing such a club would not be simple, even if just the EU and China could agree to impose a uniform price on all their carbon emissions, “that would be a major step forward; you could then envisage the US wanting to join”.

Waygood says it is encouraging that the US and China were able to put ongoing difficulties in their bilateral relations to one side in April and commit to cooperating with each other and other countries to tackle the climate crisis with urgency.9

By pricing carbon, governments capture the costs that the public pays for in other ways, such as healthcare costs from pollution, heatwaves and droughts, and damage to property from fires, flooding, and sea level rise. A carbon price would give polluters – businesses and consumers – a choice: to discontinue their activity, gravitate towards greener technologies, or continue polluting and pay for it. It would also allow capital markets to more accurately compare companies’ true cost of capital.

Establishing what that carbon price should be is not straightforward. From an economic efficiency perspective, the price ought to match the social cost of carbon (SCC), the marginal damage caused by one extra tonne of emissions. Unfortunately, estimates of the SCC – strictly speaking the social cost of CO2, not simply carbon – are highly uncertain. They depend on a multitude of assumptions about future emissions, how the climate will respond, the impacts this will cause and crucially the discount rate applied to damages, some of which will be felt far into the future.

Estimates of the social cost of carbon vary across countries since they are partially dependent on national considerations

Moreover, estimates of the SCC vary across countries since they are partially dependent on national considerations. For example, it is generally estimated to be quite high in China, where there are domestic benefits from reducing air pollution in a relatively densely populated country. By contrast, in Australia, where there is a low population density and power plants are located near the coast so emissions disperse ‘harmlessly’ over the oceans, it is lower. In February, the US government estimated it at about $51 per tonne for the US.10

The IMF says a global carbon price of $75 or more per tonne is needed by 2030 to restrict global warming to below 2°C;11 the Bank of England reckons a price of £150 might be needed;12 while the International Energy Agency said in May the price in advanced economies needed to rise to $130 by 2030 and to $250 by 2050.13

The price is right?

According to Waygood, even if there is great uncertainty as to the optimal carbon price, that is no excuse for prevarication.

“One way forward could be for countries to agree to price carbon emissions at least as high as a global floor. Others would be free to set a higher price,” he says.

He was encouraged when G20 finance ministers in July 2021 collectively endorsed carbon pricing for the first time, describing the once contentious idea as one of “a wide set of tools” to tackle climate change.14

Countries or trading blocs could be given leeway to determine how to price emissions

Nordhaus says even pricing carbon at $35-40 per tonne would be “a reasonable start”, although thereafter the price would need to rise “three to four per cent a year in real terms”.

Theoretically, countries or trading blocs could be given leeway to determine how to price emissions, whether via taxation, a cap-and trade system or a combination of the two, even if most economists tend to believe taxation would be the cleanest, most readily comparable, and therefore optimal method.

“The most efficient strategy for slowing or preventing climate change is to impose a universal and internationally harmonised carbon tax levied on the carbon content of fossil fuels,” Nordhaus says.

Forming a club would not be without its difficulties. But although it would need to be determined at what point in the production process a carbon price was to be collected, and countries would need to be monitored to ensure they were not cooking the books, few hurdles are insurmountable.

The thorniest issue would be the need for richer nations to transfer money to poorer ones

For the system to work, the thorniest issue would be the need for richer nations to transfer money to poorer ones. Otherwise, the likelihood is many would be unwilling to impose a price on carbon, fearful it would unfairly curb economic growth. Not only do they see themselves as not having caused the problem, economic development is viewed as comparatively more important than the need to mitigate climate change.

However, although discussions over the size of transfer payments undermined the Kyoto discussions, this does not mean renewed attempts are doomed to failure as well. Rather, it is an argument for setting a realistic initial carbon price, especially since there would be nothing to prevent richer nations from being more ambitious.

Carrot and stick

Taschini says that as well as the carrot of transfer payments to induce developing countries to set a minimum carbon price and join the club, a stick would be needed to discipline free riders and prevent carbon leakage.

Estimates of the potential for carbon leakage vary wildly. An analysis of 25 studies suggested countries risked giving up between five and 25 per cent of their total emissions reductions due to companies moving high-carbon production elsewhere.15 To avoid this, Taschini says the obvious stick to use would be tariffs on imports from countries that refused to join the club.

This explains why the EU in July said it planned to introduce a carbon border levy by 2026. By holding products such as imported steel, aluminium, fertiliser and cement responsible for their emissions the same way domestically produced products are, the aim is to maintain the bloc’s competitiveness, prevent carbon leakage, and ultimately encourage other countries to match the EU’s ambition.

Some sceptics see the EU’s plans as little more than a form of green protectionism, while members of the World Trade Organisation have questioned whether they would be compliant with existing WTO rules. However, Taschini believes integrating environmental concerns in a way that doesn’t infringe the WTO’s rulebook is “absolutely possible”.

Biden’s climate envoy John Kerry, having in March warned the EU that a carbon border tax adjustment should be a “last resort”,16 within two months said the US was considering copying it.17

Companies will be compelled to manage their carbon footprints with greater urgency

According to Boston Consulting Group, the size and strategic importance of the EU market means a border tax “could transform the fundamentals of global advantage”. In a report published in June 2020, it said companies around the world will be “compelled to manage their carbon footprints with greater urgency”. The degree of impact on industrial sectors would be largely influenced by two factors: carbon intensity and trade intensity.18

One of the most frequent arguments against carbon taxation is that it is regressive with poorer members of society hit hardest. However, since taxes would be levied and retained at the national level, there is nothing to prevent countries redistributing those tax receipts progressively.

Carbon pricing schemes have been growing both in number and ambition. According to the World Bank, as of April 2021 there were 64 initiatives – 29 emissions trading schemes and 35 carbon taxes.19 However, those covered just 22 percent of global emissions.

Figure 2: Share of global emissions covered by global pricing initiatives (ETS and carbon tax) (per cent)20
Share of global emissions covered by global pricing initiatives
Note: The GHG emissions coverage for each jurisdiction is based on official government sources and/or estimates.  The information on the China national ETS represents early unofficial estimates based on the announcement of China’s National Development and Reform Commission on the launch of the national ETS of December 2017.
Source: The World Bank, April 1, 2021

Worse still, the size of levy on the emissions being taxed is woefully inadequate. According to Germany’s statistics office, global CO2 emissions reached a record 38 billion tonnes in 2019, with G20 states responsible for around 80 per cent, or 30.4 billion tonnes.21

Although the Institute for Climate Economics estimates carbon revenues collected by the G20 almost tripled from $16.9 billion to $47.8 billion between 2016 and 2019,22 this implies an average CO2 emissions taxation rate of just over $1.5 per tonne in 2019. While the IMF puts the figure for the world as a whole at closer to $3 per tonne23, even that is just a tiny fraction of what most believe is needed and little more than six per cent of what the US government estimates the SCC to be.

Figure 3: Carbon pricing revenues in G20 countries (US$mn)
Carbon pricing revenues in G20 countries
Note: RGGI = Regional Greenhouse Gas Initiative (Connecticut, Delaware, Maine, Maryland, Massachuetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont).
Source: Institute for Climate Economics

Not that taxing

One reason the world struggles to kick its addiction to fossil fuels is the perceived cost of doing so. Although many activists and politicians promote climate mitigation policies as an opportunity to create jobs and boost growth, the argument looks specious. The fact so few countries come even close to doing their fair share speaks volumes. After all, burning carbon enables valuable activities to happen, such as driving cars, heating houses and manufacturing steel. Taxing carbon, until greener replacements become more available, inevitably leads to a reduction in consumer welfare as those activities are reduced.

Establishing an effective carbon price seems unlikely to be as ruinous as some fear

Having said that, establishing an effective carbon price seems unlikely to be as ruinous as some fear. Take a carbon price of $40. That would add around $74, around 12 per cent, to the price of a tonne of steel, $72 to the cost of a return flight between London and New York and would be equivalent to just 9.2 US cents (6.6 British pence) on a litre of petrol.

Imposed around the world, a carbon price of $40 would raise tax revenues of around $1.5 trillion, or roughly 1.7 per cent of global GDP. But while it might seem that would lead to a corresponding drop in consumption and investment, that ignores the fact the same tax revenues would be recycled.

The dead-weight loss likely to result from taxing carbon would be a small fraction of that. Moreover, it would most likely quickly diminish as new technologies were developed to facilitate the shift away from burning carbon. Indeed, Bank of America suggests tackling climate change offers a massive opportunity to get ahead of rivals in developing the clean technologies of the future.24 Besides, the costs need to be judged against the long-term consequences of inaction.

For the time being, the world appears to have got the worst of both worlds. Not only are the measures being taken well short of what is needed to meaningfully tackle global warming, governments are creating massive economic inefficiencies by failing to co-ordinate action. Take the huge disparity in fuel taxes. Whereas diesel levies in the UK, Germany and France are 59, 58 and 43 per cent respectively, the US levies just 12 per cent and China does not tax it at all.25

Figure 4: Filling the (80-litre) tank of a Ford Transit with diesel – proportion of cost made up of fuel cost and tax26
Filling the (80-litre) tank of a Ford Transit with diesel – proportion of cost made up of fuel cost and tax
Source: UHY, 2014

The world’s ongoing failure to price carbon has led to a mishmash of command-and-control policies. They range from the imposition of auto emissions standards or the complete phasing out of internal combustion engine car sales, to the subsidisation of various green technologies. In many cases these come at a high cost and are of questionable benefit.

The world’s ongoing failure to price carbon has led to a mishmash of command-and-control policies

One of the clearest examples is Germany’s Energiewende legislation. In 2010, the country set itself an ambitious renewable energy target of 60 per cent by 2050. However, the programme is widely seen as an unmitigated disaster.

Following the Fukushima nuclear accident of 2011, Germany decided to close its nuclear plants. Unable to build renewables fast enough, it turned to lignite, a particularly dirty form of coal. As a result, CO2 emissions have hardly dropped at all. In 2000, the country derived nearly 84 percent of its total primary energy from fossil fuels; this share fell to about 78 percent in 2019. At this rate, fossil fuels will still be providing nearly 70 per cent of the country’s primary energy supply in 2050. Meanwhile, the average cost of electricity for German households has doubled since 2000. By 2019, they had to pay 34 US cents per kilowatt-hour, compared to 22 cents in France and 13 cents in the US.27

Pricing power

In many instances, with politicians unwilling to grasp the nettle, the problem is being outsourced to the private sector. While not denying the private sector has a vital role to play, for example by refusing to finance a coal-related project or demanding higher returns from investments in oil exploration companies, Waygood says it needs a carbon price to perform this function efficiently.

In 1920, British economist Arthur Pigou outlined the merits of using “bounties and taxes” to tackle the problem of externalities – an issue first identified by his tutor Alfred Marshall. By using prices to correct market failures, such a solution would be preferable to regulation that risked strangling people with red tape.

While no one would suggest we immediately stop driving, flying, or using steel, the sooner we admit these activities come with a cost, the better

As Waygood says: “We have the world's biggest market failure in climate change, and this will go on until we start to price at least a significant chunk of worldwide carbon emissions more appropriately. While no one would suggest we immediately stop driving, flying, or using steel, the sooner we admit these activities come with a cost, the better.”

While Stoft is pessimistic on the prospects for change in the immediate future, he retains hope that increased interest in, and acceptance of, national carbon pricing “might naturally lead to global carbon pricing in another five years, when people get more desperate”.

Edward Teller came to be seen by some in the scientific community as something of a villain, partly because of his outspoken support for the development of a hydrogen bomb by the US. But by pointing out the dangers of burning carbon, he alerted the world to an even bigger threat. In doing so, he arguably deserves to be cast in a more favourable light. As for Pigou, while his work is not without critics, it would appear to offer the world an obvious way of dealing with the problem Teller helped identify.

Investing in anticipation of higher carbon prices

While the world may have so far failed to impose a sufficiently high price on carbon to limit the consumption of fossil fuels, investors would be wise not to bet on this persisting indefinitely.

In May 2019, over 75 businesses, including BP, eBay, Nike, Mars, Microsoft, Nestlé, PepsiCo, Shell, Tesla and Unilever, met with US lawmakers to call on Congress to pass meaningful climate legislation. Placing a price on carbon was high up their agenda.28 Influential policymakers including Janet Yellen, Christine Lagarde and Ursula von der Leyen, have also joined the call for action.

The growing clamour for the world to start pricing carbon closer to its true societal cost means investors should be trying to incorporate higher carbon prices into their valuations of securities issued by a wide range of companies, not just fossil fuel producers and energy suppliers.

“While an effective carbon price may be some way off, the direction of travel is clear. Companies that better manage climate transition risks – for example by minimising potential externalities such as the impact of the imposition of a carbon price on their operations and hence earnings – should outperform in the long run,” says Julie Zhuang, global equities portfolio manager at Aviva Investors.

This helps explain her “fairly negative views” on steel and fertiliser production companies. Zhuang believes many firms in high-emitting sectors such as these face years of materially increased capital expenditure in lower-emitting technologies, and potentially diminishing returns if their businesses are to avoid being rendered uncompetitive by tougher regulations and/or higher carbon prices.

Similarly, Justine Vroman, investment grade credit portfolio manager at Aviva Investors, says while the introduction of an explicit and meaningful carbon price may be some way off, credit investors need to recognise the issue threatens to radically alter the investment landscape.

“With the introduction of the EU Emissions Trading System, many European utilities have become pioneers in terms of investing in renewables and smart grids and decommissioning thermal-coal facilities. Meanwhile, their US counterparts still have a long road ahead to decarbonise. As a result, the cost of debt of some US utilities may not fully reflect the amount of capital expenditure needed,” she says.

In the absence of more effective action from governments, it is often left to companies to introduce some form of internal carbon pricing mechanism. They are doing this both to help determine projects in which to invest, and to reduce carbon emissions within their supply chains.

According to a May 2020 report from CDP – a not-for-profit charity that runs the global disclosure system for investors, companies, cities, states and regions – of more than 5,900 companies worldwide who disclosed information, 853 said they already use an internal carbon price, representing a 43 per cent increase in two years. A further 1,159 said they planned to do so within two years.29

Vroman says the climate transition credit strategy she co-manages uses this information to help identify leaders and laggards in the transition to a low-carbon economy.

“Companies that use an internal carbon price are more likely to be taking steps to incorporate climate risk into their business strategy and committing to set science-based targets,” she says, adding the adoption of these targets is an effective way of driving change as it puts pressure on emissions reduction throughout the value chain.

However, both she and Zhuang concede that, while the growing prevalence of internal carbon pricing is welcome, it is a far-from-optimal solution.

As Zhuang points out, several oil majors have in recent years begun adopting internal carbon pricing to evaluate new projects, under pressure from investors. In many instances that has led the likes of Shell, Total and others to divest assets.

Unfortunately, all too often this has merely shifted assets from a publicly listed owner to private companies or foreign state-run operators, who are often under little or no scrutiny from investors and other stakeholders.

“If all we’re doing is shifting assets from one type of company to another, that’s not going to tackle climate change. It’s another argument for a carbon tax mechanism that would apply to companies, regardless of who the ultimate owner is,” says Zhuang.

As for Vroman, she says while the accuracy of carbon accounting remains an issue, especially for Scope 3 emissions that factor in supply chains and product use, regional carbon pricing initiatives have had an impact by forcing companies in various sectors to adapt faster. She concludes a more coordinated approach applied by governments across the board with regards to carbon pricing would be “a powerful catalyst for global decarbonisation”.

Unfortunately, that still appears some way off. In the absence of governments imposing an explicit price on all activities that emit carbon, markets will struggle to accurately gauge the climate transition costs facing individual companies.

Nonetheless, Vroman says investors can seek to identify the long-term winners and losers of a transition toward a low-carbon world. She and her team are investing in both solution providers to climate change, enabling the transition towards net-zero, and transition-ready companies that are making their value chains resilient to climate change.

“The push for further climate regulation globally is inevitably going to accelerate the gap between leaders and laggards. Companies that are pivoting ahead will outperform over the long term,” she says.


  1. Hannah Ritchie and Max Roser, ‘CO₂ and greenhouse gas emissions’, Our World in Data, August 2020
  2. ‘COP21: UN chief hails new climate change agreement as ‘monumental triumph’’, United Nations, December 12, 2015
  3. Mark Evans, ‘Businesses march on Washington to demand action’, Better Society Network, May 23, 2019
  4. ‘Business, finance, academia and civil society call on the UK Government to lead high ambition carbon pricing club at COP26’, Circular, November 25, 2020
  5. ‘Calls increase to use carbon pricing as an effective climate action tool’, United Nations Climate Change, September 22, 2020
  6. Ben Geman, ‘Yellen says Biden is "fully supportive" of carbon pricing’, Axios, January 21, 2021
  7. Frank Watson, ‘ECB sees rapid progress on carbon pricing: Lagarde’, S&P Global Platts, January 25, 2021
  8. Andrea Shalal, ‘IMF chief urges G20 to adopt carbon price floor to reach climate goals’, Reuters, April 22, 2021
  9. ‘U.S.-China joint statement addressing the climate crisis’, U.S. Department of State, April 17, 2021
  10. Jean Chemnick, ‘Cost of carbon pollution pegged at $51 a ton’, Scientific American, March 1, 2021
  11. Vitor Gaspar and Ian Parry, ‘A proposal to scale up global carbon pricing’, IMFBlog, June 18, 2021
  12. ‘Climate change – plotting our course to net zero - speech by Sarah Breeden’, Bank of England, May 18, 2021
  13. Anita Hafner, et al., ‘The importance of real-world policy packages to drive energy transitions’, IEA, July 9, 2018
  14. ‘Italian G20 Presidency, Third Finance Ministers and Central Bank Governors meeting: Communiqué 9-10 July 2021’, G20, July 2021
  15. Frédéric Branger and Philippe Quirion, ‘Would border carbon adjustments prevent carbon leakage and heavy industry competitiveness losses? Insights from a meta-analysis of recent economic studies’, Ecological Economics, March 2014, vol 99.
  16. Leslie Hook, ‘John Kerry warns EU against carbon border tax’, Financial Times, March 12, 2021
  17. Frank Jordans, ‘Kerry says US examining carbon border tax, sees risks’, AP, May 18, 2021
  18. Ben Aylor, et al., ‘How an EU carbon border tax could jolt world trade’, BCG, June 30, 2020
  19. ‘Carbon pricing dashboard’, The World Bank, April 1, 2021
  20. ‘Carbon pricing dashboard’, The World Bank, April 1, 2021
  21. ‘International statistics: Environment’, Statistisches Bundesamt, 2021
  22. Sébastien Postic and Marion Fetet, ‘Global carbon accounts 2020’, Institute for Climate Economics, May 2020
  23. Vitor Gaspar and Ian Parry, ‘A proposal to scale up global carbon pricing’, IMFBlog, June 18, 2021
  24. Bank of America research paper, February 2, 2021
  25. ‘European companies struggling with the world’s highest fuel costs’, UHY, May 6, 2014
  26. ‘European companies struggling with the world’s highest fuel costs’, UHY, May 6, 2014
  27. Vaclav Smil, ‘Germany's Energiewende, 20 years later Germany's far-reaching program to reduce the share of fossil fuels in energy has achieved almost exactly what the United States achieved, but at greater expense’, IEEE Spectrum, November 25, 2020
  28. Mark Evans, ‘Businesses march on Washington to demand action’, Better Society Network, May 23, 2019
  29. ‘Putting a price on carbon: The state of internal carbon pricing by corporates globally’, CDP, April 2021

View Cleaning Up Capitalism edition online

To tackle the climate crisis, economies and markets need a systems reboot. In AIQ: Cleaning Up Capitalism, we examine what it will take to get us back on track to achieve net zero; from transforming the financial system and accounting, to decarbonising heavy industries and ensuring polluters pay.

Find out more

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our privacy notice.

Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.