Do current carbon prices align with Covid-19 recovery goals?

Carbon pricing is considered a key tool for reducing emissions and fighting climate change. However, despite praise from the media and international organisations, carbon pricing implementation does not always align with international climate goals, such as the Paris Agreement. In light of the Covid-19 crisis and the opportunity for new policies during the recovery, it is important to examine carbon prices with a critical lens to see if they are functioning properly.

The EU Emissions Trading System (ETS) is the largest carbon price in the world, and it has been around since 2005. After suffering through years of market instability and low allowance prices, the EU ETS finally recovered in 2019 when the allowance price rose above €20 for the first time since 2008. That the price is remaining high during the ongoing public health and economic crisis is a good sign that the reforms made to the system within the last 5 years are doing their job, keeping the market stable and more resistant to exogenous shocks. Although it dipped to €15 in March, the price rebounded back to nearly 30 €/tonne by the beginning of July, matching its previous peak in July 2019.

However, compare the current situation in the EU to the claims made about how carbon pricing can help meet Paris Agreement targets. For example, at the 9 June IEA Clean Energy Transitions Summit, UN Secretary-General António Guterres mentioned that placing a price on carbon will be essential for a sustainable recovery from the Covid-19 pandemic. Similarly, in a recent Financial Times article entitled ‘What does the pathway to net zero look like for miners?,’ the author James Whiteside states that ‘under a Paris aligned two-degree scenario, the price of carbon dioxide per tonne needs to rise to $110 a tonne everywhere by 2030.’ This outcome seems highly unlikely under existing carbon pricing schemes.

While the EU ETS is experiencing its highest allowance price ever, at 30 €/t, it is much higher than most other carbon prices around the world. According to the World Bank’s 2020 State and Trends of Carbon Pricing report, the average carbon price globally is 2 $/t, while half of the emissions covered by such schemes are priced at less than 10 $/t. Only a few countries, such as Norway and Sweden, have prices as high or higher than the threshold cited by Whiteside.

This example highlights the incongruence between modelled and actual carbon prices. Economic models often require a significantly higher carbon price in order to see a change in emissions in line with Paris targets. However, current prices are nowhere near the level needed and there is no indication that the status quo will change by 2030. If governments are committed to hitting Paris targets, and they want to use a carbon price to get there, they will have to reconsider massively the implementation of current carbon pricing schemes.