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The fundamentals of carbon pricing

The fundamentals of carbon pricing

Carbon emissions are a threat to our health, infrastructure, and economy - but who pays for the damages? CO2 volumes released by companies into the atmosphere create effects that are detrimental to us all. The issue is that those responsible for these emissions do not pay for the damage they cause. This is what we call a "negative externality."

To fix this problem and generate the funds needed to address the negative effects of carbon emissions, we need regulatory measures like putting a price on CO2. Carbon pricing makes sure that those who release emissions pay the costs of their impact on society. This can be done by governments through a regulated carbon market, or via voluntary carbon credit markets.

When it comes to regulated markets, on the one hand, there are carbon taxes - directly charging companies or individuals a set fee for each ton of CO2 they emit. The higher the emissions, the higher the tax. On the other hand, there are emissions Trading Schemes (ETS) - setting a limit on the total amount of CO2 that can be released. Companies acquire emission allowances, and they can trade these with other market participants.

There are also voluntary carbon markets where businesses or individuals choose to buy carbon credits to offset their emissions. These markets are very different in their structure, scale and effectiveness government-regulated schemes.

Once you understand the specific characteristics of different carbon pricing approaches, it’s clear that emissions trading schemes are the most effective way to tackle climate change at scale.

Linked content

Are carbon allowances the same as carbon credits?

Are carbon allowances the same as carbon credits?

Carbon allowances and carbon credits are fundamentally different. European Union Allowances (EUAs) operate in a massive, regulated compliance market. In contrast, carbon credits can take all sorts of shapes and sizes - they belong to a voluntary market and are often used for corporate carbon accounting purposes.
What is the social cost of carbon?

What is the social cost of carbon?

Releasing carbon into the atmosphere damages human health, societies, and the economy. The social cost of carbon (SCC) estimates the monetary value of the total damages caused by each tonne of CO2 released.
Are carbon allowances permits to pollute?

Are carbon allowances permits to pollute?

European Union Allowances (EUAs) are not permits to pollute. The EU Emissions trading scheme (EU ETS) drives decarbonization by incentivizing all companies to go green, not by favoring the rich. 
Why do we need to put a price on carbon emissions?

Why do we need to put a price on carbon emissions?

If governments fail to implement effective carbon pricing, there is nobody to pay for the cost of pollution. Instead, they are left for future generations to handle. 
How does a cap-and-trade scheme work?

How does a cap-and-trade scheme work?

The objective is straightforward: decarbonization. However, there are many ways to achieve it. Cap and trade schemes apply the free market laws of demand and supply - they incentivize industries to cut carbon emissions in the most optimal way they find feasible for their operations.