In a low carbon economy, carbon must be priced and traded. Indeed, the many carbon markets around the world reflect the common conclusion of policy makers that pricing a ton of carbon is essential to bring market forces to bear on marginal emitting activities. Markets now cover 20% of global emissions, a 4X increase in ten years. While the many active carbon markets demonstrate the utility of pricing carbon as a policy tool, the sovereign limitations of regulatory regimes preclude have commoditize carbon.
Commoditization is important
Commoditization is an important final step for carbon markets. The Chicago Mecantile Exhange puts it thus:
It is a difficult task to mitigate climate risk without a universal benchmark, which has proven elusive … [t]he uniqueness and regional nature of emissions trading schemes and carbon offset projects have prevented harmonization between programs, and ultimately, the development of a standardized price.
Carbon is in many ways the ultimate commodity. Carbon is totally fungible, with greenhouse gases having the same environmental impact whether they are released in Alaska or Zimbabwe. Emission reduction efforts in any economy have the same environmental benefit, regardless of the cost of the reduction. Accordingly, a ton a carbon should have the same value regardless of origin.
To complete the process of commoditization, a ton of carbon needs a commonly recognized base price. We know from other commodities, a base price is the essential element to unlocking financing. However, fragmentation in compliance markets and lack of fungibilty between offset credits means today there is no base, reference price for a ton of carbon.
Carbon functioning as a commodity
Carbon, as a commodity, has inherent scale. In addition to outright pricing of emissions of carbon itself, carbon is imbedded in most other commodities from energy and metals to soybeans and corn. In a low carbon economy trading of these commodities will implicitly be linked to trading of carbon to manage price risks. Already much electricity and many energy commodities are influenced by price of carbon in the relevant geography. Corporate decision making relies on pricing carbon for strategic decision making, accounting and regulatory financial risk disclosures.
The absence of a base, reference price for carbon frustrates these efforts and impedes the transition to a low carbon economy. To maximize environmental outcomes, economic models tell us that emission reductions should be done where the cost of mitigating or sequestering that ton of carbon is cheapest. Thus, each dollar spent achieves the greatest environmental benefit. When pricing for a ton of carbon varies widely between different markets, economic actor’s decision nmaking is inefficient and does not maximize environmental benefits from low carbon investments.
We know from the emergence of the other high-volume commodities that markets rely on the base price for the physical commodity to provide access to a robust, global financing system for commodities industries. Trade finance provides financing for production, storage and transport of commodities. Bank lending relies on offtake contracts with credit worthy buyers to de-risk lending decisions. Supply chain finance provides working capital efficiency.
This robust financial ecosystem that can fund the transition to low carbon economy will remain out of reach until carbon is commoditized with a base price.
