Energy prices must reflect their real cost to society

The green economy needs to get the fundamentals right.

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Economies work best when prices reflect the underlying value and all the costs that come with producing and using the product at hand. Unfortunately, that is frequently not the case.

In today’s green economy, this creates a major barrier on the road to net zero. If we are going to succeed in this epic endeavour, we need to talk about energy pricing, for oil and for carbon.

Oil prices are highly distorted. Subsidies for fossil fuel production and distribution have reached the staggering heights of 6.5% of global GDP, according to the IMF.

By comparison, the world’s spending on education amounts to just 4.5% of global GDP. 

Encouragingly, the G7 committed to phasing out such harmful subsidies by 2025 at its annual summit earlier this month. Hopefully, more progress will follow at the G20 in October and COP26 in November.

Halting fossil fuel subsidies and redirecting funds towards renewable energy should be a top priority if governments are serious about moving to a sustainable and inclusive economy. 

Relevant Sustainable Development Goals

At the same time, carbon prices need to be reviewed too. It would be most helpful to establish a carbon price that includes the total cost to society, as per the polluter-pays principle.

This can be done through taxes, which set a relatively constant price on carbon, or through market mechanisms where prices are allowed to fluctuate. 

Sweden is a notable leader in carbon taxes, imposing its first levy in 1991. Sweden’s tax on carbon emissions also remains the world’s highest, at US$126 per tonne, increasing government revenue while helping bring down greenhouse gases.

Even so, it only applies to 40% of the country’s emissions. It would be better still if this tax applied to all sectors equally. 

Sweden is also part of the world’s largest carbon market – the emissions trading system in the European Union (EU).

However, there are massive fossil fuel subsidies here too. Roughly half of carbon allowances are given away for free, and airlines only pay for 15% of their required allowances. 

Even so, the EU’s price for an allowance to emit carbon dioxide rose above €50 (~US$60) per tonne for the first time in May. The price has held above this level since.

 

Carbon prices should be higher

In 2017, the World Bank-backed High-Level Commission on Carbon Prices concluded that allowances to emit carbon dioxide should cost at least US$US40-80 per tonne by 2020, and US$50-100 per tonne by 2030, in order to achieve the goals in the Paris Agreement.

These price estimates already look outdated, however. One sign can be found in the internal carbon prices adopted within the private sector. 

In January, insurance giant Swiss Re set an internal price of US$100 per tonne. This applies to both direct and indirect operational emissions, including business travel.

Furthermore, Swiss Re plans to gradually lift its internal price to US$200 per tonne by 2030. That is a strong indication as to where the price ought to be. 

Carbon credit markets, where companies or individuals can purchase credits to voluntarily offset their emissions, also have a role to play.

CIX, a new carbon credit market set to launch in Singapore later this year, will focus on nature-based solutions while capitalising on technology to ensure a transparent and verifiable marketplace. 

Carbon credit markets are not tied to emissions trading systems or regulatory requirements. Many people see them as a way to legitimise continued emissions.

However, we are likely to need all the tools in the climate-positive toolbox to hit net-zero targets. Scaling up voluntary action in private markets can certainly sharpen this particular tool to the benefit of all. 

 

An unprecedented challenge

More than 100 countries have committed to net-zero emissions of CO2 and equivalent greenhouse gases by 2050. China has made the same pledge on the 2060 horizon.

The International Energy Agency’s recently published roadmap requires oil’s share in the global energy mix to drop from 80% to 20% to hit these targets.

The remaining 20% would be embedded in products such as plastics and in industrial processes such as steel and cement.

Hence, net zero means full fossil fuel phase-out across all other areas. 

Engineering this radical transformation in practically everything we do is an unprecedented challenge.

The most powerful way to bring about success is to stop using fossil fuel. That is easier said than done. 

The Biden administration’s support for extended drilling in Alaska’s National Petroleum Reserve is incomprehensible in this context.

So too is the fact that as many as 91 new major offshore oil and gas projects were approved worldwide in 2019, up from 32 in 2016, according to energy consultancy Rystad Energy. This needs to, and can, end immediately.

Nevertheless, given this resistance, market forces can stack the odds in favor of a positive outcome.

Getting pricing right optimizes capital flows across the green economy, steering money to where it is needed the most.

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Marie Owens Thomsen

Head of Global Trends and Sustainability, Lombard Odier Private Bank

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