Determining the price of Carbon: taking several roads

Asset Management - 7/28/2016

The prospect of COP21 sparked considerable debate over how to set a price, or several prices, for carbon. In years to come, it is hoped that an increasing number of countries will take action. It remains to be seen which path will be chosen, as we consider the intensity of the debates and the many experiences already underway.

For many players (heads of state, company directors, economists), setting a price for carbon is fundamental to foster the in-depth transformation of the world economy and its compatibility with a 2 degree global warming limit1. The core idea is to create a positive incentive for companies and financial institutions to devise and deploy low-carbon solutions that can be “valued” based on carbon prices. As of today, around forty countries have set up a carbon tax and/or a market for quotas. Prices vary from a couple of euros per tonne of CO2 to over one hundred (in Sweden). France has implemented a form of carbon tax ( limate-energy contribution tax) as acomponent of the carbon tax on petroland fuel. This year, the tax amounted to 22 euros per tonne of CO2 and should rise to 30.5 euros in 20172, 56 euros in 2020 and 100 euros in 2030.

The Paris Agreement signed at the end of the COP 21 summit refers to the usefulness of a carbon price in article 137. The law recognises “the importance of providing incentives to reducing emissions, particularly through tools such as national policies and carbon pricing”. At the same time, it is important to reduce the subsidies given to fossil fuels (500 billion dollars every year), which the lower price of oil is facilitating. This may happen through pressure from the international community – although this will have to take into account local specificities. Subsidies to corporate companies in the U.S. fossil fuel industry cannot fall under the same heading as those awarded to households in the poorest countries.

Be realistic

 To remain on a 2 degree trajectory, it is important to act swiftly and to overlook “political imperfections” and country and sector discrepancies. The main objective is to find a road that is as realistic as possible. It is counterproductive to aim for the creation of a unique international price or for a global CO2 quota market. In this context, the debate over taxes and quotas is rather pointless. In practice, countries and groups of countries will always implement hybrid solutions (taxes, quotas, rules, subsidies) or a series of measures.

 Regulation, standards and subsidies are often viewed by theoretical economists as non-optimal, and by liberal economists as against their economic ideal of free-trade. This theoretical point may be discussed, but in practice, we have observed that these mechanisms can be implemented in our democracies and that they can be effective in lowering emissions in a number of industries (such as construction – a key challenge –, or the car industry even if the Volkswagen scandal demonstrated that a powerful and credible environment “police” was needed). Of course, it is necessary to identify the eligible sectors. Note that these regulatory signals infer an implied carbon price signal that can sometimes be high.

The ultimate convergence of carbon prices

 Each country or group of countries makes its own arbitrage regarding “the measures package”. Aiming to reach an agreement on the best theoretical solution - and particularly on the allocation of the resulting income – is deeply unrealistic. This is why it is preferable that a club of voluntary countries and companies - as widely representative as possible – should commit to setting a price for carbon, but within boundaries (a price range that increases over time). This club can operate alongside the World Bank’s “Carbon Pricing Leadership”3 initiative. In our report « Mobiliser les financements pour le climat – Une feuille de route pour financer une économie décarbonée »4, we suggested a range of 20/25 dollars that would rise to 60/80 in 2030. These figures are open to discussion.

The ultimate convergence of carbon prices is possible through market connections or solutions that are currently being implemented. It could also occur through mechanisms designed to provide a competitive equilibrium, such as the CIM – Carbon inclusion mechanism – through which importers of products into Europe would have to buy pollution quotas.

The same price signal expressed in euros per tonne of CO2 has varying effects on different sectors when expressed relative to euros per labour unit tonne and as a ratio of cost of CO2/cost of a unit of work. Just looking at one example, a carbon tax of 20 euros per tonne of CO2 accounts for 32% of the price (VAT excluded) of a tonne of cement5 and 3% of a MWh of electricity produced in France and sold on the wholesale market in 2014. Applying one single mechanism to sectors that react so differently to the price signal can only lead to a race to the bottom. Consequently, the sectors that are most affected exert pressure on political leaders to limit these impacts. Compensation mechanisms can be set up (free allocations for instance) - but these are not optimal as far as the fight against climate change is concerned. A similar observation can be made from a regional perspective: a given price can have a very different impact depending on a country’s economic advancement.

1. Target: limiting the rise of global temperatures to 2 degrees.
2. Source: 2015 Budget Law. The annual carbon tax rises will nevertheless have to be voted every year.
3. International coalition in favour of a global carbon pricing which brings together 25 countries and local players, alongside 100 companies.
4. Report from the Pascal Canfin – Alain Grandjean commission published in June 2015.
5. The “carbon content” of cement is 0.8 tonne CO2 per tonne; at €20 per tonne, the cost of carbon is €16, which relative to a price of 50 euros, for example – as this price fluctuates – comes to 32%. Based on a higher price for cement, for instance 150 euros/tonne, the conclusion is unchanged (CO2 would therefore weigh 10%).



Setting a price for carbon may be considered as :

  • Reflecting the discounted value of the present and future damage caused to the environment. It would therefore be a single price (yet impossible to calculate as it implies relying upon a perfect modelling of the aforementioned damage and of their value for current and future generations).

  • A signal that would act as an incentive for those concerned to modify their behaviour and reduce greenhouse gas emissions (GHG). It would therefore be logical to imagine that the price may vary depending on the industry and country. A price set at €50/tonne of CO2 does not have the same macroeconomic consequences in Nigeria as it would have in France.

  • Needing to reflect the cost of emissions that need to be avoided by a given player in order to remain on a two-degree trajectory. This would be the equivalent to the cost of reconstituting the natural capital, provisioned in the concerned entity’s accounts.

Depending on the preferred philosophy, the logic for calculating the price(s) of carbon may vary. At this stage, the incentive philosophy dominates worldwide and explains the use of diversified sets of measures.


Alain Grandjean is a graduate of Ecole Polytechnique and Ecole Nationale Supérieure de la Statistique et de l’Administration Economique; he holds a PhD in Environmental Economics and is co-founder of Carbone 4, a consultancy firm specialized in carbon strategy. He coauthored the report “Mobiliser les financements pour le climat” with Pascal Canfin, former Minister of State in charge of Development, and has written many books on climate issues. Ségolène Royal has mandated Gérard Mestrallet, Pascal Canfin and Alain Grandjean to work on the price of carbon at European level; the report should be published mid-July.

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