The role of carbon pricing in meeting energy goals
Carbon prices can help prevent energy price shocks, but they are not the only tool available, argue Assia Elgouacem, acting head of tax and the environment, and Jonas Teusch, economist, tax and the environment, Organisation for Economic Co-operation and Development.
The lack of carbon pricing to date – around 60% of greenhouse gas emissions are not priced – has in part delayed the energy transition away from fossil fuels. Against this backdrop, it is encouraging that between 2018-21 carbon prices increased in 47 of the 71 countries covered in an Organisation for Economic Co-operation and Development report, strengthening incentives for households and businesses to reduce greenhouse gas emissions.
The highest carbon price increases were observed in countries where carbon prices were already relatively high, heightening differences among countries over the extent to which they rely on carbon pricing as part of their efforts to combat climate change. Carbon prices increased in all of the 10 countries with the highest prices in 2018, driven by a threefold increase in emissions permit prices in Europe. However, carbon prices only increased in half of the 10 countries where prices were lowest in 2018.
Many factors are behind the energy price hikes and it would be wrong to blame carbon pricing. Carbon pricing provides incentives for households and businesses to reduce carbon-intensive energy use and shift to cleaner fuels. Greater reliance on a diversified energy mix with a substantial share of clean energy, such as wind and solar, and more investments in energy efficiency would have limited the impact of rising fossil fuel prices on energy bills and could do so in the future.
Since mid-2021, several countries have reduced taxes on energy use – or introduced fossil fuel subsidies – in response to the energy price shock. Fuel tax cuts and subsidies in some countries have reduced the effective carbon prices substantially.
Shielding vulnerable households from price shocks is important to avoid energy poverty and can play an important role in building longer-term support for carbon pricing and the energy transition. Better targeting of support measures could be just as effective in addressing energy affordability needs, but at much lower fiscal cost than broad-based tax cuts and other price support measures.
Maintaining energy price signals will help to reduce the risk that the policy responses to the energy crisis slow down the transition to net zero. At the same time, preserving price signals would contribute to better protecting energy users from fossil fuel price shocks in the future, to the extent that prices help to drive investment in energy efficiency improvements and clean technologies.
Carbon prices and support measures are not the only tools to keep an eye on in the energy and climate space. Countries employ a range of policy approaches to work towards meeting their climate goals while ensuring access to affordable and clean energy.
Making the broader rules and regulations governing energy markets fit for the transition will have a major impact on whether private finance flows into the renewable assets that will be needed to meet energy and climate goals. Considering the decline in the cost of renewables, they are increasingly becoming more attractive investments than fossil fuel alternatives even in the absence of carbon pricing. And tax incentives, clean electricity standards and subsidies for green technologies can tip the balance in favour of low-carbon assets.
Unlike most other climate policy instruments, carbon pricing generates revenues that can be mobilised to further accelerate the green transition and meet other social and political priorities. By changing relative prices, it also draws in private sector money, reducing green spending needs, which further frees up fiscal space.
Countries will continue to use a mix of tools to meet climate goals, with some countries putting a greater emphasis on carbon pricing than others. This development highlights the importance of improved data and analysis – beyond carbon pricing – to obtain a more complete picture of countries’ climate mitigation strategies. This will be the focus of the OECD initiative on the Inclusive Forum on Carbon Mitigation Approaches.
The IFCMA will meet for the first time in February 2023 and will bring together experts from around the world to support the international community in achieving international climate goals set out in the Paris agreement.