EnvironmentSmith School of Enterprise and the Environment27Chapter 5: Next StepsPricing CarbonIt is generally agreed that one of the most useful tools in inducing action on mitigating emissions is the pricing of GHG emissions. While by itself pricing will not be sufficient to tackle climate change, it is nonetheless a key part of climate policy. The need to price environmental externalities is a basic lesson from environmental economics. It sends a signal to the marketplace that governments are serious in taking action on climate change, incentivises reductions in emissions, and draws attention to the cost-effectiveness of investment in low carbon infrastructure [48]. Importantly, a high price incentivises the research, innovation, wealth creation chain, developing new energy efficient and low carbon technologies for the market. Setting a global price on CO2 emissions would clearly prevent carbon leakage. There are three main ways of pricing CO2: CO2 taxes, CO2 trading, and implicit pricing via regulations and standards. Each of the three approaches has different advantages and disadvantages, and all three are likely to be used in some form at some level of government. Regulation and Standards-Based PoliciesThese include efficiency standards for various goods, vehicle fuel-economy standards and best-available control technology standards. While undoubtedly a useful mechanism, there are several drawbacks to using a regulation and standards approach to reducing emissions. For example, regulatory standards are very often only applied to new, rather than existing, equipment Chapter 5which limits the opportunity for near-term reduction. Emissions would also therefore be dependent on the rate of capital stock turnover. Importantly, increasing the cost of new stock without affecting that of the existing stock means that incentives are created to continue using the old, higher CO2-emitting stock, thereby delaying emissions reductions [49]. Furthermore, in terms of cost-effectiveness, standards and regulatory approaches cannot compete with CO2 trading. CO2 Taxes and TradingTaxes and trading in the economists' idealised world would provide the same results as each other [50]. However, idealised conditions seldom occur. Taxes will fix the CO2 price but leave the quantity of emissions uncertain and trading fixes quantity but leaves price uncertain. Setting taxes too low would lead emissions to overshoot their target. A globally agreed CO2 tax therefore would offer less certainty than CO2 trading in meeting a desired target. By the same logic CO2 trading can lead to much more price uncertainty and volatility than taxes which, in a world where businesses prefer clear and stable signals for decision-making and investment, is not ideal. In either case, achieving a significant reduction in emissions requires a real commitment from governments: if the CO2 caps for the trading process are insufficient, the CO2 trading price will be too low to induce effective action; and the argument for governments imposing lower taxes than needed is even stronger. It is worth noting that the UK Government, noting the need to incentivise utilities to invest in low carbon infrastructure, has decided to introduce a floor to the CO2 price.Next Steps

28Smith School of Enterprise and the EnvironmentSmith Concerns have been raised that trading in CO2 may create or reinforce power monopolies and constitutes 'carbon colonialism' [35]. These objections indicate strong advantages of moving to auctioning of permits or to other forms of permit distribution, such as on a per capita basis, as discussed in the following section.Funding for Mitigation and Adaptation in Developing CountriesOne of the big issues of climate change is that those who have not caused the problem will be those that suffer the effects most. The costs of climate change for the less developed countries are estimated to be high. Furthermore, the less developed countries, such as many of the African nations, cannot afford the high costs of mitigation and adaptation. The least developed nations are often neglected in climate change deals. In 2008, investment in sustainable energy in developing countries reached US$36.6 billion [35]. Of this amount Africa received less than 1 per cent. There is a trend for investment from developed countries to be concentrated in the countries with emerging economies within developing regions (see figure 5). For example, in 2008, of the investment in Asia and Oceania, China and India together CO2 trading schemes have become the dominant form of pricing since the Kyoto Protocol introduced market mechanisms as a way of reducing emissions. The markets have grown considerably since the formation of the EU ETS and look set to grow further both geographically and in volume. In 2008, the CO2 trading markets were worth around US$120 billion and it is estimated that within a decade trading volumes could reach US$1 trillion. This would be similar to trading in commodities like oil, gas and gold [50].CO2 trading has been adopted instead of carbon taxes largely due to its appealing political characteristics. Current trading schemes start by distributing allocations free of charge and move to auctions over time. This appeals to industry as it allows for a less dramatic adjustment than a tax. However, free allocations based on historical emissions have significant drawbacks. First, given the considerable market value of permits, free allocations imply giving high emitters significant 'windfall profits'. This effectively rewards those that are responsible for (unknowingly) causing the problem. It can also incentivise increases in emissions in order to gain more permits. Such 'grandfathering' could act to give competitive advantages to incumbent firms if they get large allocations; thereby reducing competition [51]. Figure 5 - Registered CDM projects by host party, total number 3195. (Source: http://cdm.unfccc.int)Chapter 5Chapter