Carbon Pricing

Strategy for a clean energy future

Reducing global carbon emissions was the dominant subject at the recently held 23rd Conference of the Parties on climate change in Bonn, Germany. While many countries are incentivising renewable energy, others are penalising carbon emissions in the form of carbon pricing in order to discourage the use of fossil fuels and deploy clean energy technologies. Experts discuss the global experience with regard to carbon pricing and the possibility of India formulating a common carbon tax as a policy instrument to reduce emissions and increase investments in the emerging clean energy sector….

Does carbon pricing in the form of various cesses have a quantifiable impact on emission reduction and renewable energy expansion? What has been the global experience?

Vaibhav Chaturvedi

Carbon pricing can be in the form of a specific instrument such as a carbon tax or in the form of a cess like India’s coal cess. The amount levied is more important than the form of pricing. The question of carbon prices having an impact on emission reduction and renewable expansion cannot be looked at in isolation for a particular technology. Ultimately, competitive dynamics and relative prices of technologies have to be assessed. For example, India has had a coal cess for almost three years now. Initially, the increase in the price of coal-based electricity, from Rs 3 to Rs 3.30 per unit owing to the coal cess, did not have a major impact because the alternative, solar power, was very expensive at Rs 5 per unit.

However, with solar prices currently at around Rs 3 per unit, any increase in coal prices will have a significant impact on the promotion of solar energy. Even if there is no coal cess or carbon pricing, factors such as the low cost of solar, technology improvement and better financing mechanisms will help solar gain traction. Therefore, a quantifiable impact may occur due to any form of intervention and not just carbon pricing. A carbon tax can work only when non-fossil technologies are not competitive in its absence.

Moreover, the impact depends upon the sector on which the price is levied and on the substitution technologies that are available. For example, there are many generation options available in the power sector, such as wind, solar and hydro, whereas the transport sector has only limited alternatives. If the demand for petrol is not elastic, an increase in prices will not make a difference to people’s daily and necessary commute. Although metro cities do offer good public transport, not all regions in India have these facilities.

Anmol Singh Jaggi

A large-scale global impact was seen through the Clean Development Mechanism (CDM), which had been in place for seven to eight years. It contributed to the increase in renewable energy installations across the world by incentivising clean energy. Organisations have benefitted from the mechanism and, therefore, in my opinion, levying a price on carbon makes green energy more lucrative. In addition, this would increase awareness about the carbon footprint and the price associated with it. Hence, actions can be taken on a day-to-day basis to reduce this footprint. Therefore, levying a carbon price has a quantifiable impact on emission reduction.

Thomas Kerr

Carbon pricing in the form of various cesses definitely has a quantifiable impact. Over the past few years, a number of countries have imposed carbon pricing. European countries, especially northern European countries like Denmark and Norway, have high carbon taxes, which have made a significant impact on the investment decisions in these countries. Over the past 20 years, Denmark has gone from 70 per cent fossil-based energy to almost all renewables. In fact, during end-December 2017, the country generated 100 per cent of its power from renewable energy sources. This has been partially attributed to the use of carbon taxes over the years.

Global experience shows that when carbon prices are lower, it can be difficult to ascertain if price was the only driving factor in increased renewable generation. Prices can be a part of a larger policy package that includes phasing out fossil fuel subsidies and implementing performance standards. California is a case in point where a combination of policies has driven such changes. The region had implemented a carbon price several years ago but reported an increase in the use of clean energy after its renewable energy mandates. Besides, the European Union Emissions Trading System (EU ETS) has helped countries such as Portugal and the UK to increase their renewable energy capacity.

Several countries have implemented a carbon pricing policy. In your opinion, should India introduce formal carbon pricing?

Vaibhav Chaturvedi

When we say formal carbon pricing, we usually refer to a carbon tax. India has a coal cess, so a formal carbon pricing policy is already in place. We can have this mechanism for all sectors, but if it is as low as the current levels of $3-$5 per tonne of CO2, it is not going to make any difference. Global experience has shown many successful instruments for levying carbon prices in order to make a substantial impact. These can be in the form of an explicit carbon tax, a coal cess, or an emission-trading scheme like the EU ETS. The effect would be the same irrespective of the tool used. This is because an investor would take the same decisions while dealing with the same level of carbon tax through any of these instruments. However, the choice of policy adopted by the implementing agencies depends on various factors including different governance arrangements.

Anmol Singh Jaggi

I believe a formal carbon pricing policy is extremely necessary and unavoidable in India. Initially, there may be some resistance to this as India is still a developing country and requires low-cost energy to expand its industries. However, to overcome the issues associated with pollution and global warming, we need to expedite the implementation of such a policy and ensure that the polluters pay a price for the negative impact on the environment.

Thomas Kerr

Over the past few years, many countries such as Columbia, Argentina, Chile, South Africa, Singapore, and China have turned to carbon pricing by introducing very low carbon taxes, which are planned to be increased over time. This forms an important aspect of their larger fiscal strategy, wherein the countries plan to use these revenues to promote clean energy development, energy bill reduction for lower income groups, or mitigation of competitiveness in the energy industry. This is something that India could also consider. India already has a coal cess and has reduced its subsidies for fossil fuel recently. It has, therefore, started on the road to carbon pricing.

Ensuring competitiveness is the primary concern of most governments. “Carbon leakage” can result in a shift of factories to a neighbouring country due to high carbon prices. However, we have not seen any evidence of carbon leakage, as the price on carbon is one the many factors influencing cost competitiveness. The second political concern is that carbon pricing can lead to a spike in energy prices. This has been mitigated in most cases as a part of the revenues can be used to subsidise energy costs for lower-income households. Therefore, residential consumers do not really feel the impact of carbon taxes.

Is it possible to replace the PAT scheme for energy efficiency, the REC scheme and the cess on coal production with a common carbon tax? What are the challenges in doing so?

Vaibhav Chaturvedi

Yes, it is definitely possible. A common carbon tax could help stakeholders adopt the best investment route by providing them with multiple options such as energy efficiency, switch to cleaner fuels and carbon credits. for meeting the specified norms. This gives flexibility to the market and so I believe this is a preferable instrument as compared to a specific instrument.

Schemes such as Perform, Achieve and Trade (PAT) and renewable energy certificate (REC) can cover different areas like energy efficiency and renewable energy, which directs the market in a particular direction. However, this can be beneficial in many cases. For example, sectoral policies can be very useful if India wishes to become a manufacturing hub. However, there have to be dedicated policies for helping the sector grow. A common carbon tax may not work in this scenario, as it will achieve the emission reduction objective but not the strategic objective.

One of the challenges associated with levying a carbon tax is the perception of the word “tax”, which is a highly politicised term. The reception of the REC scheme, on the other hand, has been very positive as it is seen as a tool to incentivise renewable energy. A carbon tax achieves the same results, but its implementation can cause a backlash from the industry owing to the general outlook against increased taxes.

Therefore, the choice of instrument often depends on the political economy rather than just economics. To this end, it is crucial to have a clear, long-term policy signal from the government, regardless of the instrument used. Investments are made for a longer term and if the government outlines a roadmap, companies would have no option but to align with it.

Anmol Singh Jaggi

After a lot of difficultly, India was able to implement schemes such as PAT and REC. As policy changes are very time-consuming, scrapping these schemes to get a new one can put years of hard work to waste. Even though the current compliance on PAT and REC is not very high and the government is making continuous efforts to improve this, it could be a good idea to retain these schemes for the next five to ten years and to then introduce a common carbon cess.

Thomas Kerr

Most economies worldwide do not have a single carbon tax/price. In fact, they follow a mix of policies that can include PAT and other taxes. For example, European countries have set a cap on trade for some sectors, but they also have a tax on carbon for other sectors. Moreover, energy efficiency performance schemes are used for targeted sectors. Carbon pricing depends on a country’s policy goals and its reliance on fossil-based energy generation. It is, therefore, the decision of the policymakers to retain the existing schemes, if they complement carbon pricing, or to modify or remove them. The challenge would be to completely get rid of such schemes and replace them with just a single carbon levy.

Can voluntary internal pricing on carbon work in a country like India or is a mandatory central economic and environmental policy necessary?

Vaibhav Chaturvedi

Voluntary carbon pricing is good because it demonstrates that businesses are coming on board. However, if we look at the bigger picture, it is not going to make a huge difference. In order to change the entire system, prices of $45-$50 per tonne of CO2 are required.

However, voluntary pricing is happening at a very low value of $8-$10 per tonne. Further, companies are smart enough to assess their own needs and make changes only in areas where profits are not affected. When it comes to making large-scale modifications for a significant impact, it has been seen that voluntary pricing has not achieved much. Therefore, we need a very strong environmental policy to make system-wide changes.

Anmol Singh Jaggi

In the past, voluntary methods have not been very successful in making a significant impact. If India makes carbon pricing voluntary and internal for companies, it is likely to be adopted by less than 1 per cent of the industry players. Therefore, a central policy that puts a mandatory price on carbon is extremely crucial.

Thomas Kerr

Over the past two years, we have seen almost two dozen major Indian businesses voluntarily adopting internal pricing on carbon. The move can help these companies to increase efficiencies, use cleaner fuels and meet their sustainability targets. Internal carbon pricing can work, but it should deliver maximum emission reductions. To ensure this, countries should supplement these internal targets with government policies.

The advantage with businesses adopting these measures first is that they can learn design lessons on the use of carbon pricing and can then assist the government in formulating policies. For instance, some companies in California performed an emission trading simulation, and these results were considered by the government before putting an official cap on trade. This is something that can be implemented in India as well.

Can carbon pricing help India unlock new investment opportunities?

Vaibhav Chaturvedi

Carbon pricing would definitely move us towards a cleaner, low-carbon future. However, in the larger scheme of things, carbon pricing is only one instrument for this. There are many reasons for increased investments in an economy. If there are investment opportunities, these may be present not only because of carbon pricing, but also owing to good sectoral policies. This is because policy changes can give rise to investment opportunities even when carbon prices are not levied. These opportunities are aligned with the kind of future a country envisions, rather than what form of instrument it will use. In general, a clean energy future will have a lot of opportunities. However, these may not strictly depend on carbon pricing.

Anmol Singh Jaggi

Yes, I am sure that carbon prices can help India unravel new investment opportunities. A good carbon policy will boost the renewable energy sector. Segments such as energy efficiency will also benefit from this. An additional price on carbon could result in higher tariffs for coal-based power and if the same could be purchased at a lower cost from a renewable source, consumers will be motivated to opt for clean energy. However, a very low carbon tax would not make a significant impact in dissuading coal-based power generation. So, the government should decide on a price that is neither too low nor so high that the country’s development is hampered.

Thomas Kerr

Carbon pricing can help initiate new investments in cleaner solutions. While renewables are competitive and extremely attractive in India, segments such as energy efficiency, electric vehicles, energy storage and minigrids need a little push. It is estimated that $3.4 trillion of investment opportunities can open up if the country meets its clean energy targets. Moreover, the IT sector can work towards scheduling and optimising the logistics and transport sectors for faster deliveries, efficient fuel consumption and subsequently emission reductions.

Therefore, apart from direct business opportunities, there will also be many indirect opportunities. Many companies are now using these internal carbon prices to fund sustainability-related projects, which could result in profitable businesses in the future. In addition, many companies’ investors have started asking for plans to prepare for climate risks, new policies, etc. As a result, organisations are now formulating internal policies to demonstrate their preparedness by factoring in the policy risks and future costs associated with carbon.

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