Carbon pricing

Carbon pricing mechanisms are market-based tools designed to reduce greenhouse gas (GHG) emissions by assigning a monetary cost to carbon emissions. By taking into account the environmental and social costs of carbon, these mechanisms incentivize businesses and individuals to reduce their carbon footprint and transition to cleaner technologies.

Carbon pricing mechanisms operate by either directly setting a price on carbon emissions or by creating a market for emission allowances. The two primary instruments are:

• Carbon taxes: whereby governments impose a fixed price on each ton of GHG emissions or the carbon content of fossil fuels. Carbon tax sets the costs of emissions, however the emission reduction outcome is not pre-defined and is left for the markets to respond.
• Emissions Trading Systems (ETS) (Cap-and-Trade): a cap is set on total emissions, and companies are issued allowances that they can trade. The market determines the price of carbon based on supply and demand. The EU Emissions Trading System, covering power generation, industry, and aviation, is the largest ETS globally.

Carbon pricing encourages the most economical emission reductions by allowing market forces to drive change. It also generates funds that can be reinvested in RE or environmental programs, and works well in combination with other climate policies. However, it may increase costs for consumers and carbon-intensive sectors, cause industry relocations to lower/avoid carbon pricing (leakage risks), require complex monitoring, reporting and verification systems.

As of 2024, carbon taxes and ETSs were implemented in 39 and 36 jurisdictions globally[1]. In 2023, carbon pricing revenues reached a record 104 billion USD. Carbon taxes and ETS covered 24% of the world’s emissions in 2024[2].

Despite the record revenue and the increased coverage, average carbon prices are still insufficient to incentivise renewables or energy efficiency on their own. At a global level, the effective price on carbon emissions from the energy sector was only around 3 USD/tonne of CO2 in 2023. Therefore, carbon pricing has to be supplemented by other policy measures.

[1] Carbon Pricing Dashboard, World Bank, https://carbonpricingdashboard.worldbank.org

[2] IRENA, COP28, COP29, GRA, MoEA and Government of Brazil (2024), Delivering on the UAE Consensus: Tracking progress toward tripling renewable energy capacity and doubling energy efficiency by 2030