In the fight against climate change, one strategy being used by government entities is carbon pricing.
TYPES OF CARBON PRICING PROGRAMS
Below is a quick guide to understanding the basics of different carbon pricing programs including three of the most common types:
Low carbon fuels programs
Cap and Trade
Each of these programs seeks to lower greenhouse gas (GHG) emissions, but they approach this goal differently. Understanding how each program is set up and where these programs are in place can create a competitive advantage in sustainable supply chain management strategies.
WHAT IS A LOW CARBON FUELS PROGRAM?
Low carbon fuels programs incentivize the use of lower carbon intensity energy sources, specifically as they relate to transportation.
These programs define a target for the amount of alternative fuels that should be blended into the fuel supply. This amount often increases the share of low-carbon fuels over time. In a low carbon fuels program, energy with high carbon intensity—like diesel, gasoline, and other fossil fuels—generate deficits that result in fines for being over the limit. Providers that generate fuels with carbon intensity below the target generate credits that can be sold as a carbon offset to heavy emitters.
The trading of credits generates on-cost for high-carbon producers and incentives for low-carbon producers. In this way, low carbon fuels programs can limit emissions by creating a lowering target intensity while also creating lower costs of alternative energy to help individuals and businesses in making a more environmentally and financially sustainable choice.
Low carbon fuels programs often begin with a limited price impact, as carbon reduction targets are set close to current fossil fuel carbon intensities. This allows for low carbon fuels to generate excess credits, which can be banked to help with future years of tightening targets.
Low carbon fuels programs are currently enacted in California, Oregon, and British Columbia.
Here’s how a low carbon fuels program works:
- Regulators establish carbon intensity targets for future years.
- Regulators determine a methodology for assessing the lifecycle emissions scores of fuel types and fuel production methods.
- Fuel producers or importers apply for fuel pathway certification for the transportation fuel they are selling within the regulated region.
- The carbon intensity score of fuel producers or importers is measured against the annual intensity target to determine the credits (or deficits) generated from selling their fuel to end-users.
- Fuel producers or importers that generate deficits must purchase credits from low-carbon fuel producers to hit the annual intensity target
Read more about the California Low Carbon Fuel Standard, one of the most widely recognized low carbon fuels programs.
WHAT IS CAP-AND-TRADE?
Many industry experts believe the most effective climate results come from cap-and-trade programs. Cap-and-trade limits the total allowable GHG emissions using allowances while lowering these limits over time. Companies must then either reduce their emissions to fall within the given year’s cap or acquire more allowances. The application of cap-and-trade often expands beyond transportation, including power generation and industrial sectors.
Acquiring more allowances is where the trade portion of cap-and-trade comes in. Additional allowances can be purchases from the regulating body of the program or from other companies that have excess allowances. The added revenue from trading allowances provides an incentive for companies to go above and beyond in limiting their GHG emissions. Additionally, the funds generated by the regulatory agency selling allowances are funneled back to the market through funding projects to mitigate the costs of low carbon projects.
Cap-and-trade programs currently exist for transportation in California and Quebec (which are linked together). The Northeast United States has a current cap-and-trade program for power generation, with plans to institute a program for transportation in 2022.
Here’s how a cap-and-trade program works:
- Regulators establish a cap (or ceiling) on total emissions allowed in a specific region or industry.
- The total cap is dispersed into allowances, providing an emissions cap for each emitter under the program’s jurisdiction.
- The cap decreases over time, creating environmental and financial incentives for involved parties to invest in long-term emissions reduction strategies to achieve carbon compliance.
- Emitters that achieve their emissions reduction more rapidly and/or utilize fewer carbon allowances than their cap have the liberty to sell or trade their allowances to those struggling to stay aligned with their emissions allowance.
- The annual reduction of the emissions cap causes overall GHG emissions to decrease, as total available credits also decrease simultaneously.
- Funds from cap-and-trade are used to support low carbon projects.
WHAT IS A CARBON TAX?
The third type of carbon pricing program is a carbon tax. Carbon tax programs establish a flat fee on emissions that escalates over time (usually annually). Higher carbon-intensity fuels are taxed at a greater rate than lower-carbon alternatives. The tax differential ultimately assists in the financial viability of lower-carbon alternatives, especially with ongoing carbon tax increases.
The revenue generated from carbon taxes stays within the taxed region and is most often reinvested into low carbon projects. These projects include technological advancements, carbon-reduction research, alternative fuel adoption incentives, or other innovations that ultimately lower GHG emissions.
Carbon tax programs currently exist in multiple provinces across Canada (many due to the federal carbon backstop) and in Mexico.
Here’s how a carbon tax program works:
- Regulators establish a price of carbon (USD/MT) and subsequent escalation
- Regulators align on the carbon intensity of various energy types.
- Emitters are charged for their emissions at the flat rate, with high-carbon intensity fuels being charged at a greater rate.
- Emitters face raising expenses for using high carbon intensity fuels as the cost of carbon escalates.
- Funds from the carbon tax are most often distributed back through low carbon projects to assist in transitioning away from high carbon fuels.
HOW DO CARBON PROGRAMS IMPACT MY COMPANY?
Carbon pricing programs bring an on-cost for companies that continue business as usual with fossil fuels. On the other hand, carbon programs bring financial incentives for companies to lower their carbon footprint. The intricacies in different programs and regions require a more targeted approach to optimize results, as the best solution in one area may not always translate to the ideal solution in another. Finding the right partners and collaborative stakeholders can help make the best low carbon choices. The benefits for business continue to grow as carbon pricing mechanisms mature and spread across more regions and applications.