Carbon is the most obvious free-riding externality to the climate that stems from any process. This means that they are negative implications that are a byproduct of a product or a service. These externalities are often not reflected in the products. Policy levers and incentives are required to change business models to make them more sustainable. Some of these policy levers have been detailed below.
Carbon Pricing
In June last year, the IMF came out saying that some type of carbon pricing and a carbon tax would be an important initiative to catalyze businesses. This stand has been echoed by the Ministers at the G20 last year and by the OECD. In order for this to work, efforts will have to be made to put a price on carbon and similar free-riding negative externalities. Changes could be made to the income statements prepared by corporations where a carbon line of expense could be added within the cost of goods sold (COGS). This could be a significant policy lever given its implications on the free cash flow and on the margins. All of a sudden, returns could be quite similar in some cases for some sectors, and maybe even worse in others. Including this carbon price helps in comparing apples to apples and oranges to oranges, in understanding what a sustainable company looks like and the costs around that.
Carbon Taxonomy
In the field of taxonomy, some of the work is with regard to the TCFD, which helps to provide information and guidance on the path to carbon neutrality. However, there is a need for stronger levers and incentives. One of the big discussions that are going on in the G20 this year is around transition finance, and how the heaviest carbon emitters that are absolutely essential to the economy can be financed. It’s going to be a critical area of finance, for multilateral banks, investment banks, venture capitalists, and private equity.
Carbon Credit Markets
Recent discussions have been focused on the idea of ‘net zero’ emissions. The word ‘net’ implies that emissions have to be set off against something else. This need to balance has given rise to the carbon credit market, which is developing but is still a long way from being fully developed. It certainly needs serious pricing that’s consistent with what is a carbon credit. There needs to be a clear and transparent methodology on what counts as a carbon credit. A registry needs to be created to validate carbon credits and ensure that they are not being double-counted. It could be argued that this is another area that’s very ripe for coordination among countries and around the private sector and which needs serious regulations. Net zero carbon cannot be achieved unless there is a consistent definition of carbon credit.
Key Takeaways
- Changes should be made to the way products are priced such that carbon emissions, which have been free-riding externalities, are reflected in the price of products.
- The carbon credit market needs to be developed with serious pricing policies and a clear and transparent methodology on what counts as a carbon credit.
- The implications of net zero transition on sectors such as agriculture, real estate, and mobility will have to be considered and funding must be directed toward these sectors to ease the transition.
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