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The world needs a Libor for carbon pricing

Setting a price would make it easier to run economic models and explain choices to voters

Global leaders made plenty of bold — and often pious — pledges about climate change this week as they gathered in Davos. One of the most thought-provoking comments came from Axel Weber, UBS chairman, about carbon taxes.
He predicted that finance is on the verge of “a big change in market structure”, as investors wake up to climate risks and embed carbon prices into their portfolio decisions. “The carbon price will become like Libor,” he declared. The London Interbank Offered Rate — its full name — served as a vital benchmark for western loan markets for three decades, until revelations in 2012 that some traders had manipulated Libor prompted a regulatory overhaul.

Is this comparison far-fetched? Some UBS rivals think so. “The analogy doesn’t work,” a leading Wall Street banker snorted on Thursday after hearing Mr Weber’s prediction. He noted that Libor rates are set daily based on banks’ estimates of market conditions, while a carbon “price” would be an externally imposed concept largely devised by bureaucrats.
Moreover, the history of carbon pricing is not a happy one. The concept first cropped up in the previous century when economists suggested that companies and other institutions should pay penalties for emitting carbon pollution, either at a flat rate set by government or at a “price” established through market auction. This was supposed to push companies to reduce their emissions.

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The EU and some other places have already introduced such penalties, to a limited degree. But the existing rate of global adoption is so uneven — and the mechanisms underpinning these projects sometimes so imperfect — that the existing implied “prices” for carbon have hitherto had limited impact.
The IMF recently calculated that with the world’s current hodgepodge of carbon pricing systems, there is an average global “price” of $2 per tonne today. But it warned that the world needs an average price of $75 a tonne to hit the Paris climate change goal of limiting global warming to less than 2C.
The gap is depressing but does not mean the idea is dead. On the contrary, the fact that it came up repeatedly at this week’s World Economic Forum shows a rising level of interest.

On Wednesday alone, Britain’s Prince Charles called on the Davos delegates to back a carbon tax and Ursula von der Leyen, European Commission president, warned that the EU plans to introduce tariffs on imports from countries without carbon prices in an effort to prod wider global adoption.
The current White House derides this as “protectionism”. But some US Republican luminaries including Hank Paulson and George Shultz are calling for a carbon tax, albeit renamed a “carbon dividend” to appeal to voters. Oil companies, including BP, ExxonMobil and Total, are supporting this initiative.

This does not guarantee that the world will heed Prince Charles’s appeal anytime soon, in a sensible or globally consistent way. But talking about a carbon tax now helps make clear to companies the looming costs to them if governments get serious about climate change. This week, Refinitiv calculated that if global policymakers do impose a $75 per tonne carbon price in the future, it would create a $4tn hit for companies. That scary number can be factored into models for valuing assets.

Discussing carbon prices now has a second benefit: it helps us think about the financial transfers which could or should be used to help specific populations or entire countries adjust to a climate shock. When economists outline schemes for carbon taxes, they usually assume that the cash taken in will be redistributed. Setting a price would make it easier to model future economic scenarios and help politicians communicate the looming choices to voters long before a carbon tax system is actually put in place.
Such models do not equate to anything as precise (or as widely accepted) as a Libor benchmark rate. In that sense, then, Mr Weber’s bold prediction still seems far-fetched. But if nothing else, this week’s events have shown that the debate in business about climate change is moving faster than anyone might have predicted a year ago.

That in turn is sparking an explosion in green finance — and a commitment to overhaul corporate accounting systems. Sooner or later somebody is going to need to devise some credible benchmarks to anchor green financial products, and help the fast-swelling ranks of green auditors. Given the lack of alternatives, an imperfect carbon price is probably the least bad option. Let us hope that it turns out to be less scandal-tainted than Libor.

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