Carbon pricing can help put clean energy at the heart of stimulus packages

The Covid-19 crisis is likely to lead to the largest drop in energy-related CO₂ emissions since World War II. This drop not only occurred at a huge human cost but will also be temporary unless governments make sustained structural efforts to reduce CO₂ emissions in the long term. Such efforts could include a key role for carbon pricing – a cost applied to greenhouse gas emissions to encourage polluters to emit less.  

Energy use has already rebounded in several places. In the People’s Republic of China, April oil demand almost returned to 2019 levels, more new coal-fired power plants are under development than in 2019, and CO₂ emissions overshot pre-lockdown levels in May. Moreover, the Covid-19 crisis has only slowed the increase in concentration of CO­₂ emissions in the atmosphere.

For countries to “build back better” from the Covid-19 crisis, they must align their concern for a rapid economic recovery with their other strategic policy objectives. Sustainable recovery is possible and can deliver economic growth and jobs, while reducing CO₂ emissions and meeting the Sustainable Development Goals. 

Robust climate policy can therefore promote short-term economic recovery as well as the long-term energy transition. Carbon pricing tools help guide immediate investment and spending decisions with the long-term in mind. They are also resilient and flexible in the face of external shocks, such as those induced by Covid-19. 

The IEA has called for governments to use the historic opportunity of post‑Covid‑19 economic recovery spending to accelerate clean energy transitions. These near-term investment and spending decisions will have long-term impacts on emissions, and present an opportunity to secure a more sustainable energy future. The measures needed to achieve a sustainable recovery require sound policy frameworks, whether to support deployment of renewable energy, modernise and extend the electricity grid, reduce methane emissions or reform fossil fuel subsidies.

With the current drop in energy investment, policy support for certain sectors and technologies has increased revenue certainty and allowed clean energy technologies to better handle the downturn, whether renewables or electric vehicles. For this reason, climate policy is being linked to recovery plans in the Republic of Korea and the European Union as well as within individual EU countries. Climate objectives are also important in shaping recovery plans in Canada, Colombia, New Zealand, Sweden and Switzerland, as discussed during the recent IEA Clean Energy Transitions Summit, and a recent OECD/IEA Climate Change Expert Group Global Forum.

Reflecting environmental and climate costs in energy prices can be critical for a cost-effective and sustainable recovery. The current crisis has slashed the market price for fuels, including for oil, gas and coal, bringing them closer to the subsidised end-user prices that prevail in many countries. This gives governments greater fiscal space, or budget flexibility, offering a golden opportunity for countries that maintain these prices below their market value to revise energy pricing policies.

Adjusting energy pricing can reduce budgetary pressure at a time of declining government revenues, and correct price signals for energy consumption that can encourage greater efficiency once the prices rebound. The IEA is currently working with South Africa, one of its association countries, which is keen to use the current fiscal space to review energy taxation and subsidies, to ensure that economic and social costs of energy use are reflected in prices.

Carbon pricing, in particular, is a useful tool to guide investment decisions, especially those that will have long-term impacts on future emissions, and can complement stimulus packages focusing on short-term recovery. Stimulus measures can help clean energy technologies compete with carbon-intensive alternatives and encourage more efficient energy use. While support measures to reduce cost and enhance performance may be launched under recovery funds, these will require longer-term investment certainty. A progressively increasing carbon price alongside stimulus packages will provide essential confidence for investment in long-lived, low-carbon infrastructure and research, development and demonstration of clean energy technology. Developing important decarbonisation technologies such as carbon capture, utilisation and storage, and hydrogen, relies on long-term policies, such as carbon price signals. If such technologies do not benefit from stimulus measures, this could delay their deployment.

Of the USD 1 trillion that could be mobilised by the IEA sustainable recovery package, 70% would need to come from the private sector; substantive carbon prices can be a vital way of mobilising this investment and are an integral part of IEA scenarios. Carbon prices and companion policies can therefore drive sustainable investment decisions, fostering both short- and long-run economic growth and job creation. 

Carbon pricing tools act in tandem with economic cycles. When emissions decrease in line with economic activity, compliance cost and liability do too – which is good for businesses during a downturn. At the same time, a reduction in carbon price revenues can constrain government budgets, particularly if the revenue is expected to be “recycled” to drive sustainable recovery.

While businesses are provided relief from carbon pricing during a crisis, they know that a carbon price will make emitting more costly as economic activity resumes. The right level of carbon pricing gives emitters the policy certainty that high-carbon investments are less attractive than low-carbon alternatives.  

Intensity-based emissions trading systems are designed to adjust to economic cycles. In a capped system, an unforeseen rapid change in emissions levels induced by an external factor can alter the allowance supply and demand equilibrium: a lower demand will create a surplus of allowances in circulation. This surplus of allowances would lead to a drop in allowance price, reducing the burden for businesses but also jeopardising the effectiveness of carbon pricing.

Stability mechanisms can be designed to control the quantity or price of emissions allowances to make emissions trading systems more responsive to unforeseen changes. For example, the EU Market Stability Reserve brings allowances into (or retires them from) the market if the quantity of allowances reaches pre-determined thresholds that signal whether the market is under-supplied (or over-supplied). In the United Kingdom, a carbon price floor set through taxation ensures that the carbon price drives low-carbon investment even when market conditions lead to low allowance prices.

As with other policies in times of crisis, governments are taking measures to provide temporary flexibility for businesses facing carbon prices during the Covid-19 crisis. Such measures include extending compliance obligations and suspending market transactions.

Many governments were also in the process of designing or implementing carbon pricing mechanisms before the Covid-19 pandemic. Although the current crisis has delayed policy implementation in some cases, or prompted industry pushback in others, most of the countries are continuing with their carbon pricing implementation plans. IEA collaborations with China, South Africa and Thailand on the design of carbon pricing measures is continuing despite the challenging situation being faced by governments.

While the Covid-19 crisis will pass, the challenge of decarbonising our economies while increasing the prosperity of our societies will remain. Carbon pricing is a tool that governments can use to provide long-term certainty and guidance while embedding climate change mitigation objectives within economic activity. Combined with other co‑ordinated policies, carbon pricing can be a key element in making stimulus packages for recovery more efficient while laying the foundations for a green and sustainable economy.