A sharp and unexpected rise in the cost to emit CO2 by USD 100 per tonne could drive inflation higher in the short term and lower GDP by 1% to 2% in most OECD countries, while the impact would be greater in carbon-intensive economies, according to a new study by the National Institute of Economic and Social Research (NIESR) from the United Kingdom.
Climate change policies such as carbon taxes and emission trading schemes (ETSs) have become key tools to reduce greenhouse gas (GHG) emissions and limit global temperature increases, according to Britain’s oldest independent research institute.
The results of the Bank of England’s stress testing exercises showed the potential for carbon prices to rise from the current USD 60 to over USD 1,000 per tonne by 2050. A rise in the carbon tax by USD 100 per tonne would be a significant shock to the world economy but falls well within the realms of potential scenarios, the study reads.
A jump of USD 100 in the price of carbon emissions would raise the price of coal by over 300 percent
The report stressed a carbon price hike of USD 100 would raise the price of coal by over 300 percent relative to renewables. At the same time, countries that continue to rely heavily on fossil fuel exports would suffer a significant loss in potential export revenue.
The National Institute of Economic and Social Research has used the National Institute Global Macroeconomic Model (NiGEM) to illustrate the expected macroeconomic fallout from a sudden and uniform rise in the carbon price.
These are the principal conclusions of the study:
- Countries that continue to rely heavily on fossil fuel exports will suffer a significant loss in potential export revenue. This will deliver significant trade losses for fossil fuel exporters, acting as a constraint on GDP as income losses feed into lower levels of domestic demand.
- This acts as a fiscal tightening equivalent to 1-2 percent of GDP in most OECD countries and considerably more in more carbon-intensive economies such as Russia, South Africa, and India. If the revenue is channeled back into the economy via income tax cuts, this will offset some of the immediate impacts on GDP.
- A carbon price of USD 100 carbon would quadruple the post-tax price of coal relative to renewable energy. The prices of gas and oil would rise relative to renewables by 60-70 percent.
- Total energy demand would be expected to decline by roughly 15 percent relative to the baseline, with coal demand falling by 35 percent to deliver more than half of the decline.
- In general, countries with a higher energy intensity of output and those that consume relatively more carbon-intensive fuels are more vulnerable than countries that predominantly use gas or renewables. For example, Russia, which is very energy-intensive, and India, which continues to rely heavily on coal, are particularly exposed to the energy transition and a rising carbon price.
Good carbon pricing strategy signalled in advance would be less costly
According to Dawn Holland, co-author of the report, carbon-pricing strategies are high on the agenda of world leaders, whether via a carbon tax, where a fixed price is paid per tonne of greenhouse gas (GHG), or a ‘cap and trade’ principle, which sets a cap on the total amount of certain GHG that can be emitted.
A well-planned carbon pricing strategy that is signaled in advance would prove less costly, he stressed.