Carbon pricing causes companies to reduce carbon footprints by taxing greenhouse gases. Carbon pricing will be applied to greenhouse gas emissions, and businesses can either pay the tax or reduce their carbon emissions to avoid paying the tax on those emissions. This differs from methods such as cap-and-trade, which allows a certain amount of emissions to be generated tax-free.
How does carbon pricing work in the energy sector?
The cost transfer comes into play when applied to the costs paid for by the public through factors like damaged crops, healthcare costs, and damage to property, and transferred to the businesses that emit these greenhouse gases via carbon pricing. Energy companies tend to factor these costs into their overall energy pricing.
The impact of carbon pricing on energy prices
Carbon pricing can affect overall energy pricing as factors such as policy changes and market behaviours push the prices up or down of the energy market.
Short-term vs. long-term effects of carbon pricing
Shorter-term pricing may be more desirable when considering the uncertainty of policies and regulations in the short term. Longer-term carbon budgets may become a more desirable option if factors like stable policies or allowance caps can mitigate the volatility of carbon pricing, giving more confidence in the carbon pricing market.
Differences between fossil fuels and renewables
Pricing can vary between fossil fuels and renewables because the energy market for renewables tends to be more volatile than its traditional fuel counterpart. Renewable energy generation is more unpredictable than fossil fuels because it often relies on natural factors—like the weather—which cannot be harnessed as reliably as combustion power plants. However, carbon pricing can help to level the playing field, as carbon pricing is much lower for renewable energy than fossil fuels, making pricing more competitive.
Variability based on country
Many carbon pricing models apply pricing proportional to carbon emissions generated, but some countries, such as Mexico, have opted for a more variable model. This means that the carbon pricing applied varies depending on the fuel type.
Who pays the price - consumers or businesses
While carbon pricing is intended to impact businesses rather than consumers, it is thought that in the short term, consumers could foot the bill.
How does carbon pricing affect household energy bills?
With energy costs rising sharply in recent years, consumers have felt the strain. According to the UK government's Public Opinions and Social Trends bulletin, 81% of adults who reported an increase in their cost of living cited higher gas or electricity bills as a key reason, and 44% reduced their fuel use to cope. This burden could grow if companies pass carbon pricing costs onto consumers, especially in areas where lower-carbon options, like renewable energy or cleaner fuels, are not easily accessible. To offset this, regions like British Columbia are exploring ways to return carbon pricing revenue to the public through dividends.
The impact of carbon pricing on industrial and commercial energy costs
Many things affect the energy price for commercial and industrial businesses, particularly energy-intensive heavy industry. Fossil fuels are tightly linked to inflation, so when one rises, the other often does. In carbon pricing, the cost of business operations often rises unless they implement carbon reduction methods such as increasing energy efficiency or investing in renewable energy. Therefore, it's in the interest of businesses to invest in greener practices to mitigate the effect of carbon pricing.
Does carbon pricing increase energy prices for consumers?
As carbon pricing is linked to a type of ‘tax’ applied to emissions intended to increase the cost of fossil fuels, it could lead to higher energy prices for consumers.
Factors influencing energy price changes under carbon pricing
In the short term, energy pricing could increase the cost of fossil fuels, making them less competitive. This would create a preference for renewable energy as it would incur lower carbon pricing, making it a more desirable choice for consumers. The aim of this is to position renewable energy as a more desirable fuel source, but in the short term, until more consumers transition to renewable sources, fossil fuels - e.g. the more common choice - will remain more expensive and increase the cost of the majority of consumers energy bills initially.
The future of carbon pricing and energy costs
Innovation, policy shifts, and the future of carbon pricing
While prices have fallen since the high of 2022, prices may continue to rise again. This is potentially because energy prices are tied to increasing inflation, and inflation has the potential to increase.
However, prices could also fall as businesses invest in energy efficiency. As buildings become more energy efficient, businesses will consume less energy overall.
Policies and regulatory shifts can affect renewable energy schemes because it can be difficult for businesses to reach ever-moving goalposts or continuously invest in green solutions only to have targets changed or increased. However, usually, governmental schemes attempt to make things easier rather than more difficult for businesses trying to achieve carbon reduction targets, meaning those that change their business mentality for greener practices will usually benefit. We expect carbon pricing to favour sustainability-first companies in the future, with policies that encourage businesses to avoid green taxes by opening more sustainably.
Carbon pricing plays a crucial role in shaping energy markets, encouraging businesses to adopt greener practices while balancing costs between companies and consumers.
