Benchmarking a Global-level Carbon Price Framework Tracking heterogenous carbon pricing towards Paris goals OCTOBER 2022 Administered by THE NETWORKED CARBON MARKETS Climate INITIATIVE Warehouse © 2022 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of the World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; email: pubrights@worldbank.org. Design and copyediting by Clarity Global Strategic Communications (www.clarityglobal.net) Table of Contents Abstract 1 1. Key messages 2 2. Background 3 3. The role and objectives of a global-level carbon price benchmark 5 4. The construction of a global spread benchmark 9 5. Options and variations 13 6. The historical overview – a pilot study (explicit carbon prices only) 13 7. Building a financial markets benchmark 15 8. Exceptions to and limitations of initial methodology 17 9. Benchmark development steps 19 10. References and further reading 21 10.1. Glossary of terms and abbreviations used 21 10.2. Summary of the carbon spread benchmarking webinar 22 Annex A – Data source overview 24 Acknowledgements This note has been prepared by Mike Knight with inputs from Keisuke Iyadomi, Harikumar Gadde, Joseph Pryor and Ana Ferrán Torres under the guidance of Chandra Shekhar Sinha. Additionally, other colleagues outside the World Bank Group, provided useful comments, suggestions, and inputs: Jia Li (Senior Economist at Climate Change Group of the World Bank); Simon Henry (Director of Carbon Market Development, IETA); Carla Sarteriale (Senior Policy Advisor, ESG, Innovation & Growth, City of London Corporation); Mark Lewis (Head of Climate Research, Andurand Capital); Chris Shipley (Head of Global Carbon Markets, UK Department for Business, Energy and Industrial Strategy). Benchmarking a global– level carbon price framework Abstract T he Paris Agreement sets out that tackling climate change is a common but differentiated challenge across signatory Parties and other actors. COP26 was the most recent focal point to monitor and commit to progress. Various leaders specifically called for carbon pricing to act as a barometer and price signal during COP26 to help shift the trillions in finance towards a lower carbon economy and to meet the Paris goals. Establishing and securing agreement on a global-level benchmark carbon price can be achieved by consolidating a range of carbon pricing initiatives (explicit, implicit and implied) into a single global platform that can be broken down into regions or sectors. This can then be compared against a target price corridor required to achieve the Paris Agreement goals. A benchmark serving these dual purposes can be embedded into financial markets via an investable or tradable price, which in turn can facilitate forward pricing capabilities. In addition, a user-defined data visualization framework can support a variety of stakeholder interests. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 1 1. Key messages – Underpin corporate decision making and reporting on shadow carbon pricing, or for instance, in relation to fossil fuel provisions within the COP26 agreements ● Various leaders specifically called for carbon pricing to act as a price signal for meeting Paris – Support implementation of carbon pricing Agreement goals at COP26 by helping shift instruments and build relationships with and the trillions in finance towards a lower carbon between international carbon markets economy. – Support the harmonization of global trade ● The World Bank has been exploring an objective, policy regarding border adjustments and other transparent and credible consolidation of carbon factors pricing information that has regard to disparate pricing initiatives such as emissions trading, – Develop the universally acknowledged, carbon taxes and credits, broader energy taxes, adopted, transparent, responsive, and agreed subsidies and policies, border adjustments, global-level carbon price framework. unpriced greenhouse gas emissions, the latest COP26 developments related to carbon markets (‘Article 6’), and other factors. ● This consolidation is then to be set against a Paris Agreement-consistent target price corridor to create a ‘spread’. This can be deconstructed for regions or sectors and be made dynamic, responsive and potentially real time. ● This spread benchmark will create the following benefits that will: – Provide a key and coherent pricing barometer and signal for overall progress towards Paris Agreement goals – Guide and verify the climate transition or risk relating to some US$130 trillion in capital claimed at COP26 to be available to support Paris 2 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 2. Background Yet there are currently few, if any, agreed global-level pricing or financial metrics that frame, verify or guide such claims and pledges. It should not be forgotten that the ‘common but differentiated’ [between Parties] The challenge formulation of the Paris Agreement 5 may be a factor T in reducing direct comparability between actions. In he achievement of Nationally Determined respect of pricing and finance, there are a multitude of Contributions (NDC) submitted by countries (at times conflicting) metrics, indicators, models, data, under the Paris Agreement is expected to standards, accreditations, scenarios, and taxonomies. require massive domestic and international financial resources. With limited public and concessional For example, prior to COP26, estimates as to finance available, there is a need to leverage financial assets labeled as or being ‘Paris-aligned’ private capital intelligently.1 vary between $130 billion, as of end-2020,6 to some US$35–40 trillion (out of an estimated US$100 trillion Alongside this, there has been an increasing desire in total global managed financial assets) by mid 2021.7 to shift trillions in capital investment towards a lower carbon economy. Policymakers, central banks and This fragmentation of information makes it difficult other promoters of the rapidly expanding ‘ESG’ to verify the carbon-reducing effectiveness of these (Environmental, Social and Governance), green new brands of finance. It also may risk creating or sustainable finance sector, have been seeking expectations gaps between policymakers, central mechanisms to support this dynamic; and in particular, banks, sustainable finance actors, and the like. mechanisms that may lessen the need to impose Each grouping may look to others to set standards costs on, or risk disrupting the availability of energy. and a pathway for this shift in finance. This in turn exacerbates market failure – expectations gaps act In this direction, COP26 saw several high-profile as a barrier to making finance flow to support climate financial initiatives being announced. For example, actions. US and UK financial regulators are now the UK Government outlined an intention to ‘rewire’ beginning to question the veracity of some climate the global financial system to support Net Zero.2 and ESG claims made by financial institutions and In addition, a financial alliance with a purported others. 8 The Bank of International Settlements has $130 trillion available in capital to support Net Zero raised the risks of a green finance ‘bubble’.9 was announced. 3 No single stakeholder grouping may have the Separately, the finalization of the COP26 ‘agreement’, mandate or jurisdiction to remedy this. Energy and the Glasgow Climate Pact, brought the inclusion of climate policymakers may not feel competent in text on the future of fossil fuel and related subsidies addressing finance sector behavior; finance sector into sharp focus.4 regulators and policymakers may not wish to enter the fray of geopolitical tensions behind global energy and climate negotiations, nor be required to make environmental assessments.10 1 Research outlines the potential financing needed to meet global or regional abatement costs of NDCs: Hof et al. (2017). https://www.sciencedirect.com/science/article/pii/S1462901116308978 2 https://www.gov.uk/government/news/chancellor-uk-will-be-the-worlds-first-net-zero-financial-centre 3 https://www.gfanzero.com/ 4 See para 36 within https://unfccc.int/sites/default/files/resource/cma2021_L16_adv.pdf 5 See Article 2 (2) 6 https://blogs.imf.org/2021/10/04/how-investment-funds-can-drive-the-green-transition 7 See https://californianewstimes.com/investment-industry-at-tipping-point-as-43tn-in-funds-commit-to-net-zero/427561/ It is also worth noting that in the lead up to COP26, it has been claimed that some 55 percent of global GDP has pledged Net Zero https://www.reuters.com/world/europe/big-nations-urged-heed-climate-activists-demands-bolder-action-2021-10-02/ 8 See for instance https://www.reuters.com/business/sustainable-business/us-sec-consider-new-sustainable-fund-criteria-data-disclosure- rules-2021-07-07/, https://www.pinsentmasons.com/out-law/analysis/uk-fca-tackles-greenwashing-fund-mis-selling-risks 9 https://www.bis.org/publ/qtrpdf/r_qt2109v.htm 10 See for instance reported comment by the UK Financial Conduct Authority https://todayuknews.com/finance/fca-board-tells-city-regulator-to-clearly-articulate-its-esg-limitations/ B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 3 The carbon pricing perspective ● The current bottom-up development of carbon pricing and international carbon markets Putting a price on carbon, through measures such as brings about a diversity of approaches. This a domestic carbon pricing instrument, fiscal policy creates fragmentation of information, reducing or, for that matter, carbon offsets or international transparency and comparability between climate carbon markets, can play an important role in driving actions and increasing the complexity of market innovation across sectors and facilitating an orderly integration. This in turn reduces visibility over transition towards low carbon economy. Much effort is existing and future carbon prices and whether dedicated to developing various such initiatives and these collective efforts form the right trajectory to mechanisms. achieve the Paris goals. Carbon pricing can act as a price discovery and signaling tool and financial metric for a wide range of stakeholders. For instance, it can aid investors in their investment decisions (that is whether and what to invest), or to risk manage their investment portfolios by conveying the quantum and trajectories of carbon- related risk, and help policymakers understand the impact or effects of policy choices and actions. This pricing and climate-financial dimension can then complement other key climate change data on emissions, temperature change, energy generation and so on – the data that may fall, for instance, within the purview of key global institutions such as the Intergovernmental Panel on Climate Change (IPCC) and the United Nations Framework Convention on Climate Change (UNFCCC) and its subsidiary bodies. This potential for carbon pricing, however, may not yet being embedded into ‘shifting the trillions’. This may be due to: ● Only approximately 20 percent of global greenhouse gas (GHG) emissions being directly subject to explicit carbon pricing. It is unclear to investors or policymakers what carbon price applies or should apply to emissions beyond this. 10 See for instance reported comment by the UK Financial Conduct Authority https://todayuknews.com/finance/fca-board-tells-city-regulator-to-clearly-articulate-its-esg-limitations/ 4 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 3. The role and The World Trade Organization (WTO) has recognized the disruptive potential of differential carbon pricing objectives of to global trade policy and has called for a coordinated approach – between IMF, OECD, the World Bank and the WTO – to understanding a consolidation towards a global-level global carbon pricing.13 The World Bank has already published research on the overlap between global trade and climate policy.14 carbon price Investor groups (one of which has a stated US$6 trillion in assets under management) have benchmark called for policy-makers to set a global carbon pricing corridor.15 A high-profile financial markets media column has further called for an indexed benchmark for finance sector players to monitor and invest in Role progress made in this direction.16 A n agreed and transparent carbon price Whilst a global-level price benchmark may not be a benchmark that consolidates and reflects the top-down policy-mandated single price placed on entirety of global GHG emissions can help global emissions; it can nonetheless synthetically promote greater benefits of carbon pricing, and in create some of the benefits of such a global turn, the further Paris-alignment of finance. Such framework. Carbon-intensive industry has repeated a benchmark would need to provide greater and a call to ‘please put a price on carbon’.17 coherent insight into how the entirety of carbon prices may affect financial assets beyond those subject to In a sense, a global-level benchmark is a response direct or formal carbon or emissions regulation. to these needs. It can complement and display latest developments A two-step carbon price benchmark framework that in carbon policy. Indeed, it is noted that the consolidates heterogenous carbon pricing information G20 has recognized the potential role of carbon on a weighted average basis and sets a consolidated pricing in climate mitigation and is also seeking an price against a credible Paris Agreement-consistent internationally coordinated approach to climate carbon price target corridor (creating a ‘spread’) could financial risk. Many experts including International address some of those challenges. Regard will need Monetary Fund (IMF) staff and the Organisation for to be given to various sources of price information: Economic Co-operation and Development (OECD) explicit, implicit, implied and voluntary carbon pricing. have called for coordinated international pricing of carbon.11 IMF staff have also called for standardization In addition, the benchmark construction may need of climate financial information.12 to allow for customization; so that users could focus on carbon price type, region, or sector. (For example, users may wish to seek a comparative analysis of explicit carbon pricing initiatives seen at national level.) Further detail can be found in the ‘Options and Variations’ section. 11 https://www.imf.org/en/Publications/staff-climate-notes/Issues/2021/06/15/Proposal-for-an-International-Carbon-Price-Floor-Among-Large- Emitters-460468, https://www.ft.com/content/334cf17a-e1f1-4837-807a-c4965fe497f3 12 https://blogs.imf.org/2021/10/04/how-investment-funds-can-drive-the-green-transition 13 https://uk.sports.yahoo.com/news/create-global-price-carbon-wto 14 https://openknowledge.worldbank.org/handle/10986/36294 15 https://www.reuters.com/business/sustainable-business/asset-owners-managing-6-trln-call-global-carbon-price-2021-07-05/ 16 https://www.afr.com/policy/energy-and-climate/global-carbon-pricing-too-important-to-leave-to-governments-20210707-p587nt 17 https://www.reuters.com/business/energy/reuters-impact-please-put-price-carbon-says-europes-biggest-utility-2021-10-05/ B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 5 Objectives Credibility and undeniability may take time to establish. Nonetheless, stakeholders must see The overall or strategic objective of this carbon price that there is a development pathway towards benchmark project is to develop the universally these benchmark characteristics. acknowledged, adopted, transparent and agreed ‘top- down’ global-level carbon price framework. In other ● Build or bridge between the carbon policy realm words, to put an agreed price framework on carbon, and the global financial sector, such that the as seen through a global-level lens and incorporating trillions in private capital requiring mobilization the entirety of global greenhouse gas emissions. to support the low-carbon transition has greater visibility over carbon policy direction and progress, This is to provide definitive price ‘discovery’ for and vice versa. carbon – the process of providing visibility, signaling and transparency over the carbon pricing landscape This bridge-building includes forming acceptance – and to strengthen the relevance of this for financial around the process of commodification of carbon, assets beyond those subject to emissions regulation. given the role of secondary market Emissions Trading System (ETS) pricing in the proposed To aid universality of the benchmark, it is constructed initial methodology. Whilst there may be different in two parts: views as to whether commodification is a desirable outcome, its potential price-signaling effect can ● Consolidation of a range of heterogenous carbon support long-term financial flows, investment and pricing data into a single global effective price policy development – aiding the orderly transition away from high-carbon activities.21 ● Facilitation of the comparison of this against a global-level ‘Paris-consistent’ target value or It is noted that the mid-2021 rise in natural gas corridor.18 prices and the concurrent increase in key traded ETS prices (particularly the EU ETS), may raise Supporting objectives questions in the minds of some policymakers and To enable the overall intent, there are a number of observers as to the desirability of more short-term supporting objectives, without which the benchmark market price movements. may not deliver its potential impact. The benchmark must: ● COP26 saw further progress towards implementing the Paris ‘rulebook’ and as part of ● Be credible in the eyes of; relevant and accessible this, the setting of guidance 22 around market- to, the stakeholder groups set out in Table 1, in based co-operation between Parties in achieving their decision-making processes on carbon and their NDC goals (known as Article 6). climate matters.19 Stakeholders should see the value to use this benchmark – in preference to any other – as a price reference. Existing global-level price references – to the extent they exist – may be variously credible, or relevant or accessible; without necessarily being all three.20 18 See ‘References and Further Reading’- internal World Bank Group webinar discussing background to these objectives. 19 For instance, there should be an intersection or cross-over between the benchmark and the various ‘global shadow carbon price’ scenarios set out in the ‘Network for Greening the Financial System’ Climate Risk Scenarios https://www.ngfs.net/en/publications/ngfs-climate-scenarios 20 As examples, two benchmarks link existing liquid ETS markets together to form, notionally, global-level carbon price benchmarks – IHS Markit https://ihsmarkit.com/products/global-carbon-index.html, and ICE Data https://www.theice.com/publicdocs/data/ICE_Global_Carbon_Futures_Index_Methodology.pdf (both covering approximately 5 percent of global emissions). Separately, Kepos Capital produces an annual assessment of explicit and implicit pricing across 25 major GHG emitting economies (Kepos estimate this covers 80 percent of global emissions). https://www.carbonbarometer.com. A newly published benchmark set also focuses in detail on explicit carbon prices https://www.realcarbonindex.org/ As a comparator, consider the liquidity and price profiles in global oil benchmarks (WTI and Brent crude) existing alongside as well as 21 informing forward pricing visibility for such activities a) as upstream oil and gas exploration and development of reserves (capex often has a project pay-off profile of 10 years or more); or b) the global airline and transport sector need to accurately or dynamically hedge fuel cost risks, or both. Liquidity can aid price discovery. 22 https://unfccc.int/documents/309980 6 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K ● Concurrently, several initiatives to develop What the benchmark is not seeking infrastructure in furthering voluntary carbon market to achieve activity have been announced. Various players are developing and promoting initiatives designed ● It does not, in and of itself, set a pre-determined to support suppliers and buyers of offsets and global-level price. It may however support the credits. setting of any such price. The calculation of the global effective price is positive rather than There has been longstanding discussion as to normative – it is merely a mathematical and how a ‘corresponding adjustment’ accounting empirical synthesis of existing carbon pricing capability – through for instance registries or meta initiatives. Similarly, it does not set compliance prices registries – can be introduced to reduce the risk of for regional or sectoral constituents of the global double counting of emissions reduction actions. effective price, but can indicate the comparative pricing between constituents and trends in their The benchmark should aid the consolidation of development. global-level activities of this nature: ● The benchmark does not validate nor verify (nor ● By providing a coherent pricing overview of for that matter deny nor invalidate) any particular the entirety of global GHG emissions. This can carbon pricing mechanism or initiative. For instance, form a backdrop to carbon market development. it does not validate the environmental or social value The global overview may be broken down into nor quality of a carbon-offset or credit. Similarly, its components in such a way as to provide it is not seeking to assess the subjective labelling comparative analytics. or branding of any carbon related initiative – as initiatives that have an effect on carbon prices may ● By including ETS secondary market price or may not be labelled as such. feeds, as well as foreign exchange market price feeds, the benchmark can respond to events ● The benchmark is not a means to substitute carbon and developments – providing an up-to-date and climate mitigation mechanisms. So, it is not pricing level. intended to be a global-level emissions regulatory compliance mechanism with a dedicated pool of ● Subject to the various terms and factors set out emissions allowances, nor a global-level carbon in this paper, the benchmark can be developed offset or credit market in the manner of Article 6. relatively quickly. It is a synthesis of information In the longer term, however, it may be developed and data, so securing agreement and consensus towards interoperability with existing national, on the methodology will be a key driver. The regional or sectoral (perhaps shipping or transport) published price feed can then provide the initiatives of this nature. backdrop to carbon pricing activity. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 7 TABLE 1. UNDERSTANDING AND SUPPORTING STAKEHOLDER INTERESTS EXAMPLES OF RELEVANT BENCHMARK ELEMENT OR CHARACTERISTIC POTENTIAL USERS Trade, climate and energy • Paris-consistent target price corridor provides key metric to policymakers understand and stimulate progress towards Paris goals. • Components (explicit, implicit, implied pricing) of global effective price allow understanding of cumulative effect of existing policy mix. • Ability to compare contributions of regions and sectors to that policy mix or, for instance, understand possible border adjustment requirements and effects, or the comparative effects of policy alternatives such as the imposition of taxes as opposed to emissions trading. • Global overview can support Article 6 market development, the green finance agenda in the differential pricing of green assets and underpinning of sustainability reporting obligations. Central banks and their • An agreed global-level carbon price trajectory can take climate risk entity supervision divisions, frameworks beyond ‘what if’ physical and transition risk scenarios financial stability and reporting through more definitive and responsive shadow pricing that could be regulators, financial risk seen at individual entity level or at systemic level. managers • This strengthens climate-related market, credit and default risk modelling and understanding by providing market-based reference price[s] with relevance to all financial assets. • A universally accepted benchmark can also strengthen the link between financial statement reporting (balance sheets, income statements and so on) and narrative reporting (sustainability, the Task Force on Climate-Related Financial Disclosures (TCFD), and risk management approaches). Corporates (across numerous • A more definitive and responsive reference point to assist in sectors, but particularly those determining internal or shadow carbon pricing forward curves within the energy chain) and and abatement costs. their professional advisers • Auditors can challenge company management approaches to applying these disciplines. Voluntary market participants • Providers of and purchasers of offsets or credits can better understand how voluntary carbon markets (VCM) pricing and activity contributes to or compares to policy-driven pricing such as taxes and ETSs. • Comparing the pricing and effects on emissions between VCM and policy-driven may also help build a consistent ‘corresponding adjustment’ approach, overcoming a possible constraining factor to VCM development. Investors and financial market • Investors have increased visibility and understanding over global participants carbon pricing trajectories at global, regional, or sectoral level, and for financial assets beyond those subject to emissions regulation. • This can aid investment decisions (that is, whether to invest). • A tradable benchmark could also allow investors to take a financial position (long or short) across the entirety of global carbon pricing, enable the spread to a Paris-consistent target or both. This can allow hedging of or arbitrage between existing commodities, energy, carbon, or climate investing. 8 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K Benchmark name and uniqueness The name of the benchmark should be easily 4. The recognizable, memorable and one which can fall into the lexicon of carbon and climate policy and construction of a global spread financial markets. This can be in the manner of energy benchmarks, ‘WTI’ or ‘Brent’ oil, or equities benchmarks, ‘Dow Jones’, ‘S&P’, ‘Nasdaq’, ‘Hang benchmark Seng’, ‘Nikkei’ and the like. In this direction, a three word and three letter acronym is suggested: GCS – Global Carbon Spread. T Put simply, the benchmark should be unique in three he conceptual framing for developing the key aspects: benchmark should be simple. The design of the benchmark is seeking to: ● It will be the agreed, comprehensive benchmark, covering the entirety of global emissions.23 Only ● Source observable and obtainable data on various such a framing can provide the capability to carbon pricing initiatives accurately understand the global carbon pricing landscape and its development. ● Consolidate this data via an agreed algorithmic (weightings) methodology ● With the right governance, oversight and endorsement by globally recognized institutions, ● Display the results of this consolidation in an it can build profile, branding and momentum agreed form and location towards the universally recognized and adopted carbon price reference. ● Allow for a modular development, in relation to the scope of data considered, the complexity of ● This can complement and stimulate – rather than the weightings methodology and the regularity of substitute or override – the current bottom-up update of calculation and display. develop direction of carbon pricing initiatives, the sustainable/green finance agenda and climate risk Global-level carbon and climate investment data and frameworks. It should have sufficient data display research may nonetheless be complex. Perfecting and analytics functionality – as well as being the consolidation process may take time, resource, investable – to serve a wide variety of interests. reflection and debate. There may be diverse and strongly held views across carbon and climate stakeholders as to how any consolidation could or should occur. Stakeholder views and interests may elicit debates and challenges such as: ● A wish to see clear and explicit prices and price signaling in the form of explicit carbon prices only (to the exclusion of implicit, implied forms of pricing, or voluntary markets); ● A wish to see a wholistic or comparative overview of the geopolitics and direction of policy-driven carbon pricing – so a blended picture of explicit and implicit pricing, but without perhaps voluntary markets; Kepos Capital Carbon Barometer claims 80 percent coverage of global emissions; IHS Markit and ICE Data global carbon indices link 23 liquid ETS prices covering approximately 5 percent of global emissions. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 9 ● A wish to understanding the development of Core design principles and assumptions voluntary market activity and trading only; or The ‘Paris-consistent’ target carbon price framing: ● A global overview outlining the cumulative picture of carbon pricing set against global emissions, ● Demonstrating a spread between the current together with a comparative and undiluted global pricing landscape and a carbon price perspective of nations, regions or sectors set corridor that supports the goals of the Paris against each other. Agreement requires the setting of a corridor. As a starting point, the May 2017 Report of the In addition, the definition and scope of carbon prices High-Level Commission on Carbon Prices24 to be considered and incorporated into a benchmark, can provide that price corridor. when set against the entirety of global greenhouse gas (as defined by the Kyoto Protocol – see glossary), ● This report sets out the reference as being ‘at will be central to the look, feel and utility of the least US$40–80/tCO2 by 2020 and US$50–100/ benchmark. So it is important to be both clear and tCO2 by 2030’. consistent in the language and concept used in framing the benchmark. Deriving a globalized price ● For simplicity, an arithmetic averaging of this range based on explicit carbon pricing initiatives only, will provides a US$60/ tCO2, rising to US$75/ tCO2. have a significantly different feel to a price derived from a wider range of carbon price sources. ● If we apply a daily compounding approach to this range of prices, then: Taking all of this into account, the following sets out the scope and parameters of a proposed initial – Future value = Initial value (1 +r/100) nth power benchmark methodology. – Where the daily compound rate = r, number of days compounded = n What the initial methodology is seeking to do – So 75 = 60 (1 + r/100) (10 years * 365) It seeks to harness the capabilities and design flexibility provided by algorithmic linking of data – And daily compound rate = 1.000061137125 sources to provide a global overview of the carbon The Global effective price (see also glossary) – pricing landscape and developments. In other words, scope of incorporated explicitly priced emissions to link through a centralized mathematical formula, and policies: data on carbon prices and trends. ● It is important that the initial base data is viewed This will consolidate a range of heterogenous carbon with confidence by a wide range of stakeholders. pricing data into a single framework of two parts: ● It is therefore proposed that 60 carbon tax, ETS – a global-level effective price; and and 7 credit records (67 complete records have – enabling the comparison of this against a been identified) downloadable from the World ‘Paris-consistent’ target value. Bank Carbon Pricing Dashboard (‘Dashboard’), form the explicit carbon pricing elements of that The methodology will endeavor to do this in a data.26 This data is currently updated annually. manner that is logical, credible and rational. ● It is assumed that the ETS static data records will reflect, for instance, the price effects of auctions of emissions allowances. 24 https://www.carbonpricingleadership.org/report-of-the-highlevel-commission-on-carbon-prices 25 Via online calculator https://captaincalculator.com/math/root/nth-root-calculator/ 26 The Dashboard contains additional, downloadable, tax, ETS and credit records, but these may not necessarily contain complete information that allows their inclusion into the methodology. For instance, these records may represent schemes under development. 10 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K ● Where secondary market ETS price feeds can be ● If it can be accepted that explicit carbon policies reasonably and reliably sourced, these feeds will (ETSs, carbon taxes and credit mechanisms as take priority over static dashboard data. per the Dashboard), represent only 11 percent of overall effective marginal carbon rates (inclusive The weighted average approach for the global of fossil fuel subsidies and broader energy taxes effective price: – see glossary), then, for simplicity, an averaged ‘overlay’ can be applied to explicit pricing, ● The proposed approach for consolidating carbon adjusting total tax (and static ETS data) Dashboard data sources is to use an arithmetic weighted data by dividing by a factor of 0.11. average. ● However, it should be stressed that this is a ● This will assume that a unit of carbon emitted in simplified approach, but one that nonetheless any location has the same climate effect. serves as a basis for further development. ● The primary weightings indicator will therefore Developing parity of pricing – the use of a common be the proportion of global GHG emissions currency: attributed to or covered by each scheme as per the Dashboard data. ● One important element in applying a purchasing power parity discipline across Dashboard records The implicit pricing overlay for the global ‘effective is to convert local prices into a common or default price’: currency. In this case, the default currency will be US dollars (US$). ● Incorporating implicit carbon pricing into the benchmark methodology provides a broader view ● The currency cross rate series (showing currency of pricing policy and helps to navigate around any pairs – a local currency versus the US$) will be labelling anomalies (that is whether a policy is sourced from a financial market information labelled climate related or otherwise). platform (Bloomberg was used for a pilot study set out below). ● An optimal methodology of incorporating a range of implicit policies into the benchmark may ● H owever, it should be noted that much of the data prove complex and would need to acknowledge downloadable from the Dashboard is already overlaps between explicit and implicit pricing expressed in US$. factors. Adopting a ‘levelized’ approach to energy generation or consumption may be one option Developing parity of pricing – the use of inflationary here. indicators: ● As an initial step, an ‘overlay’ approach is ● A second element to a purchasing power parity proposed. This can allow for the GHG proportional discipline is to adjust source data by comparative weightings as set out on the Dashboard to be leading consumer price indicator fluctuations; retained and to remain relevant. ● The approach to be used it is to apply the relevant In this regard, it is noted from recent OECD research: national or regional leading inflation indicators (generally changes in consumer or retail price ‘Across countries, taxes represent 93 percent of the indices expressed monthly), against US inflation overall effective marginal carbon rates and emissions data for the same period. (Again, for the pilot trading systems account for 7 percent. Fuel excise study, Bloomberg data was used.) taxes, which usually are not primarily motivated by climate objectives, account for 89 percent of effective marginal rates. Carbon taxes represent only 4 percent.’ 27 27 See https://www.oecd.org/tax/tax-policy/effective-carbon-rates-2021-0e8e24f5-en.htm B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 11 Addressing carbon leakage: As the methodology is further refined and developed, the relative weighted-average pricing ● O ne of the challenges of carbon pricing policy is of each component of the global effective price addressing carbon leakage – where economic (so each individual carbon tax, ETS, credit and so activity may transfer to jurisdictions with on), will become clearer. And relative carbon prices slacker emission constraints. Identifying and embedded throughout an economic value chain (for understanding the circumstances under which this example, from manufacture through to sale of a good) may occur – and the cumulative and other effects should also become clearer, making the risk of carbon of this – is an important step. The nature of the leakage easier to identify. benchmark should aid this understanding. Defining a central consolidation formula: ● D ata downloadable from the Dashboard suggests that global GHG emissions are currently running ● I ndividual carbon pricing initiative price data will at approximately 54 giga tons of CO2e annually.28 be consolidated into the benchmark methodology This becomes the effective denominator for the via the following formula: global-level benchmark calculation. [individual tax, ETS, credit scheme price] * ● I n this context, emissions for which there is no [proportion of global emissions] * [daily or real explicit or implicit carbon price policy attributable time currency price conversion] * [monthly are captured and create a fallback or catch-all marginal inflation factor] mechanism. Such emissions are not specifically identified nor captured by the Dashboard carbon Creating data assurance and integrity disciplines: price initiatives, nor through the implicit price overlay approach, but are nonetheless present in ● W ith the scope of data being set around the the background. In this formulation, these non- Dashboard, comfort can be taken as to the priced emissions have the effect of diluting integrity or assurance of data contained therein. individual explicit prices down to their weighted average price. (As a simple example, an EU ETS ● C urrency conversion and comparative inflation price of approximately US$50 – when seen data should be sourced from a reputable markets from a global perspective – is diluted down to information service, (Bloomberg being used for approximately US$1.80.) the pilot) and should therefore be ‘investment grade’. ● T he global effective price is therefore an aggregation of this dilutive process being applied ● No other explicit carbon pricing data, discretion to each underlying explicit pricing factor to create or modification should be applied or allowed. its weighted average price. The implicit pricing Data and methodology should be fully auditable. overlay is then applied to the resulting diluted, weighted average price. Source data overview ● C omfort can therefore be taken that the potential Annex A sets out in tabular form an overview of for system-wide carbon leakage is reduced. source data. By including all emissions – at least notionally – within the methodology, a clearer aggregate assessment can be made of the current carbon pricing landscape. 28 This figure is implied through reverse calculating the aggregate of carbon pricing initiatives captured by the Dashboard. As 60 complete carbon tax and ETS schemes represent 16.4 percent of global emissions, 100 percent of global emissions are thus approximately 54GT CO2e. 12 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 5. Options 6. The historical and variations overview – a pilot study T his paper recognizes the importance and (explicit carbon significance of diverse stakeholder interests and needs surrounding this benchmark. To serve this variety of interests, it may be beneficial to construct a benchmark with options and variations. In this way a user may be able to define or visualize the benchmark data for their own needs. prices only) I In compiling this paper, informal feedback was sought n March – April 2021, a pilot study was undertaken from some stakeholders as to the functionality they using the explicit carbon price elements outlined would wish from the benchmark. They expressed in the methodology above. The source data was interest in the following parameters: limited to 67 data series (carbon taxes, ETSs, credit mechanisms) downloadable from the Dashboard. ● National, regional or sectoral breakdowns – so a comparative analytical tool of emissions- Currency cross rates (conversion rates) data, adjusted (that is diluted) explicit, implicit or implied monthly comparative inflation data and secondary pricing where this can be attributed markets ETS price feeds (for EU ETS, Korea, New Zealand, California and RGGI) data were obtained ● As above, but on an undiluted basis – so without from a Bloomberg market information service. It was regard to the scope or volume of relevant assumed that ETS auction activity would be reflected emissions in either the Dashboard data records, or secondary market prices. ● As and when the VCM market grows over time – to illustrate the impact of this by allowing this to A nominal pricing version (that is not adjusted for be shown as a separate category on both a inflation) was also undertaken as a comparator. diluted and undiluted basis. As shown in Figure 1, when seen over the period Other options and variations may be developed as May 2017 – January 2021, the key findings of the pilot benchmark user interest evolves over time. study are that: ● The global effective price increased from US$1.62/ tonneCO2e to US$2.87 (nominal prices US$1.35 to US$3.16) ● Of this US$2.87, secondary market ETS price feeds contribute US$1.98, credit programs US$0.07, taxes and other ETSs US$0.82, (nominal prices - US$3.16, US$2.17, US$0.08, US$0.91) ● The spread to the Paris-consistent target price widened from US$55.01 to US$58.60. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 13 This can be examined against: This is a stark outcome and the significance of this, in climate progress terms, should not be underplayed. ● The IMF’s carbon pricing analysis in 2019, which suggests that the then average global cost of There are, nonetheless, two additional factors that emissions is US$2 (Parry, December 2019) may be relevant in this context. ● Kepos Capital’s most recent annual assessment Firstly, if the implicit pricing overlay (see ‘Core design of explicit and implicit carbon pricing, when valued principles and assumptions’) was applied at an at a global perspective, 29 provides US$12.92/ton aggregate level, the end-January 2021 global effective price would increase by approximately ● The recently published Monash/C2Zero US$7.45 to US$10.32, of which taxes and other ‘Real Carbon Price’ indices arrive at comparable ETS components contribute US$8.27. 31 This overlay explicit carbon values and consolidations. 30 effect is amplified to US$26 if the overlay is applied to the entire [explicit only] global effective price This pilot study would seem to suggest that, despite (see illustration in graph). This underscores the the progress made globally on the development of potential diversity of outcomes resulting from carbon pricing mechanisms (as shown for instance on changes in methodology; and therefore securing the Carbon Pricing Dashboard); the global outcome agreement and consensus on the methodology is in fact not only far from the Paris-consistent target is so crucial. corridor, but the situation is worsening over time. FIGURE 1: PILOT STUDY – HISTORICAL OVERVIEW 2017-2021 Overview of global effective price vs Paris-consistent target $100,00 $10,00 $1,00 2017-05-31 2017-11-30 2018-05-31 2018-11-30 2019-05-31 2019-11-30 2020-05-31 2020-11-30 Paris Consistent Corridor Aggregate Inflation adjusted Global Effective Price Aggregate Nominal Global Effective Price [With illustrative ‘implicit overlay’ applied] 29 2019 assessment https://www.carbonbarometer.com/#/ 30 https://www.realcarbonindex.org/ 31 This is derived from a simplistic division of $0.82 by the implicit overlay factor of 0.11. 14 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 7. Building a Secondly, since April 2021, there have been a number of energy market, or carbon and climate policy- related developments. Each could have, to a lesser or greater extent, an influence on the value and trajectory of a global effective price. For instance: financial markets ● The National China ETS has become operational and its secondary markets price feed would benchmark contribute to the global effective price: as a T greater proportion of global GHG become subject he benchmark’s attraction to some financial to direct and explicit carbon pricing, so the global sector players should increase with greater effective price should increase accordingly (the frequency of update of display. quantum and direction of this may vary over time as the National China ETS price changes). It is likely that the technical capability to do this will exist in the form of commercially available price feeds ● There has been a significant increase in global and application interfaces (how data is imported from natural gas prices and liquid, tradable ETS prices one IT environment into another). (particularly the EU ETS) have increased in a correlated manner. Again, this will have the effect The central weightings algorithm contains a mixture of increasing the global effective price. of static and dynamic data inputs. Two real-time (or close to real time) data feed types were used in the ● As mentioned earlier, in the lead up to or during pilot as the currency conversion exchange rates (such COP26, various COP Parties and stakeholders as the Euro or China Renminbi against the US dollar) outlined Net Zero strategies or pledges. From and traded ETS price feeds (such as the EU ETS). Both an implicit (or perhaps implied) carbon pricing of these elements were significant contributors perspective, these may serve to further uplift the towards the consolidated global effective price. global effective price. As a reference, the EU ETS price rose on the first trading day post COP26, Subject to any data rights restrictions, the capability though this may be due to prevailing energy exists therefore to update the benchmark display with market conditions. 32 increasing frequency – up to and including real time. To illustrate this process, a trial version was set up on a Bloomberg screen, alongside the pilot study showing the historical overview (see previous section). Figure 2 shows an intraday (second by second, minute by minute) price profile of the benchmark on a particular day (March 26, 2021). Overlay of global effective price (blue line – price legend, left-hand side), with the spread to the Paris-consistent and Net Zero target price (white line – price legend right-hand side). The volatility and direction of movement between 07:00 and 17:00 (UK time) is primarily due to the price activity in the underlying EU ETS on that day. https://www.spglobal.com/platts/en/market-insights/latest-news/electric-power/111521-eu-carbon-prices-hit-record-eur66mt-amid-cold- 32 snap-cop26-aftermath B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 15 FIGURE 2: Price profile of the benchmark (Graph – Bloomberg) Regulation as a financial benchmark In a practical sense, this is likely to mean finance sector participants would be able to buy or sell The benchmark may be required to be subject to something in the form of a unit or contract. A spot formal regulation, were it to meet various threshold price or futures contract can be created around conditions, including, provisionally, that it forms the the benchmark. basis of pricing of financial assets. Regulation may in fact be desirable, in that it would promote the This has implications beyond the finance sector cachet and profile of the benchmark. Conceptually, in that it can strengthen the ties or understanding benchmark regulation is intended to ensure integrity between the policy perspective and financial of pricing, such that a benchmark reflects accurate decision makers. 34 source data. 33 It is a sensible and logical starting point that the As part of this process, there may need to be a benchmark can be displayed in a location associated corporate entity that can be identified as a with carbon pricing policy development – for instance, benchmark ‘administrator’. the Dashboard. Financial product(s) and tradability To enable or encourage widespread adoption by financial players, the benchmark may need to be in a To further the impact, relevance and attractiveness form and location that embeds easily into finance of the benchmark to the finance sector, some form and risk decisions. Relevant factors include: of tangibility of financial action or decision can be created. In this way, the benchmark can develop from ● Whether the benchmark price feed (be it live, being solely a metric for price discovery, into being updated daily or less frequently), is machine a price against which finance players can engage readable into financial calculations directly. This could form a feedback loop between finance action and the pricing consequences of that action. In this regard, there would be EU and UK – and to an extent US - benchmark regulations to consider. There may be relevant regulatory 33 carve-outs or exemptions for central banks’ provision of or oversight for benchmarks. 34 Consider as comparators, the relationship between global oil and energy markets with OPEC oil production decisions; or the relationship between global interest rates markets or foreign exchange markets and monetary policy decision making. 16 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 8. Exceptions to ● Whether the benchmark can be molded into other purposes – for example, forward pricing visibility [in the form of futures contracts etc.] ● Whether there are legal [intellectual property- and limitations of initial related] barriers to the benchmark display being incorporated into financial products. methodology A finance sector ‘host’ may be beneficial in this context. Such a host may be a markets data provider, product provider or financial infrastructure (financial I exchange group) provider. A formal arrangement that provides a reference price or data feeds into a t is important to acknowledge deficiencies and financial reference may be required. limitations arising from the initial methodology. A non-exhaustive list of examples are set out below: Further, and as was discussed in the webinar organized by the World Bank on April 20, 2021 ● Paris-consistent/Global Net Zero target price (see ‘References and further reading’), there may corridor be benefits in creating interoperability between the benchmark and the existing carbon pricing landscape. – The May 2017 Report on Carbon Prices by The benchmark would then take on an ‘umbrella’ role. the High-Level Commission on Carbon Pricing remains a static model, now four years old. This would be a significant step in that, were the This framework may require review and benchmark to become tradable, overall carbon reforecasting. liquidity and transactional volume could grow and in so doing, help drive convergence or harmonization – In addition, the pricing corridor set out in of pricing overall. this report is quite broad (‘US$40–80/tCO2 by 2020 and US$50–100/tCO2 by 2030’). There may be practical limitations to this concept Reducing this to linear regression – as the in that most underlying prices contributing to the initial methodology proposes – may not global consolidated picture are not currently tradable provide an optimal level of accuracy. Some (for instance, it is not possible to buy or sell a ‘French potential users of the benchmark might find carbon tax’). Proxy pricing may be required. Some a single regression. existing ETSs may also have restrictions on trading access. ● Basis for weighted averaging formulae – The proposed consolidation approach assumes that a unit of carbon emitted in any location has the same climate effect. – However, the attributes of specific carbon pricing initiatives may not be directly comparable or substitutable. This is acknowledged in a disclaimer found on the Dashboard. 35 ‘Note: Nominal prices on November, 01 2020. Prices are not necessarily comparable between carbon pricing initiatives because of 35 differences in the number of sectors covered and allocation methods applied, specific exemptions, and different compensation methods. Due to the dynamic approach to continuously improve data quality and fluctuating exchange rates, data of different years may not always be comparable and could be amended following new information from official government sources. In addition, data for a few initiatives may be incomplete as they are in the process of being validated and will be updated following confirmation from official government sources.’ B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 17 – The weightings methodology proposed – – Carbon border adjustment policies based solely on proportion of global emissions covered – does not adequately reflect – Announced, but yet to be implemented this heterogenous nature. The weightings explicit carbon pricing initiatives. A number methodology also places great reliance on the of governments, including from large emitter Dashboard being able to accurately reflect any economies, have made announcements in the carbon price scheme policy controls adopted lead up to COP26 by policymakers (for example, market stability reserves), where ETS secondary market price – Voluntary market (offsets, credits), feeds are not included in the methodology. development and activity – and the ‘corresponding adjustments’ relationship this ● Consistency of methodology across the may have towards policy-driven carbon pricing benchmark – Net zero pledges or other commitments – The proposed construction of the global emanating from state or non-state actors made effective price starts with the consolidation prior to and during COP26. The latter would of explicit carbon pricing data and adds an include companies, investors, and financial implicit pricing ‘overlay’. institutions. 36 – The ‘Stern/Stiglitz’ framing of a global Paris- – Various green or sustainable finance consistent price, however, focuses on the instruments or initiatives (for instance growing setting of an explicit carbon pricing corridor green bond issuance) that, in complementing other policy action, can support the achievement of Paris goals. Implicit – The implementation of, or intentions to pricing factors such as fossil fuel subsidies, are implement, various forms of negative emissions nonetheless referenced in the Stern/Stiglitz technology and abatement report. – Events in relation to any of the above, such as – Care will be required to ensure consistency of a Dutch court verdict on an energy company’s approach – such that the global effective price emission reduction targets. and Paris-consistent price corridor are directly comparable. ● Consistency of historical RGGI and California ETS price data ● Pricing overlaps – The pilot exercise identified that two years’ – Data extracted from the Dashboard suggests worth of daily historical data for both RGGI that, across 60 implemented ETS and taxation and California ETS secondary market initiatives, approximately 890MTCO2e, of prices are obtainable. However, to enable a a total 8,870MTCO2e (near 1 percent), is historical overview back to May 2017, this was duplicated. This has not been remedied in the supplemented by data for legacy contracts in initial methodology. these markets, as well as, for a short period, static data obtained from the Dashboard. This ● Whilst explicit and, albeit simplistically, implicit may be a sub-optimal approach, albeit fairly pricing has been considered within the immaterial in impact. methodology, there are various data that may have an ‘implied’ effect on carbon pricing – and these have not been considered within the methodology scope. Examples include: 36 It has been claimed that investors with $US43 trillion of assets under management have made various Net Zero pledges https://californianewstimes.com/investment-industry-at-tipping-point-as-43tn-in-funds-commit-to-net-zero/427561/ 18 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 9. Benchmark or define the underlying data to be seen across regions and, possibly, sectors such as shipping or transport, providing comparative analytics development and time series. Additional data overlays such as trends in global greenhouse gas emissions could steps also be added to such a platform. ● A financial service or product that can be invested or traded. Enhancing benchmark relevance The overall development pathway for the benchmark I should recognize these distinctions. n the ‘Role and objectives’ section, various stakeholder groupings and as to how the Refining the methodology benchmark could support their respective interests, The initial methodology set out in this paper will were set out. require further refinement. Areas of focus should include: For these benefits to be fulfilled, however, users (and potential users) must be able to see the benchmark’s ● Addressing each of the items set out in the relevance: ‘Exceptions and limitations’ section37 ● In that it is calculated and defined in an undeniable ● A more comprehensive approach to incorporating and credible way. implicit carbon pricing. This should cover all forms of energy-related policy (including fossil fuel ● It is developed and implemented in a timescale subsidies) and be capable of being viewed across that complements carbon policy or infrastructure regions and sectors. When added to explicit development (in areas such as VCM) and pricing factors outlined in the initial methodology, individual regions, sectors and various entities’ this approach should largely reconcile with OECD approach to climate alignment. research on ‘effective’ carbon rates and fossil fuel subsidies38 , or the Kepos Capital Carbon ● The benchmark can be used to look backwards Barometer’39 or any related work within or outside and forward across possibly multi-year periods. of the World Bank Group. ● It changes, adapts or updates in a sufficiently timely manner to reflect developments. Regard should also be given to how any methodology can or should reconcile with World ● That there would be a feedback loop between Bank research on the nexus between trade and climate financial decisions taken and an effect or climate policy.40 consequence on carbon or climate policy progress – and vice versa. As alluded to in the methodology section, developing a ‘levelized’ approach to In this direction, the following development steps – understanding the cost of energy generation or that could be taken sequentially or in parallel – are consumption may be helpful in this direction. set out for reference. As further elements of implicit pricing are Bifurcating development added into the methodology, it is also likely that adjustments will need to be made to weightings In some senses, there are two distinct, interacting proportionality – as it may be that, for example, projects to be developed: various energy taxes, excises or fossil fuel ● A data analytics and visualization platform. This subsidies cover a greater proportion of global should allow benchmark users to understand GHG emissions. It may also be worth noting that new initiatives are arising to consider the complexities of the global carbon landscape. See for instance37 37 https://hotorcool.org/wp-content/uploads/2021/10/Hot_or_Cool_1_5_lifestyles_FULL_REPORT_AND_ANNEX_B.pdf 38 See https://www.oecd.org/tax/tax-policy/effective-carbon-rates-2021-0e8e24f5-en.htm 39 See https://www.carbonbarometer.com/assets/docs/Measuring_Comprehensive_Carbon_Prices_23_Dec_2020.pdf 40 https://openknowledge.worldbank.org/handle/10986/36294 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 19 ● Similarly, it will be important to build an agreed the ‘Stocktake’ process within the UNFCCC approach to updating a ‘Stern/Stiglitz’ Paris- framework 42 to promote consistency and cohesion consistent target carbon pricing corridor – in methodology. whether this be through a reforecasting, a more recursive modelling approach or by any means set ● Only a present value, perhaps described as a by carbon policymakers. In addition, there should ‘spot price’, is formulated for the benchmark and, be consistency of methodology between this subject to the sections below, financial markets corridor and the global effective price calculation. are in a position to express a collective opinion as to future events, and in so doing, create a forward Forward pricing capability pricing curve. This would be analogous to the approach taken currently in energy, commodities A number of stakeholder groups may wish to see a and interest rates markets. forward pricing capability. There may be three options to enable this: Governance and transparency ● A forward trajectory is embedded into a ‘Paris- A governance and oversight framework should be consistent’ target pricing corridor. established and supported by key parties and experts among carbon pricing policy makers and market ● A forward pricing methodology is agreed for the participants. target price corridor, as well as for the global effective price. This may entail the inclusion of There are a series of separate and distinct decision the phased implementation of future national, points in overseeing the benchmark that interact to regional or sectoral carbon pricing initiatives. So, form a governance framework. This framework should for instance, an incremental weightings approach reconcile with the data requirements set out in this could be given to legislative or administrative paper. steps towards implementation – perhaps 10 percent weighting be given to a public pledge, Table 2 below sets out these various decision points. 30 percent to draft framework legislation published, and so on. Documenting and publishing both the structure and outcome of the governance discipline will be essential As a comparator, it is noted that the Climate in providing transparency and building credibility. Action Tracker initiative set out a scientific This approach is seen elsewhere in existing globally assessment of the future impact of COP Parties’ recognized financial benchmarks.43 Net Zero commitments made at COP 41 – and such an approach may help build a consensus It may also be beneficial to build in expectations that towards a forward pricing approach. In addition, the mathematical and weightings methodology may regard may be given to developments from require experimentation and refinement over time. TABLE 2. DECISION POINTS IN OVERSEEING THE BENCHMARK DECISION POINT DETAIL REGULARITY OF REVIEW Methodology development Scope, design, addressing limitations and exceptions Quarterly Methodology weightings Weightings attributed to individual initiatives Quarterly Eligibility of carbon price Eligibility of new initiatives or pledges as they are Quarterly initiatives announced 41 https://climateactiontracker.org/methodology/net-zero-targets/ 42 https://unfccc.int/topics/global-stocktake 43 The benchmarks set out above serve as relevant examples. 20 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 10. References (hydrofluorocarbons and perfluorocarbons) and sulphur hexafluoride (SF6). https://unfccc.int/process- and-meetings/the-kyoto-protocol/what-is-the- and further kyoto-protocol/kyoto-protocol-targets-for-the-first- commitment-period This paper would recognize that, reading for example, the Intergovernmental Panel on Climate Change (IPCC), the United Nations body for assessing the science related to climate change, may be a peak body for assessing GHG emissions levels, whereas the Dashboard nonetheless presents data as to the 10.1. Glossary of terms and proportion of GHG emissions covered by specific abbreviations used carbon pricing initiatives. Carbon Pricing Leadership Coalition (CPLC) – Global effective price – a price of carbon a widely recognized forum that brings together determined by a weighted-average consolidation of leaders from government, private sector, academia, various existing carbon pricing initiatives. In that way, and civil society to expand the use of carbon pricing its construction is positive – reflecting the current policies. The World Bank Group provides the state of carbon pricing – rather than normative. It secretariat function for CPLC. could be described as a synthetic construction of a globalized price of carbon – in the absence of a Crude oil benchmarks – (WTI (West Texas governmental or policy-driven decision or framework Intermediate) and Brent) widely used benchmarks that might otherwise impose or create such a price. for the pricing and trading of US and non-US oil respectively. Non-traded ETS – a category of emission trading system or scheme price references that have Dashboard – the Carbon Pricing Dashboard. been sourced from static data downloaded from A World Bank Group knowledge product the Dashboard. There may or may not in fact be https://carbonpricingdashboard.worldbank.org/ trading occurring in emissions allowances under the outlining key statistics on regional, national and respective ETS. subnational carbon pricing initiatives. The Dashboard holds downloadable data on carbon taxes and ETSs Paris-consistent target – a carbon price level set and separate downloadable data on carbon credit to meet the goals of the Paris Agreement on climate programs. change. This price level may, but not necessarily, correlate at a global level with terms such as a ESG – ‘Environmental, Social, Governance’ ‘Net Zero’ price. investing – criteria setting out investment standards for socially conscious investors to use to screen Spread – a finance sector term, in this case denoting potential investments. the price gap between the global effective price and the Paris-consistent target. Effective marginal carbon rate – a term imported from OECD research on ‘Effective Carbon Rates’ Traded ETS – a category of emission trading system https://www.oecd.org/tax/tax-policy/effective- or scheme price references that have been sourced carbon-rates-2021-0e8e24f5-en.htm (See box 4.1) from live or near live data feeds via a financial ‘The effective marginal carbon rate (EMCR) shows markets data provider (Bloomberg was used in the the strength of the marginal incentive to reduce pilot study). Price fluctuations occurring through emissions, for example, via small-scale efficiency secondary markets trading will be captured for this improvements or demand reductions for an category of prices. investment that has already been carried out. Sources: Flues and Van Dender (2017; 2020).’ VCM – Voluntary carbon markets – an industry term denoting markets that allow carbon emitters to offset GHG – greenhouse gas emissions that contribute their unavoidable emissions by purchasing carbon to global warming and climate change. The Kyoto credits emitted by projects targeted at removing protocol encompasses the following six greenhouse or reducing GHG from the atmosphere. Companies gases: carbon dioxide (CO2), methane (CH4), can participate in the voluntary carbon market either nitrous oxide (N2O), and the so-called F-gases individually or as part of an industry-wide scheme. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 21 10.2. Summary of the carbon spread Carbon spread benchmark proposal benchmarking webinar A proposal for a carbon spread benchmark – April 20, 2021 | 9:00 – 10:30 am EST | WebEx including a pilot study already undertaken – was presented. The objective of the proposal is to develop Agenda a methodology for constructing and overseeing a consolidation of global carbon pricing information and ● Opening remarks: Wendy E. Hughes, Practice benchmarking this as a spread against a universally Manager, Carbon Markets and Innovation, recognized Net Zero/Paris Agreement-consistent World Bank target. This could result in a credible price signal to market participants and other stakeholders; a support ● Presentation: Mike Knight, Consultant, World to carbon pricing policy development; informing Bank (20 min). market cooperation and linkage of different carbon pricing schemes and serve as a basis for the financial ● Discussion moderated by Chandra Shekhar sector to develop investments and sustainable/green Sinha, Climate Change Group, World Bank finance-related products. Discussion points during (25-30 min). Discussants: the meeting are summarized below. – Stephane Hallegatte, Climate Change Group, ● Benchmark construction: There may be World Bank technical challenges in defining the benchmark, so development steps should be undertaken in – Florens Flues, Centre for Tax Policy and a clear and transparent manner, recognizing any Administration, OECD limitations and outlining steps to manage these. The following are some of the technical challenges – Bruce Ian Keith, Financial Institutions Group – outlined during the discussion: Upstream, IFC – Carbon price definition and reference – Angela Naneu Churie Kallhauge, Carbon price: Pricing Leadership Coalition (CPLC), World Bank It is necessary to clearly define and determine which carbon reference prices are to be ● Q&A (30 min) included; and to do so in a transparent and ● Closing remarks: Anderson Caputo Silva, objective manner. Relevant considerations Practice Manager, EFI-FCI-Long-Term Finance, include the following: World Bank – There is a need to acknowledge and explain the differences between explicit carbon pricing and the underlying enabling conditions (for example, policies and measures that result in implicit and implied carbon prices). – It is imperative to use definitions that are not (solely) based on what governments label as carbon prices since this is likely to be a subjective construction subject to discretionary modification. 44 OECD’s approach to ‘Effective Carbon Rates’ was noted in this context http://www.oecd.org/tax/tax-policy/effective-carbon-rates-2021-0e8e24f5-en.htm 22 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K – There are very different views on what – Inform impact analysis of climate risk carbon prices are and this is particularly scenarios. This initiative will contribute to reflected through the contraposition signaling climate change-related risks and to between what is traded in markets for informing financial sector stakeholders of the carbon credits or voluntary initiatives, risk and opportunities in investment portfolios and carbon prices that result from direct and risk hedging. government regulations through taxation or emission trading systems.44 – Facilitate the development of a new international financial system and architecture – Data coverage: There may be tensions framework that has climate as one of its between comprehensiveness of carbon main pillars. This system would be market information coverage versus objectivity of data driven, asset neutral and currency neutral; and weightings. A balance will need to and standardized through the Carbon be found. Pricing Dashboard and IBRD mechanisms for qualifying, quantifying, certifying and ● Use cases: This carbon pricing approach may monetizing. help overcome heterogeneity and fragmentation in the global carbon landscape and bring scale CSB use cases may be varied, with different and speed to the process of shifting investments stakeholders interested in different time horizons, into financing towards low carbon alternatives. both looking back and looking forward. Price Some potential use cases outlined during the discovery is the central proposition that draws this discussion include the following: together. The commodification effect of carbon pricing was discussed in a possible dichotomy oster the development of financial innovation. – F between the market signal or financial market This project can boost the development signaling versus policy signaling. In this sense, the of financial instruments and techniques features that might be potentially useful for financial that in turn can facilitate the transition to a markets, could generate suspicion or tensions low-carbon economy, for example, green amongst policymakers. For instance, having a year- bonds, ratio features, market trading and to-year (as opposed to, for instance, minute-to- liquidity, results-based instruments (such minute), benchmarking could be more useful to create as sustainable linked bonds), sovereign KPI political pressure and some felt fostering long-term linked instruments, and so on. Discussion investments. Separately, having a unique benchmark also took place as to i) whether and how the to measure the performance of countries with very benchmark could be interoperable with the different circumstances and approaches regarding existing carbon pricing landscape; and, in this carbon pricing could potentially lead to increasing context whether Blockchain technology, or sovereign risks for those that do not perform well existing commodities or energy benchmarks based on that benchmark. (for example, WTI/Brent crude oil) form a blueprint for a pricing relationship between In this context, it is necessary to explicitly recognize financial and ‘physical’ markets; and ii) whether the purpose of the benchmark being as clear as the benchmark could inform forward pricing possible regarding the type of decisions it should visibility, possibly via spot and futures pricing. potentially influence, as well as the design features being sought. The point was also made that the nhance climate ambition. This top-down – E benchmark needs to be both relevant to decision approach would show policymakers how making and beyond reproach in its credibility. they compare across countries and the world aggregate on climate ambition. This could help It is also worth noting that, as the project moves support a more coherent global carbon pricing forward it would be possible to customize and framework end enable a race to the top in break down this overall top-down overview into climate ambition. components (for example, regions or sectors) that might be of particular relevance for different audiences. B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 23 Annex A – data source overview The table contents recognize that much of the benchmark base data is static, or only changes over an extended time (annually, quarterly or monthly). It also notes that there are two key data inputs which are or can be live and dynamic: ● Traded ETS secondary market price feeds – these are significant in that, according to the pilot study – the cumulative weighted average value of traded ETS prices contributed over 60 percent of the global effective price (US$1.98 out of US$2.87 as at January 31, 2021); and ● Currency pairs (local prices versus US dollar), which are central to the consolidation process. This feature in relation to the timeliness of data inputs, helps provide optionality as to the regularity of review of inputs data, the weightings methodology itself, and displaying the output of the benchmark. The options across this data framework reflect – or at least are analogous to – how existing financial benchmarks currently operate in share markets, or energy and commodities markets. See for instance ICE Brent Crude Benchmark, CME WTI Benchmark. 24 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K INPUT DATA PROVISIONAL WEIGHTINGS METHODOLOGY DISPLAY COMMENTS & NOTES PRICE UPDATE/ REVIEW REVIEW OUTPUT REVIEW PERIOD PERIOD CARBON PRICE DATA – GLOBAL EFFECTIVE PRICE Carbon tax As now on Quarterly/ Quarterly Weekly initiatives Carbon Pricing Semi- Dashboard – annually Annual Credit As now on Quarterly/ Quarterly Weekly schemes Carbon Pricing Semi- Dashboard – annually Annual [Non-traded] As now on Quarterly/ Quarterly Weekly Assumption that ETS [for Dashboard Semi- the World Bank has example, annually access to Kazakhstan Kazakhstan] reporting platform. Assumption that auction prices are captured on the Dashboard. Traded ETS Real time during Quarterly/ Quarterly Weekly Five existing secondary trading hours Semi- secondary market markets feed annually feeds identified. Some (EU, NZ, ICE real time data only RGGI, CA, obtainable directly KOR, [China]) from ICE data. Also need to check other IP restrictions from exchange price feeds. Addition of National China ETS would take place in timeframe set out in each column. Additional sectors (CORSIA, shipping) Implicit – Annual Quarterly/ Quarterly Whilst OECD Energy costs calculation Semi- undertake annual [OECD] annually calculations, the underlying data appears to be updated triennially. Implicit – Annual Quarterly/ Quarterly Fossil fuel calculation Semi- subsidies annually [OECD] B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K 25 INPUT DATA PROVISIONAL WEIGHTINGS METHODOLOGY DISPLAY COMMENTS & NOTES PRICE UPDATE/ REVIEW REVIEW OUTPUT REVIEW PERIOD PERIOD CARBON PRICE DATA – DEVELOPMENTAL LEVEL – TO INCLUDE IMPLIED PRICING Implied – Monthly Monthly Quarterly Weekly present value of Net Zero/ transition pledging Implied – Weekly/Monthly Monthly Quarterly Weekly VCM (and possibly corresponding adjustments) Implied Weekly/Monthly Monthly Quarterly Weekly – green sustainable finance activity Historical/ Historical only Historical Historical only Weekly legacy data only reflecting some or all of the above CONSOLIDATION/CONVERSION DATA PPP – Monthly n/a n/a Weekly Most relevant inflation economies use indicators monthly statistics. (consumer or Australia/New retail prices) – Zealand appear both localized to have quarterly and US statistics only. Currency Real time n/a n/a Weekly pairs/ exchange rates localized currency versus US dollar. 26 B EN C H M A R K I N G A G LO BA L- LE V EL C A R BO N PR I C E F R A M E WO R K A RT I CL E 6 A PPROACH PA PER 1 27 Administered by THE NETWORKED CARBON MARKETS Climate INITIATIVE Warehouse