Accelerating the North American Shift to Clean Energy via Proxy Carbon Pricing

President Barack Obama speaks at a news conference after the seventh trilateral North American Leaders Summit in Toluca, Mexico, on February 19, 2014.

In the past year, the national governments of the United States, Mexico, and Canada have all pursued policies to curb carbon pollution. The U.S. Environmental Protection Agency, or EPA, for example, has finalized its Clean Power Plan and is taking steps to reduce methane emissions from the oil and gas sector. The Canadian premiers, in an about-face from the era of the Harper administration, are developing a pan-Canadian strategy to drive emissions reductions. Mexico, following the adoption of the Paris Agreement, has implemented its Energy Transition Law to drive clean energy development.

Such political alignment on climate change affords an opening for the three national governments to craft a coordinated North American climate strategy. Trilateral cooperation could accelerate the North American shift to clean energy and could provide momentum in the global effort to limit climate change, as the Center for American Progress, the World Resources Institute, and a coalition of progressive partners from Mexico and Canada have argued.

Proxy carbon pricing—a practice that helps facilitate climate-smart investment decisions—can help governments and businesses both accelerate and prepare for the North American energy transition. It is therefore a policy tool that could serve as a key element of a continentwide climate plan.

Proxy carbon pricing in the private sector 

Increasingly used in the private sector, the practice of so-called internal carbon pricing can take several forms. Some companies establish internal trading systems among divisions or internal fees in order to meet emissions reduction targets. Others assume a future price on carbon emissions when they evaluate the financial viability of potential long-term investments. This practice—called proxy carbon pricing or shadow carbon pricing—helps steer investments away from high-carbon projects and toward low-carbon alternatives.

Companies use proxy carbon pricing in order to help ensure their continued success in the global shift toward low-carbon energy. They understand that this shift would burden companies holding high-carbon assets with increasing costs. They also understand that the shift toward low-carbon energy is already underway and inevitable. Recent evidence of this includes the Paris Agreement, in which the scale of the climate threat motivated more than 190 countries to create a global framework to spur emissions reductions and build resilience to the effects of climate change.

As world leaders now pivot to the task of meeting the goals of the Paris Agreement—which include driving emissions down to net zero in the second half of this century—carbon taxes, emissions trading systems, and nonmarket regulatory policies will continue to burgeon. For example, Ontario and Manitoba announced plans in the past year to implement emissions trading systems linked to those of Quebec and California—which themselves linked in 2014—and Oregon began to research how it might create a system that is linked as well. Notably, more than half of the national climate plans submitted in advance of the Paris Agreement indicate that countries will use—or are considering the use of—such market-based instruments.

Progressive companies—and companies that are merely fiscally prudent—are actively encouraging the accelerated adoption of such systems, which can reduce price uncertainty as firms make long-term investment decisions. The Carbon Pricing Leadership Coalition, for example, is a partnership of governments, nongovernmental organizations, and more than 90 global businesses that encourage governments to adopt carbon pricing instruments.

In the meantime, companies that do not yet operate under the jurisdiction of a carbon tax or emissions trading system—or companies that operate under one with unsustainably low prices on carbon—are using proxy carbon pricing to prepare for a future with stricter carbon constraints. More than 1,000 companies disclosed in 2015 that they use an internal carbon price or plan to in the near term.

Proxy carbon pricing in the context of North American climate action

There has been increased recognition of proxy carbon pricing as a private-sector tool to reduce the risk of stranded assets—that is, assets that become devalued well before the end of their useful lives. Less attention has been paid, however, to the fact that it can be a tool for governments that are working to prepare their economies for the global energy transition and, at the same time, doing their part to help propel it.

The United States, Mexico, and Canada strive to be such governments. Proxy carbon pricing is therefore a policy tool that should be incorporated in a North American climate strategy. There are many roles for proxy carbon pricing in nation-level climate action, including the following three examples.

Apply a proxy price on carbon in government decision-making

Since 2010, the U.S. executive branch has considered the social cost of carbon—which refers to the damage to society caused by each ton of greenhouse gas pollution—when evaluating potential regulations that would affect emissions. Values range from $11 to $105 per metric ton in 2015 and increase over time.

But the practice of factoring in a price on carbon in government decision-making should not end with potential rulemakings. The United States, Mexico, and Canada should also apply a proxy price when, for example, they evaluate investments in—and permits for—energy infrastructure, such as export terminals and power plants. A proxy price could help determine whether potential projects will remain financially viable in—and whether they are consistent with—a future world with increasingly strict carbon limits.

Governments should also apply a proxy carbon price in decision-making regarding cross-border infrastructure, such as pipelines. This is particularly relevant in North America given the current and future levels of energy integration. The United States, for example, has robust gas, oil, and electricity trade with Mexico and Canada: U.S. energy trade was recently valued at $65 billion for Mexico in 2012 and $140 billion for Canada in 2013.

Given that energy infrastructure can have a decades-long lifespan with long-term emissions implications, it is a key area for North American climate action.

Support proxy carbon pricing in the private sector

In order to position their economies for success in the low-carbon future, the United States, Canada, and Mexico should encourage companies to adopt internal carbon pricing in their investment decisions. More than 150 North American companies—in a range of sectors, including oil and gas, finance, and technology—already report that they currently or will imminently use an internal carbon price.

The internal price chosen should be sufficiently robust to steer investments toward lower-carbon alternatives and away from risk-laden high-carbon assets. More than 160 companies around the world have committed to set science-based greenhouse gas reduction targets, for which an internal price can be a useful implementation tool. The U.N. Global Compact, a corporate sustainability effort with 8,000 business signatories, has called on companies to set an internal carbon price of at least $100 per metric ton of greenhouse gas emissions over time in order to be compatible with the target to limit warming to 2 degrees Celsius over preindustrial levels.

In the run-up to Paris, the U.S. administration, through the American Business Act on Climate Pledge, successfully enabled companies to show their support for global climate cooperation and their individual dedication to corporate climate action. A larger, coordinated campaign across North America could provide momentum for companies to adopt internal carbon pricing and to be transparent to investors about the risks that climate change poses to their companies.

Encourage proxy carbon pricing in international development finance

The United States, Canada, and Mexico should also encourage the international finance institutions to which they donate to adopt proxy carbon pricing and complementary tools to drive investments in low-carbon development projects.

Multilateral development banks, for example, have a mandate to serve the public interest in developing regions. Given that climate change exacerbates poverty and therefore conflicts with their guiding objective, they should make every effort to steer investments away from projects that would lock in unnecessary emissions.

With proxy carbon pricing just beginning to gain traction in the international finance community as a tool that can help guide climate-compatible investments, there is an opening for countries to hasten its adoption among the institutions of which they are members.

Conclusion 

As the world unites to fight climate change, the cost of carbon pollution will continue to increase. Nonmarket regulatory policies that set an implicit price on carbon—as well as carbon taxes and emissions trading systems that set an explicit price—are proliferating.

Major corporations are incorporating proxy carbon pricing in their decision-making in order to protect their shareholders from fossil fuel-intensive projects that are at risk of becoming obsolete as the world pivots toward low-carbon energy sources.

Similarly, the governments of North America have an obligation to help prevent overinvestments in fossil fuel-intensive projects that could become a burden on their national and local economies in the face of the global energy transition. At the same time, the governments of North America also have an obligation to do their part to curb greenhouse gas pollution in order to meet their national emissions reduction goals and help set the world on a path to limit warming.

By adopting proxy carbon pricing in their national and cross-border infrastructure investment and permitting decisions—and encouraging its use in other contexts, such as international development finance and the private sector—the United States, Canada, and Mexico can help meet these obligations.

Gwynne Taraska is the Associate Director of Energy Policy at the Center for American Progress. Eliot Metzger is a senior associate with the Business Center of the World Resources Institute.

Thanks to Tom Kerr at the International Finance Corporation, Jayoung Park at the U.N. Global Compact, and Lila Karbassi at the U.N. Global Compact for comments on an earlier version of this manuscript. The reviewers do not necessarily share the opinions of the authors; all errors are the responsibility of the authors.