Whilst the Paris Agreement creates a ‘common but differentiated’ approach for signatories to keep global temperatures within climate-safe limits, climate mitigation and the energy transition remain a global-level challenge.

After all, the overall climate effect of greenhouse gas emissions is not determined by where they are emitted, nor by whom the emitter may be.

A wide variety of stakeholder groupings make decisions that are relevant to the progress of mitigation and transition - governments and policymakers, energy and energy intensive industry players, investors and risk managers. To aid the effectiveness of these decisions, their context and cumulative effect should be visible and therefore understandable at a global level.

Key metrics such as a globalised price of emissions (for instance, a unit of carbon) can provide this visibility and common understanding.

Historically, other global-level challenges have been aided by - or even resulted in - a common metric or reference point. For instance, global navigation and geo-spatial understanding has been aided by agreement over a prime (Greenwich) meridian.

So which carbon current and future reference price(s) could represent a globalised price?

In reality, there are increasing numbers of carbon price references available; these derive from various sources and initiatives that are fragmented, non-fungible, overlapping and inconsistent.

For instance, reference prices may be derived from trading in regulated emissions allowances or trading markets. Otherwise, prices may be obtained from various formulations of offsets or credits offered in ‘voluntary’ markets. Each of these sources cover only a small proportion of global greenhouse gas (GHG) emissions. Even a large and actively traded emissions allowance market – the EU’s Emissions Trading Scheme (which is used by some climate risk stakeholders as a proxy live price for carbon) – covers only approximately 2.6% of global GHG emissions.

The prevailing prices of these various sources can vary greatly – from USD 50 -100 per tonne of CO2 equivalent, down to less than a single USD.

In addition, there is a broader failing in considering only direct carbon pricing – and this is observed in research from World Bank staff:

‘…although direct carbon pricing now covers roughly a quarter of global emissions, the global total carbon price is not that much higher than it was in 1994 when the United Nations Framework Convention on Climate Change entered into force. Indirect carbon pricing still comprises the lion’s share of the global total carbon price, and it has stagnated.’

Differing approaches to the make-up of a globalised carbon metric could have a significant effect on its pricing outcome – and hence on the quality of decisions that incorporate such a metric.

A lesson from markets – the role a benchmark carbon price could play

A new reference price is needed that can overcome this fragmentation and inconsistency.

Lessons could be learned from how various existing global-scaled markets operate around a benchmark price. Benchmark prices play an important anchor role in shaping consensus over both current and future prices for a particular asset or activity. This is seen in, for example, markets for commodities and energy (the WTI and Brent benchmarks), and interest rates (eg the SONIA benchmark used in the UK).

Indeed, an FCA paper states that ‘Benchmarks are critical to the efficient functioning of financial markets. They are used to …serve as reference rates… [and] increase price transparency for investors.’

Not all oil, nor interest rate prices seen in markets, financial instruments, or risk metrics, are at the level of the respective WTI, Brent or SONIA rate, but may be based on or be structured around these benchmark rates.

In this way, benchmark prices provide the accepted and respected methodological foundation on which market pricing and risk decisions are based.

Why a new benchmark is needed (and does not already exist)

The search for a politically agreed, top-down mechanism for pricing global GHG emissions has gone on for decades. However, political agreement has been elusive. Further, global multilateral institutions have not been in a position to create and implement a global level price benchmark for carbon. For example:

• The UN Framework Convention on Climate Change is developing – and has agreed at COP29 – a bespoke Article 6 framework for bilateral carbon agreements between countries and cannot go beyond this without the agreement of member countries.
• Bretton Woods institutions (IMF and World Bank) do not set energy or financial policies and focus on the provision of emergency lending or development finance.
• While the World Trade Organisation has endeavoured to embed carbon pricing into global trade agreements, this will require agreement among WTO members.
• The mandates of finance-sector regulatory authorities do not generally extend to matters of energy policy.

Further, private sector stakeholders may not see sufficient commercial benefit or rationale for attempting to rationalise a fragmented global-level carbon pricing landscape. In fact, many private sector stakeholders may have existing carbon pricing or data products and services that benefit from this fragmentation and hence may not want to lose any commercial gains arising.

A proposal for a benchmark price for carbon

To address these various issues, the wide variety of carbon price references can be synthesised into a single, weighted average, ‘umbrella’ financial metric to become the global-level benchmark price reference for carbon.

This would entail combining – via an agreed methodology, and subject to appropriate governance and oversight – existing price references and then making the resulting umbrella price easily available in an open-source format. This is both technically and logistically feasible.

A methodology would need to revolve around fundamental principles of:

• Having regard to the entirety of global GHG emissions. Total annual global emissions of CO2 equivalent are estimated to be over 50 Gigatonnes. While almost 75 percent of this is not covered by an explicit carbon pricing scheme or initiative, global emissions can be considered via effective carbon rates analysis.
• Being agnostic as to the labelling or intention of existing carbon pricing schemes or initiatives – in other words, treating carbon or energy taxes, subsidies, tariffs, emissions trading schemes, credits and offsets in a common and consistent way. Some of these are explicitly designed to create a pricing effect on carbon – for example emissions trading schemes – while others have a pricing effect on carbon implicitly, as a consequence of their design or intention. Energy excise taxes are an example of the latter.
• Multiplying the relative size (as a proportion of global GHG emissions covered) of an existing explicit or implicit carbon pricing scheme or initiative by the prevailing (currency adjusted) price of that scheme.
• Identifying, understanding and eliminating overlaps in scope between various heterogenous explicit or implicit carbon pricing schemes or initiatives.

World Bank staff’s ‘Total Carbon Price’ (TCP) formulation achieves many of these principles. The use of TCP could also bring support from global multilaterals through their Platform for the Collaboration on Tax.

TCP incorporates an intention to be ‘be transparent and easily verifiable, requiring using publicly available data and minimizing modelling, particularly where assumptions are not easily verifiable.’

Further extrapolation would be required to cover the entirety of global GHG emissions – in particular, to cover economies not already within TCP – and to repurpose the TCP to provide a single global price. This can be done credibly through the use of national economy taxonomies within the TCP methodology. The base data for this can be a combination of:

• OECD data on countries’ effective carbon rates.
• EU EDGAR emissions database.

Once an initial benchmark price methodology is established, it can be refined and developed and the resulting price updated. Where pricing inputs could be live or dynamic – eg trading in emissions allowances or from voluntary markets – the resulting benchmark price becomes dynamic.

The benchmark itself wouldn’t be tradeable; but could provide the basis for tradable futures. ‘Tradability’ would allow markets to shape a view on the forward pricing of carbon – taking into account, for example, announced but not implemented carbon pricing initiatives.

Separately, a global ‘net zero’ target price – a price that indicates the global climate mitigation required to meet climate goals – could also be created to illustrate a ‘spread’ – the gap between the prevailing metric price and this target.

The criticality of features of a benchmark and the adoption cycle

It’s perhaps stating the obvious, but for a benchmark to be viable, it would need to be widely adopted – and not, for instance, merely remain an academically interesting exercise.

Arguably, widespread adoption is procyclical and self-referencing; the gravitational pull for potential users builds as they see others using the benchmark. To trigger such an adoption cycle, the benchmark initial methodology needs to be sufficiently credible.