Message from Davos: Carbon pricing is back

On the eve of the World Economic Forum's Annual Meeting in Davos, CDP announced the Carbon Pricing Corridor initiative, the world's first industry-led initiative aimed at defining the investment-grade carbon prices needed for the power and industrial sectors to meet the Paris Agreement. The initiative seeks to address the emerging questions on how companies can manage climate change risk through the use of carbon price scenarios.

The announcement was a part of the Carbon Pricing Leadership Coalition's "Doubling The Wave" event, where Heads of state and business leaders convened to discuss progress and uncover the challenges of achieving its goal of doubling the coverage of emissions subject to carbon pricing by 2020, and doubling it again within the next decade.

In a further emphasis of the need for scenario analysis, the Task Force on Climate Related Financial Disclosures (TCFD) has called for the potential impact of different scenarios, including a 2C scenario, on an organisation's business, strategy and financial planning. The considerations associated with these scenarios is a key step to better understanding the potential financial implications of climate change. As Stuart Gulliver, CEO of HSBC said in Davos, "Carbon disclosure and pricing are two sides of the same coin, together they enable an assessment of risk and where required a reallocation of capital."

Introducing the Carbon Pricing Corridor

By bringing together CEOs and chief investment officers on an expert panel, we will create the reference scenario of carbon-related price signals that deliver the ambitions of the Paris Agreement, in the short-to-medium term. The three critical audiences for this work are: investors, as they undertake stress-testing of their portfolio's against a Paris-compliant economy; corporations, when running Cap-ex and Op-ex decisions against an internal carbon price; and policy makers, giving them a clear picture of price signals needed to drive private sector investment.

In a session in Davos on the TCFD there was general consensus that consideration should be given to evolve the scenario analysis recommendation to agree reference scenario, for example those of the IEA or the reference scenario emerging as part of the corridors initiative.

Why is this different to anything that has been done before? Economists internationally have done similar things within the IPCC and the IEA, offering a range of numbers for a direct carbon price. But that hasn't been updated for a long time, it has always been done by macro-economists and scientists, and it has always projected into the very long term. Our Carbon Pricing Corridor instead involves the investors and CEOs directly, from the finance and utility sectors right out to industry. This is industry talking about the factors that they take into account - the barriers to and drivers of to high or low carbon investments. Then, and only then, can you talk to governments to say 'here are the carbon pricing corridors needed if you want to make a clear investment signal for the private sector'.

From economic theory to real world application

Currently, most price signals for carbon are weak and inconsistent - they limit the effectiveness of existing schemes and the ability for the private sector to prepare for future pricing, particularly at the scale and speed needed to deliver on Paris. Furthermore, apart from a few good practice examples, there is little information on how prices will develop - improve and strengthen - in the coming years. Without stronger prices and more reliable information, carbon pricing policies will remain limited in their effectiveness, which impacts not only government efforts to decarbonize, but those by the private sector too.

Investors are asking for clear signals which will help them to place a monetary value against the risks they may face in their portfolios as we transition to a low-carbon economy. At this point, there are a plethora of economic signals which either increase or decrease the costs associated with high carbon activities. It is sometimes said that investors are good at pricing risk, whilst not so good at pricing uncertainty, this work aims to translate the uncertainty of future carbon prices into scenarios of risk so this can be integrated into investment analysis.

The Carbon Pricing Corridor offers a Paris-compliant reference scenario; which can serve as a guide for investors to help them monetise transition risk, updated twice a year, by a panel of business CEOs and investment insiders. There will be two publications a year, the first of which will be coming out this Spring, to tie-in with the G20 finance ministers meeting in Baden Baden, Germany and the IMF Spring Meeting in Washington DC.

At the outset, the publication will present future carbon price signals as a global adapted average for the G20. Over time, we expect to develop corridors specific to key markets and regions.

We want to hear from you

The Carbon Pricing Corridor, facilitated by We Mean Business and CDP, will also feed directly into the Carbon Pricing Leadership Coalition (CPLC) facilitated by the World Bank Group. It will complement the work of leading economists such as Joseph Stiglitz and Nick Stern who will also be reporting on needed carbon price levels in the Spring of 2017, focusing on the social costs of carbon, among other topics.

The make-up of the panel will be 70% business and investors, 30% related experts. Our initial panel of 15 includes Else Bos, CEO, PGGM, Gérard Mestrallet, Chairman, Engie, Jose Ignacio Sanchez Galan, CEO, Iberdrola, Rana Kapoor, CEO of YesBank, Abyd Karmali, Managing Director of Climate Finance, Bank of America Merrill Lynchand Saker Nusseibeh, CEO of Hermes Investment Management. The ultimate target is a panel of 30-50 experts.

With the momentum now building following our successful launch at Davos, we are keen to hear from other senior leaders and investors who want to be involved. Together we can make carbon pricing the mechanism that ultimately delivers a well below-2 degree world.