Carbon Pricing

Carbon pricing is a policy mechanism that attaches a direct financial cost to greenhouse gas (GHG) emissions, measured in carbon dioxide equivalent (CO₂e). Its purpose is to make the economic cost of emitting reflect the environmental cost, creating a financial incentive to reduce emissions at source. 

There are two primary instruments:

1. A carbon tax sets a fixed price per tonne of CO₂e emitted, giving businesses cost certainty but leaving the volume of emissions open. 
2. An Emissions Trading Scheme (ETS), also known as cap-and-trade, sets a ceiling on total emissions and allows companies to buy and sell allowances within that limit, so the price is determined by the market.

In practice, both operate across multiple jurisdictions. The EU Emissions Trading System (EU ETS) is the world’s largest carbon market, covering power generation and heavy industry across EU member states. The UK Emissions Trading Scheme (UK ETS) operated on a similar basis following the UK’s departure from the EU ETS. 

For businesses, carbon pricing creates a direct cost exposure tied to emissions volume. The higher a company’s GHG emissions, the greater is the liability under a carbon tax or ETS. That exposure is also expanding beyond domestic borders: the EU’s Carbon Border Adjustment Mechanism (CBAM) applies a carbon price to certain goods imported into the EU, meaning companies exporting to European markets face carbon pricing obligations regardless of where they operate. 

Carbon pricing is distinct from carbon offsetting. Offsetting involves compensating for emissions through external projects; carbon pricing applies a cost directly to the emissions themselves.