Going Carbon Neutral Using Free Markets
By: Timo Horstschaefer
Tags: Policy, Carbon Emissions, Climate Change, Economy

There are many debates going on about introducing a CO2 tax to become carbon neutral, achieve the goals of the Paris Agreement, and limit global warming to 1.5 ℃.

The big question is obviously: How much should a ton of CO2 cost? And how can the price be updated in the future to reflect a new situation?

Here is a proposal to achieve carbon neutrality without a government-defined CO2 price. It is instead based purely on dynamics of the free market.

Carbon emission and removal

The basic concept is simple: we make carbon compensation mandatory. This is achieved with 3 concepts:

Compensation: If a company emits 1 ton of CO2 (or equivalent), it has to purchase a certificate of another company that in turn removes 1 ton of CO2 from the atmosphere. The easiest is by growing trees or crops, but of course also sophisticated technical solutions are permitted. Enforcement: If the emitting company fails to buy the required carbon removal certificates, it has to pay a fine to the government. The fine must be sufficiently high to have an effect, for example €1,000. It also serves as an upper bound to the market-indicated CO2 price. Accreditation: The carbon removal certificate providers themselves must be accredited by the government to make sure that actual carbon extraction from the atmosphere is performed. Simple carbon reduction in other places, like installing more efficient cookstoves in low-income countries, are not allowed as they don’t get us to actual carbon neutrality.

These concepts are sufficient to achieve a 100 % carbon neutral society. All carbon that is emitted in some place is absorbed in another. The price of the CO2 emission is not set to an arbitrary level by the government but depends only on the current supply of carbon removal services.

Gradual steps to carbon neutrality and beyond

Obviously, it takes some time to build the supply side of carbon removal. If we make all carbon removal mandatory at once, prices will rise to levels beyond what the society can handle. Thus, we need to find a gradual transition to slowly grow the market and infrastructure. This can be achieved by a stepwise increase in carbon compensation enforcement. Let’s say in year 1, only 10 % of the CO2 has to be compensated. In year 2, this is increased to 20 %, in year 3 to 30 %, and so on until 100 % carbon neutrality is achieved within 10 years.

If carbon neutrality is not sufficient, we can also overcompensate with this approach. The compensation could be increased to 200 %, which means that if a company emits 1 ton of CO2, it has to buy carbon removal certificates for 2 tons. This additional lever can be used to make certain countries compensate for increased per-capita emissions. For example, Germany currently produces 2 % of global greenhouse gases, even though only 1 % of the world population lives in Germany. Thus, an overcompensation at 200 % would be adequate.

Effects of forced carbon removal

This simple concept brings interesting effects to the market: it will spur competition in finding the cheapest method for carbon removal at scale.

The most effective and immediately available method is probably reforestation. As trees grow they capture CO2 from the air and thus qualify as carbon removal. Since the enforced compensation will generate a large demand in carbon capture, reforestation might well become a major industry around the world.

The big advantage in this proposal lies in the dynamic pricing of CO2 emission depending on the market situation. No government has to think about a fair and adequate price tag for the CO2 tax. Furthermore, while carbon removal in the beginning might be cheap via reforestation, we might at some point hit a limit in how many trees we can still grow. As soon as the supply of reforestation gets lower, the price of CO2 certificates will rise, making way for new technologies of carbon removal that have been too expensive in the beginning.

And who knows, given the huge market opportunity for carbon removal, maybe there is still an undiscovered method to remove CO2 from our atmosphere at scale and at low cost?