The power behind clean power: carbon pricing
We explore the role of carbon pricing in incentivising lower-carbon activities.
Carbon pricing is not a commodity as such, but it is viewed as the single most effective policy tool to incentivise the shift away from fossil fuel use by increasing the cost of polluting. Therefore, carbon pricing is considered another key tool of the energy transition.
In the previous blog of this series, we covered the role of metals in enabling the shift to clean power. Carbon pricing as a policy tool takes this process to the next level.
Cap and trade schemes cap the total amount of certain greenhouse gases that can be emitted and reduce it over time to meet emission-reduction targets. Stable to rising carbon prices increase the cost of pollution. Lower quantities and greater prices of these allowances make it less and less economical for firms to pollute.
More than 40 countries have carbon pricing mechanisms in existence, but we highlight three carbon allowances schemes as being particularly significant based on their liquidity, size and length of time in existence:
- European Union Allowance (EUA): The world’s first, largest and most liquid market, the EUA makes up 90% of the value of the cap-and-trade market.1 Targeting power generation, industry and most recently aviation, it targets a 55% reduction in emissions by 2030 compared with 1990 levels.2
- California Carbon Allowances (CCA): The second most liquid market in the world, the CCA targets a 40% reduction in emissions by the power generation, industry, buildings and transport industries from 1990 levels by 2030 and an 80% decline by 2050.3
- Regional Greenhouse Gas Initiative (RGGI): The first mandatory multi-state and market-based US initiative, with a specific focus on the power generation industry, it targets a 30% reduction in emissions compared to the 2020 cap by 2030.4
Together, these three major carbon markets have generated almost $200 billion in revenues since inception to help fund the transition. Globally, carbon pricing is gaining momentum, and the number of hard-to-abate sectors covered by carbon pricing is set to increase.
Demand from the energy transition is putting pressure on already supply-constrained metals. Policy tools such as carbon allowance schemes are another crucial element needed to make the energy transition a reality.
Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.
1. Source: International Carbon Action Partnership, 2024.
2. Source: ibid.
3. Source: ibid.
4. Source: ibid.
Key risks
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Elisa Piscopiello
Senior ETF Analyst
Elisa joined LGIM as ETF Analyst in June 2021. She contributes towards the development and analysis of investment strategies, whilst also supporting ETF distribution and marketing efforts. Prior to that, Elisa worked as Multi Asset Investment Support Executive at Liontrust, and as Investment Dealing Assistant at Architas. In 2016 she graduated from the University of Kent with a First Class degree in Financial Economics with Econometrics. She holds the Diploma in Investment Management (ESG) and is a CFA charterholder.
Michael Stewart
Head of Pooled Index Strategy
Michael focuses on the creation and ongoing support of investment strategies for LGIM's ETFs as well as the strategic role for ETFs within the business. Before joining us in 2019, Michael worked in ETF product development at Invesco, developing and supporting a wide range of ETFs across all asset classes. He holds an MBA from Bayes Business School (formerly Cass), University of London, and is a CFA Charterholder. When he’s not studying investment strategies, Michael likes running, vegan cooking and European train travel.
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