Pricing Carbon Emissions

The appropriate time path for emissions prices, which economists call the "Social Cost of Carbon," should be thought of as the solution to an optimal control problem. The price of carbon is the brake that society uses to accelerate or decelerate the rate of usage of the atmosphere's unknown capacity to safely absorb emissions. Right now the incentive to reduce emissions is strongly negative, i.e. governments around the world heavily subsidize the creation of emissions. Potential climate-risk tail events, together with societal risk aversion (which is best observed in the equity risk premium) and expectations of technological change determine the appropriate time path for emissions prices. Societal understanding of this issue is at a tipping point. As expectations of incentives being created sooner and higher increase, the valuations of stranded assets, such as coal and coal fired power plants will decline. But understanding how forward expectations of carbon emission prices drive current valuations is complex. It is also important to understand that it is not the act of pricing emissions that destroys the value of these assets – it is the economic externality that has already destroyed their value. What the recognition of that externality will do is to reduce their current false valuations. Exxon and Shell have, in their public discussion of stranded assets, shown that they do not understand this issue. Paraphrasing Upton Sinclair, "It is difficult to get a company to understand something, when the valuation of its assets depends on it not understanding it."