The Currency of Decarbonization
An in-depth convo with Peter Sainsbury (Carbon Risk) about commodity markets, carbon pricing, and the power of incentives.
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Climate is not a technology problem but a story problem.
Delphi Zero is a consultancy and newsletter about the narrative potential of climate.
Did you ever sit in a room where people discussed carbon markets? 👀
If yes, then today’s interview guest - my friend Peter Sainsbury (Founder of Carbon Risk) - is someone you should listen to. His writing will equip you to become the smartest person in that room.
In our conversation, we discussed:
Why carbon is more like a currency than a commodity 💶
How he’d build an effective carbon market from scratch 📝
And much more…
Enjoy ✌️
The Currency of Decarbonization
By Art Lapinsch
Talk us through your journey. How did you end up in climate? Was there a specific moment that set the path to where you’re at today?
My interest in the environment was sparked when I was at school. I remember my science and geography teachers explaining, in very vivid terms, the impact that human activity was having on the planet. At the time I probably didn’t have the knowledge to explain the things I saw in the world. I understood, at least intuitively, that energy was intrinsically linked with the environment.
My earliest encounter with carbon markets came in the early 2000’s. At the time I worked for an energy trading firm involved with improving access to electricity and power markets, and one of the environmental products we investigated was carbon. It was way too early but the idea that markets could have a positive impact on the environment left a lasting impression with me.
It was only after working for the ‘dark side’ that I realized my economics skills could change the world for the better. I spent about 5 years working for an energy consultancy focused on oil supply dynamics. It was my first real deep dive into the world of oil and other fossil fuels, and the impact their extraction and consumption were having on the environment.
I joined an environmental NGO called WRAP in their economist team. In many ways it was my dream job. Being at the intersection of economics, policy, and the environment was exciting. I helped policymakers - particularly those working for the UK Government - design new environmental policies and improve upon existing ones.
My focus was always on how we can leverage incentives, especially prices to move the economy to better environmental outcomes, while always having one eye on the potential for unintended consequences, such as oligopolistic behavior that could limit competition.
What is a common misconception about commodity markets? And what is one thing that more people should understand about commodity markets? Why is that important?
One misconception about commodity markets has a particular tendency to recur throughout history: that they are scarce.
Perhaps the most famous example of this misplaced fear is evident in the writing of Thomas Robert Malthus, a British cleric and scholar. His work “An Essay on the Principle of Population”, published in 1798, suggested that although population rises exponentially, agricultural output could only increase arithmetically because of the finite amount of land available. The inevitable result according to Malthus was famine, disease, and war. If couples had fewer children, he argued, the population growth could be sufficiently slowed for agriculture to cope. Similar dire warnings surfaced again during the 1970’s as people like Paul Ehrlich warned of overpopulation and resource exhaustion.
Fears over the shortage of other commodities such as oil, rare earth metals, and copper have all surfaced in the past. For example, the peak oil theory is based on the observation that the amount of oil under the ground in any region is finite and so the rate of discovery, which at first increases quickly, must eventually reach a maximum and decline.
The term “peak oil” refers to a hypothetical date after which oil production will gradually diminish, with oil production following a bell curve, leading to permanent upward pressure on oil prices. The idea started to gain enormous popularity in the early 1970s when US oil output peaked. At the time, the US and other oil dependent nations were groaning under the weight of high prices and long queues for gasoline after OPEC restricted output.
The basic tenets of Malthus, Ehrlich, and others has been proven to be false. None of these commentators counted on the one thing that has been proven time and again never to bet against: human ingenuity. A commodity shortage leads to higher prices and in turn incentivizes the development of improved technology that may ultimately lead to the discovery and exploitation of more reserves, perhaps those that were previously thought uneconomic.
The implications of this are important when trying to understand commodity markets. Scan any chart showing the long-term price of oil or other commodity and you will see long periods of rising prices, followed by a slump for several year, with an eventual rebound in prices. These commodity super-cycles are the result of incentives; as prices rise producers try to ramp up output, but this can take several years, while at the same time demand might soften as consumers cut back or switch to a cheaper alternative. The same process acts in reverse when prices have fallen for a long period of time.
Why is that important? Because fortunes are lost, and governments go bankrupt by mistakenly extrapolating periods of rising and falling commodity prices indefinitely in the future.
Before we dive into your online writing, I’d like to ask you about your books. You have published four books on topics ranging from commodity trading to betting on Formula 1 races. Why did you write these books and what were some surprising learnings along the way?
Looking back at the books I’ve published I think my overriding motivation was driven by an urge to help other people. Even if I only helped one person develop a different perspective, one that perhaps helped them avoid the same mistakes that others have done so in the past, then I could be happy that my book had done its job.
The most important thing I learnt from writing the books is the power of maintaining a consistent voice and the expectation that has with my readers. For while the first two books were clearly focused on commodity markets, the final two books strayed into completely different subject areas. It’s not surprising that the last two books were nowhere near as successful, at least in terms of sales. That insight came to be of use later.
You are writing a Substack exclusively about carbon markets. How come this niche focus? What were the considerations in-favor and against niching down when starting the publication?
Perhaps it was the impact of the pandemic, I’m not sure. Whatever it was though, in early 2021, I realized that I needed to make a move and be my own boss. It had been on my mind – at the top of my internal to-do-list – for some time. And now I had the motivation and the opportunity to do something about it.
My dream was to write for a living.
Full of optimism and brimming with ideas, I spent the next couple of months attempting to write a second edition of my book, ‘Commodities: 50 Things You Really Need To Know’. However, one chapter was three times longer than any other, and something about it was getting stick in my head. The title of that chapter was simply, 'Carbon markets'.
It hit me that the price of carbon underpinned everything I had discussed throughout the rest of the book. It influences the speed with which companies divest from fossil fuels, the investment case for renewables, and the demand for copper to upgrade the power grid. It influences the speed at which commodities are transported around the globe and the investment plans of the ship owners. Carbon also determines the economics of green hydrogen, the environmental trade-offs of landowners in tropical rain forests, and the demand for lithium from the battery industry.
Fundamentally though I could see that the price of carbon would start to have wider, profound changes on the macroeconomic landscape and the incentives for investors. Inflationary pressures would begin to build as the cost of decarbonization would be passed through supply chains. Whole industries would see their business plans disrupted by new competitive pressures. High carbon prices would bring forward innovation and ideas previously thought unviable, opening new opportunities for investors in commodities, technology, and other industries.
Rather than carry on with writing the book, only for readers to see the fruits of my labor several months later, I decided to experiment and launch a Substack instead. With a newsletter I would have a platform to tell readers about carbon markets place in the world, how I envisaged it in the future, and how investors and other market participants could benefit. That nugget of insight about carbon markets, developed more than 15 years earlier, had finally started to bloom.
I knew carbon was – and still is - a niche subject to devote a newsletter to. I had faith though that the price of carbon would have an increasingly important role in in determining each of our future economic decisions. Many people have been writing about these markets before me, but I felt that I had a unique perspective and range of insights that others would find hard to match. If I brought my own voice to Carbon Risk and was able to do it week in, week out I knew it would grow into a success.
Your main tagline/concept is that carbon pricing is the “Currency of Decarbonization.” Please walk us through this idea. Why do you think people should understand it?
Shortly after I began writing Carbon Risk, I realized that much of the media were lumping carbon prices along with commodities such as oil and natural gas. At the time the price of carbon in the EU emissions trading scheme (ETS) was on a tear and approaching €100 per tonne for the first time. The headlines in the press were along the lines of – “carbon - the best performing commodity in the world.”
That got me thinking. Is ‘commodity’ the right way of thinking about the carbon market? It is certainly governed by demand and supply, but other asset classes do too, and that doesn’t mean they are automatically commodities. Instead, I began to think about what an emission allowance (a permit to emit one tonne of CO2) represents.
It's important to remember that the carbon price embedded in ETS’s is a government construct. Without the commitment of the government (or other institution) to a set of emission reduction targets, market participants would not be willing to put a price on carbon. Trust is the bedrock of the carbon market. And so rather than commodities, I realized that currencies were the more appropriate asset class.
A strong carbon price is a signal that investors, businesspeople, and citizens trust their government’s commitment to combat climate change. A weak carbon price delivers the opposite signal; namely that the market has little trust in the government’s commitment. In the same way that trust in individual currencies supports investment, innovation and trade, trust in the carbon market helps to bring about the capital, skills and long-term planning that is required to help meet decarbonization goals.
Indeed, the currency analogy came into the forefront of carbon market developments during 2023 and into early 2024. Up until the end of 2022 the UK carbon price had been trading at an average ~15% premium to the EU ETS. In late 2022 and into early 2023 that premium closed, and for a while the two markets were joined at the hip.
During 2023 the EU carbon price declined by ~10%, the price in the UK ETS dropped by almost 40%. The reason? The wheels started to fall off the UK’s credibility. The first signs were emerging in the autumn of 2022. In September, the UK Government led by Liz Truss – for 49 days – signaled a desire to circumvent, or at least disregard the mandate given to independent institutions like the Office of Budget Responsibility (OBR).
Under the next Conservative Prime Minister, Rishi Sunak, the government began to water down the commitment to net zero targets. In June 2023, by adopting the least ambitious emissions cap possible for the UK ETS, and then in September in very publicly announcing a dramatic weakening in net zero policies. For example, putting back the timetable for the ban on the sale of new petrol and diesel cars by 5 years.
From an average premium of 15%, the UK carbon price ended the year at a 40% discount.
People seem to agree that pricing carbon is one of the best tools to tackle the climate crisis. Yet, I feel that the rollout of these schemes is too slow. What’s your take? How are we doing?
It’s important to differentiate between carbon taxes and ETS’s.
A carbon tax involves the government or other jurisdiction setting the price of carbon and letting the market decide the emissions response. The problem with taxes is that the government cannot know the correct carbon price, and as new technology develops that price level will evolve over time. In contrast, an ETS controls for emissions (by setting a cap) and lets the market decide the price. I firmly believe, and many other economists do too, that the greater the share of global emissions covered by ETS – also referred to as ‘cap-and-trade’ schemes - the better.
The larger the percentage of global emissions covered by carbon pricing, the more efficient the allocation of scarce resources is likely to be, and the lower the carbon price will need to hit to achieve the required emission reductions. As of 2024, almost one-quarter (24%) of global carbon emissions are covered by ETS’s or carbon taxes, according to the World Bank. Approximately 18% of emissions are covered by an ETS, carbon taxes cover 5.5%, while 0.5% is covered by both an ETS and carbon taxes. The share of global emissions covered by carbon pricing has jumped by ~10 percentage points over the past decade, mainly due to the launch of the Chinese ETS in 2021 which currently covers the country’s power sector.
Between now and 2030 other major emerging economies are also expected to launch ETS’s including Brazil, India, and Turkey. The imminent launch of the EU’s carbon border levy (known as the CBAM) has incentivized exporters of carbon intensive commodities to Europe to introduce their own ETS, or otherwise be priced out of the European market. Sector specific ETS covering airlines and shipping are also expected to increase coverage.
However, as with the previous 10 years, China is likely to account for most of the growth: 7 carbon intensive industries including building materials and iron and steel are expected to be included over the next few years. Overall though it looks very unlikely that carbon pricing - whether through an ETS or a carbon tax - will cover much more than 40% of global emissions by 2030.
The United States remains an outlier when it comes to carbon pricing. Apart from California, a dozen or so states in the north-east (under the so-called RGGI ETS scheme), and most recently Washington State, there is little appetite for anything at the federal level. It’s ironic in someways that the country that gave birth to the idea of a cap-and-trade scheme (the Clean Air Act of 1990 set out a market for sulphur dioxide emission allowances), has so far at least been set against using it to cover carbon emissions on a national level.
Imagine that you can create a new carbon market from scratch. What would be your main takeaways from existing - well-functioning - carbon markets? What works? What doesn’t? Why?
All existing ETS’s have gone through similar phases as they have developed. The exception is the UK ETS since when the UK left the EU it essentially copied the EU ETS.
Anyway, in the most part governments initially seeks to cover the power generation sector, keeping the carbon price low to get utilities used to the idea, and avoid it becoming a political issue. The latter is a big risk if energy prices are pushed too high, too fast.
Only gradually is carbon pricing expanded to cover other sectors of the economy such as heavy industry (e.g. cement, iron & steel) and airlines. This is because governments don’t want to disadvantage their domestic industries or force them to shutdown and invest elsewhere instead.
The upshot is that many ETS suffer from an oversupply of allowances after that initial stage. Naturally this weakens the incentive to decarbonize, and whoever is in charge must do something to eliminate it.
Perhaps they need to go through these growing pains to develop into a credible carbon market!
Nevertheless, there are certain things I would incorporate, learning from the past, and looking to the future. I think there are five things that I would bake into a new carbon market if I was designing it from scratch:
Cover a broad sector of the economy right from the start but announce a carbon border levy at the same time.
Give other countries an opportunity to join your market. When Switzerland wanted to join the EU ETS, it took several years of negotiation. That should be avoided at all costs.
Incorporate carbon credits so that they can be used for compliance, but ensure they are Article 6 compliant → Article 6 of the Paris Agreement allows countries to voluntarily cooperate with each other to achieve emission reduction targets set out in their NDCs (Nationally-Determined Contributions).
Build as many commitment devices as possible. This could include the legal duty to take advice from an independent body – as in the UK – or better still establish a link between the price that the government can borrowing and the price of carbon.
It’s essential that society is onboard. The impact in terms of higher costs on the least well off needs to be mitigated. It’s important to be transparent with how the money raised from the ETS is being spent.
What are some wilder ideas you have seen in your research? Do you think we’ll see markets for other greenhouse gases? If yes, why? If not, why not?
CO2 wasn’t the first gas to be priced through an ETS. That honor goes to sulphur dioxide. As I mentioned earlier, the US was the pioneer in this area and pricing emissions proved very successful in reducing air pollution from America’s power stations during the 1990’s.
We’re already starting to see other GHG’s being taxed. The Inflation Reduction Act (IRA) introduced a charge on methane emitted by oil and gas companies. The methane emissions fee began in 2024 at $900 ($36 per tonne of CO2e), increases to $1,200 ($48 per tonne of CO2e) in 2025, and will rise to $1,500 a tonne ($60 per tonne of CO2e) in 2026.
Europe has followed this up with the EU Methane Regulation. The regulation will progressively introduce more stringent requirements to ensure that exporters of fossil fuels to the EU gradually apply the same monitoring, reporting and verification obligations as EU operators. Crucially, the EU Methane Regulation will impose methane emission intensity limits on imports of fossil fuels into the EU. By 2030 imported fossil fuels will have to meet a maximum methane intensity threshold, or the importer must pay a financial penalty.
The energy industry is firmly in the sights of regulators keen to crack down on the potent GHG. However, that still leaves agriculture and waste as two very large methane emitters who don’t currently face a price on their methane emissions. One of the problems is identifying the source and being able to cheaply fix the leak. That’s relatively inexpensive in the energy industry, but much harder elsewhere. As remote monitoring technology improves (satellites and drones, etc.) I expect agriculture and waste to also be covered by emissions pricing.
What have you learned about communicating complex topics to broader audiences? What’s under-rated? What’s over-rated?
I decided right from the beginning that I would be taking my readers on a journey of education with me. I’m learning on the way too, and if I can write an article explaining a complex subject, in a way that people understand without dumbing down, then I feel that I’ve done a good job.
Most of my readers will be familiar with other asset classes and other types of environmental policy. If I can use examples from other industries (e.g. currencies) to explain how people should think about something important then its much easier to get your point across.
I think you also need to play to your strengths. I’m not someone who needs a diagram or picture to understand something, and I’d probably do a poor job of using an image to explain a thousand words.
What are some climate-related problems that keep you up at night? Why? What’s your best guess on how to solve it?
The past decade has been divisive on many areas of public interest. Climate change and how we should tackle it are towards the top of that list. The problem of course if that we can’t agree on anything, then nothing gets down. There needs to be some kind of consensus, and I fear that we will leave things too late and end up being forced into an expensive solution – both financially and socially.
A related climate-related problem is ensuing that the public are onboard with policies designed to improve the environment, even if they pose a cost. The ‘just transition’ as it’s often called needs to be just that if the costs and opportunities are to be shared equitably.
This then leads me nicely into the third climate-related problem – how to deliver energy to the world’s poorest countries, enabling them to develop, but without having to burn fossil fuels, and in particular coal. Access to electricity is one of the main factors that needs to be present to help a country develop. But at what cost?
I think all three of these climate-related problems can be solved using carbon pricing. As we’ve seen in commodity markets, prices can signal periods of stress in advance, which forces people to invest in solutions. Carbon prices are also agnostic; it doesn’t matter how the imbalance in the market is solved. Carbon pricing can be used to generate tax revenue which can be used to invest in regions that need support, and channel climate capital to countries that need help developing their power grids.
What is something that you have changed your mind about since working in the climate space? What is something you have doubled down on?
I think I can answer both questions in one answer: engineered carbon removal.
It might have been my lack of knowledge at the time, but I was sceptical of the need to invest in engineered carbon removal solutions such as direct air capture (DAC), biochar, or bioenergy with carbon capture and storage (BECCS). Maybe I was concerned about the potential knock-on impact it would have on the incentive to cut emissions! I realize now that there just isn’t anyway to meet the targets without significant investment in technologies that capture, and then permanently store the carbon.
Some people say that carbon removal should just be used for the residual, i.e. that last bit of carbon that is too difficult to cut any other way. They might also say that we shouldn’t be devoting any dollars, euros, or pounds to that endeavor until we’ve exhausted every other option. I think that’s a big mistake, and so what I’ve doubled down on, especially since writing Carbon Risk, is the need to invest in these systems now. There’s simply no way to develop such a huge industry overnight.
As we look back from a net-zero future, what do you think they will say about us?
Wow that’s a difficult question. I guess it depends on when that happens and what the CO2 concentration in the atmosphere is at the time. If it’s late and CO2 levels are such that the climate is warming much faster than we feared possible, then it will mean that much more needs to be done. It will mean going “net-negative”, a state where we’ve removing more carbon than we’re emitting.
We can glean some insight from the Precautionary Principle. This suggests that we should pay a high price to protect ourselves against catastrophic losses, even when there is a high degree of uncertainty.
Hopefully people won’t look back at us today and say we wish we paid a higher carbon price.
🙏 Thanks, Peter for taking time and sharing your perspective.
Thanks, Berkay for helping with some of the questions.
I’d love to hear from you, please get in touch and tell me whom I should interview next or which topics you’d like to see covered ✌️
@petersainsbury, one question I had: if the estimate is that 25% of global emissions are currently covered under an ETS, then why are the forecasts for the size of the carbon market to grow by 50-500x (and not 4x)?
The article looks great Art. Many thanks again for asking such great questions.