Dignitaries at the COP28 in Dubai, United Arab Emirates.
Credit: Reuters Photo
CoP28’s Global Stocktake underscored the crucial role of private sector finance in transitioning away from fossil fuels. Achieving national net-zero emissions in industry and energy requires a collaborative effort between public policy and business management. A financial model generating new revenue from carbon fees is vital to channelling private funds for a sustainable transition. Each company should adapt the same model to its parameters, facilitating seamless aggregation at the macro-sectoral level.
This model revolves around “transition debt,” a notional quantification of a firm’s accountability in the climate crisis, analogous to financial debt. The magnitude of transition debt is the net present value (NPV) of a legitimate annual carbon tax paid on emissions along the firm’s phase-out trajectory to net zero. The carbon tax rate matches the social cost of carbon (SCC), and the discount rate for the NPV computation matches the social rate of time preference. Revenue from the firm that accrues to the regulating agency comes from real interest on transition debt (like financial interest payments), yielding a carbon fee. The policy ensures predictable transitions, linking regulatory responsibility, manager fiduciary duty, investor confidence, and firm performance.
Illustrating a scenario tailored to India, consider a representative “micro firm,” one-millionth of India’s national levels. Its parameters, when scaled up by a million, align closely with the macro-level 2022 figures for India’s combined industry and energy sector. Let us start with a transition debt of $10,380,000 for this firm, about one-millionth of what it would be nationally. Later, we will illustrate how this number is determined. Transition debt is notional, but it is instrumental in determining the very real carbon fee. Assuming a 1.5% transition debt interest rate, annual interest payouts amount to $156,000 every year possibly to perpetuity or until maturity of the debt in the distant future. This is revenue received as a carbon fee by the regulating agency.
Following the Economists’ Statement on Carbon Dividends, published in 2019, returning all carbon fees to citizens aligns with fairness and political viability. This approach, called the “Carbon Fee and Dividend,” incentivises emission reduction. The scaled-up national carbon fee of $156 billion for the industry and energy sectors can fund welfare programmes if India were to use the carbon fee and dividend policy. This additional revenue from the carbon fee also removes concerns about the sustainability of India’s current 3% GDP spending ($112 billion) on welfare. For a family of four, it adds $445 as a lump-sum carbon dividend. Even if energy prices rise due to the carbon tax, the additional per capita dividend after price adjustments leaves more for those who consume less. Rich consumers may overspend the dividend, but they should care less. In addition, it provides an incentive for firms to further reduce emissions. Both individual consumers and firms would be better off when they reduced their emissions—a win-win. The additional revenue from the carbon fee provides ample resources to finance payments for ecological services (see ‘Agri sector policy bias must go,’ DH, Aug 9), rather than disburse as an equal lump-sum payment to all citizens. This policy should find broad political support.
The scenario must be further calibrated to determine the transition debt. The ambition of the micro firm is to phase out 2,980 tCO2e in the next 48 years, from 2022 to 2070. When scaled up by a million, this target aligns with the IPCC’s specified SSP1-2.6 as well as India’s NDC. At a linear phase-out rate, the cumulative emissions emitted by this micro firm until net zero are about 71,500 tCO2e. This carbon budget is close to one-millionth of India’s 12.5% population-based share of the world’s remaining carbon budget (390 GtCO2e to remain below 1.50 C). A plausible scenario is a carbon tax matching what the Social Cost of Carbon (SCC) will likely exceed in the near future, $200 per tCO2e (according to an update from Resources for the Future & UC Berkeley). With a social rate of preference of 2% on a linear phase out to net zero in 48 years, the annual carbon tax yields a net present value of $10,380,000—the transition debt.
Regulators can adjust transition debt through the carbon tax and the carbon fee through the transition debt interest rate. The transition debt approach to the Carbon Fee and Dividend Policy allows a fine balance between public and corporate policy, enabling micro-management for sectors. In high-risk scenarios, companies should swap looming annual liabilities for extended transition debt tools, providing cash flow stability and fixed interest rates. This strategy, tailored to phase-out trajectories and policy integration, becomes increasingly appealing in worsening future scenarios, underscoring the vital role of public and corporate policies in a time of climate crisis.
(The writer is a former faculty member at leading B-schools in India, Singapore, and the US)