Intro to Carbon Pricing: The Simple Math of Carbon-Equivalent Prices

Despite their economic utility, carbon taxes and cap-and-trade systems are relatively unpopular methods of greenhouse gas regulation in the United States. However, many efforts are underway at all levels of government to make the cost of pollution more visible at key decision points.

The first blog post in this series suggested three rough categories for carbon pricing policies using a wider, and more chemically inclusive, definition of “carbon prices.” Here, we consider the first rough grouping: carbon-equivalent prices, which are just a simple units conversion away from more traditional carbon prices. Methane fees, severance fees or royalties, and various carbon removal efforts all fall into this category.

Methane is second only to carbon dioxide (CO₂) in terms of the warming its excess emissions have caused since the Industrial Revolution. It has a well-defined and well-understood CO₂-equivalent value; that is, how many molecules of CO₂ it would take to equal the warming caused by one molecule of methane. This value includes methane’s indirect effects—the cumulative impact methane has on other atmospheric constituents that either warm or cool the planet as the molecule breaks down. CO₂-equivalency values are calculated not just for methane, but for many greenhouse gases, and such values are commonly expressed after both 20 years and 100 years.

Politicians tend to favor the lowest of these numbers in policymaking, i.e., the 100-year value, since it makes emissions targets seem closer. Multiply a CO₂ price (expressed in dollars per ton of emitted CO₂) by the 100-year CO₂-equivalent value of methane, currently 27, and you get the carbon-equivalent price of methane, expressed in dollars per ton of emitted methane.

Little noticed in the Inflation Reduction Act was a methane fee. The United States is one of only two countries to impose such a fee, with Norway being the other. The Inflation Reduction Act prices methane emissions at $900/ton in 2024, $1,200/ton in 2025, and $1,500/ton in 2026, where the fee will stay. The fee applies only to methane emissions that greatly exceed the industry average, and it is designed to work in tandem with regulations that were announced in the first days of the 28th Conference of the Parties in Dubai.

The fee applies only to big facilities that emit over 25,000 metric tons of CO₂-equivalent per year and exceed applicable waste emissions thresholds—in other words, the biggest and least efficient producers. If the company drilling the methane is in full compliance with the regulations, no fee is due. A Congressional Research Service report estimates that 2,172 facilities will be subject to the methane fee. The fee would not apply to wells permanently plugged in the previous year, nor to emissions caused by an unreasonable delay in environmental permitting of transmission pipelines. Combining carrots with sticks, the program further provides $1.55 billion for the US Environmental Protection Agency to fund and provide technical assistance for methane abatement in the oil and gas sector.

Similarly, severance fees or royalties are just a simple units conversion away from a carbon price. Severance fees are in place in 36 states. States assess them based on the market value of the fuel that oil and gas companies extract, the volume extracted, or some combination thereof. However, because the chemistry of these fossil fuels is so well-characterized by the companies that extract them (since that in turn determines the fuel’s value), and because it is a safe assumption that all the fossil fuels extracted will be burned, it is straightforward to convert carbon content into dollars per ton of CO₂.

Royalties are similar. The distinction is that severance fees are levied on resources extracted from private lands, and royalties are collected from resources extracted from public lands. Both severance fees and royalties are quite different from carbon prices, however, because they are not intended to slow the extraction of fossil fuels. Eliminating royalties and severance fees is also quite problematic for some states, such as Alaska, where such revenues not only have enabled them to get along without a state income tax, but to fund wildly popular government programs, such as the Alaska Permanent Fund.

The financial and cultural repercussions of threatening such programs are frequently, and counterproductively, ignored by climate advocates. However, they are an effective riposte to some arguments on mechanical grounds, i.e., that it’s administratively too difficult to price carbon.

When a government fails to collect or undercharges for a severance or royalty fee for a fossil fuel, this is considered an explicit subsidy. Note, even for these explicit subsidies, there is no direct payment by a government to a fossil fuel company. Rather, it is a failure to collect revenue that would otherwise be owed. This is a point of confusion for many people, and I believe there is further confusion when, for instance, one hears news from the International Monetary Fund that there were over $7 trillion of subsidies for fossil fuels worldwide in 2022. While some of this amount is due to explicit subsidies (18 percent), the bulk of this astonishing number (82 percent) is due to implicit subsidies. The International Monetary Fund defines implicit subsidies as undercharging for environmental costs and forgone consumption tax revenues. For both explicit and implicit subsidies, the only way to remove them is to actually charge, or charge more for, fossil fuels. In other words, when advocates call for removal of all fossil fuel subsidies, in a way, they are calling for universal carbon prices.

Finally, let’s consider CO₂ removal. This is less a change of units and more a shifting of those units from one side of the ledger to the other. Warming is caused by emissions from greenhouse forcers in the atmosphere. It is not caused by CO₂ stored in the ocean, held underground, or tied up in the organic matter of living things. These “carbon sinks” correspond to the four major reservoirs of carbon on Earth: the atmosphere, the hydrosphere, the lithosphere, and the biosphere. Moving CO₂ from the atmosphere to one of these other reservoirs addresses the problem of global warming, though it might have other negative effects we’d like to avoid, such as ocean acidification in the hydrosphere, induced seismicity in the lithosphere, or nutrient removal in the biosphere. All these side effects should be responsibly addressed before undertaking any efforts at such reservoir shifting.

Perhaps the most widely known (and controversial) method for reservoir shifting is carbon capture and sequestration. This generally refers to the capture of CO₂ from a smokestack, and sequestering (i.e., storing) it permanently underground. CO₂ removal is a more general and inclusive term. CO₂ removal need not happen at a smokestack, and the term is applied to processes that may or may not include sequestration. When the process includes sequestration, the CO₂ storage may not be as permanent. Plants, for example, perform CO₂ removal when they photosynthesize. Direct air capture is another form of CO₂ removal that refers only to removing CO₂ from the well-mixed air we breathe, but does not involve sequestering the captured CO₂ for any length of time. The Intergovernmental Panel on Climate Change has grown increasingly unequivocal in its reports about the need for CO₂ removal. In a fact sheet to accompany its most recent report, the scientific panel states flatly that CO₂ removal “is required to limit global warming to 1.5°C.”

CO₂ removal, and carbon capture and sequestration more specifically, each have a cost associated with it, and thus put a price on the carbon being removed from the atmosphere. This creates a very direct linkage between such projects and carbon pricing. There is, in fact, a bit of a gold rush going on right now, with a lot of money going into technologies and processes for removing CO₂ from the atmosphere and storing it. This is being driven in part by federal investments made both in the Infrastructure Investment and Jobs Act (also known as the Bipartisan Infrastructure Law, passed in 2021) and the Inflation Reduction Act. These two laws created a number of incentives for various kinds of CO₂ removal, but perhaps most eye catching is the increase in the value of the subsidy the federal government is willing to pay under section 45Q, which was updated to pay $180 per ton of CO₂ removed by direct air capture that is sequestered geologically.

Companies are increasingly interested in paying high prices for the certainty of permanent removal, largely in response to internal emissions goals and an aversion to other offsets with questions about the permanence of the carbon removed. For example, in November, a company called Heirloom opened the first commercial direct air capture facility in the United States with a contract from Microsoft and plans to open a second facility soon. Companies are deciding today that it’s worth it to pay very high prices to actively remove and sequester CO₂ from the atmosphere. Their choice to pay for removal suggests a mirrored price to avoid emitting it in the first place.

In this blog post, I’ve considered three very concrete examples of carbon-equivalent prices: the US methane fee, the severance fees and royalties that state and federal authorities have levied (or not levied) for decades, and the price companies are willing to pay for shifting CO₂ from the atmosphere to the lithosphere. The next blog post in the series will consider conceptual carbon prices. While these policies address less tangible prices that, in some cases, no one will ever pay, the impact they have on people’s lives and their decisions is very, very real.