Harnessing Carbon Pricing to Build Competitive Advantage

Lucian Go is a Yale Fox International Fellow visiting the Liu Institute for Global Issues for 2016-17. His research is focused on climate policy and innovation.
A Clear Signal: Harnessing Carbon Pricing to Build Competitive Advantage
Trudeau’s government made waves this month by announcing plans for a national minimum carbon price, set to rise to $50 per tonne of CO₂ emissions in 2022. The price is to be administered where provincial leaders fail to implement their own carbon pricing system, with all revenues returned to the provinces.
For emissions-intensive firms facing climate regulations in Canada and elsewhere, the writing is on the wall. The Paris Agreement, which will enter into force on November 4th, is ushering in a carbon-constrained era that calls for fundamental changes to the way companies do business. Canada’s plan will be one of the first broad-based national carbon prices to be introduced towards meeting international climate commitments. As an early mover on carbon pricing, the federal government is sending resource-intensive industries a stable market signal in a global oil-and-gas market where instability reigns.
De-coupling regulation and competitive disadvantage
A fundamental reason that market-based regulations like carbon prices are being pursued is their ability to drive beneficial behavioral changes in businesses—changes that, under the right conditions, create benefits to firms that may ultimately offset the costs of compliance.
In the early 1990s, Harvard Business professor Michael Porter changed traditional thinking on business and regulation by proposing a theory known today as the Porter Hypothesis. The hypothesis posits that properly-designed environmental regulation can actually benefit companies by encouraging innovation and boosting competitiveness. Because pollution is typically associated with wasted resources and lost energy potential, reducing it often coincides with improving the efficiency with which those resources are used. Furthermore, regulation provides an incentive for firms to invest more in R&D, developing emissions reduction practices and technologies that can be exported to other markets. Ultimately, these benefits can partially or completely offset the costs of compliance.
Porter and his co-authors described “properly-designed” regulations as flexible, outcome-based strategies, rather than ones that prescribe methods for pollution reduction, such as control technology mandates. Properly-designed regulations encourage continuous improvement. They provide companies with certainty that encourages rapid innovation, rather than a wait-and-see attitude. Finally, they anticipate and are consistent with global trends.
A sufficiently stringent and increasing carbon price can satisfy these requirements, providing an omnipresent incentive for firms to reduce pollution by applying to every unit of emissions. With a schedule of rate increases laid out ahead of time, firms know that investments in abatement are long-term investments in competitiveness. And in the wake of the Paris Agreement, few would argue that a carbon price runs afoul of global trends.
Ahead of the curve: the example of the Montreal Protocol
Innovation plays a key role in the Montreal Protocol, an oft-cited success story of international environmental governance. Introduced in 1987 to regulate substances that deplete the ozone layer, including chemicals used in refrigerants and air-conditioning, the Montreal Protocol’s first application was to phase out the use of chlorofluorocarbons (CFCs). Initially, parties to the agreement agreed to cut 50 percent of a certain group of CFCs and other chemicals within 12 years. In the following two years, confident that they could do better, the parties upped the reductions to 75 and then 100 percent of CFCs within 10 years. The agreement has also made a massive contribution to climate change mitigation—nearly 20 times the contribution of the Kyoto Protocol—due to the fact that many ozone-depleting chemicals are also greenhouse gases.
Before the introduction of the Montreal Protocol, DuPont was the world’s largest producer of ozone-depleting CFCs, with 25 percent of global market share. With $500 million in CFC-based revenues, the company was initially a fierce opponent of action to curb CFC production. Within 10 days of what it calls the first “scientifically-backed” consensus linking CFCs to ozone depletion, DuPont committed to a phaseout. It moved quickly to develop CFC substitutes, launching a family of refrigerant alternatives that could be used in existing and new equipment—ultimately gaining market share and increasing profits.
This month, the Montreal Protocol has been re-tooled to phase out the use of hydrofluorocarbons (HFCs) in refrigerators and air-conditioners. HFCs are a greenhouse gas with 1,000 times the heat-trapping potential of CO₂, which in many cases were used as a substitute for CFCs. A rapid phaseout of HFCs could once again be a boon for companies on the leading edge. Many of the existing HFC replacements are manufactured by American chemical companies like Dow and Honeywell.
Innovating for a changing landscape
The story of the Montreal Protocol should resonate with emissions-intensive firms, particularly in extractive industries. In contrast with the story of DuPont, silver-bullet solutions to adapt business models to CO₂ regulations are fewer and farther between. However, these regulations should spur firms to move in the right direction, if they are not already doing so. The global oil and gas market that some of Canada’s provinces are hanging their economic prospects on is a volatile one. Drastically low commodity prices and the changing global forces that contribute to them suggest that volatility could be the new normal. This new reality underscores the need for the private sector to leverage Canada’s early movement on carbon pricing to build competitive advantage in a carbon-constrained world.