Using Risk, Carbon Markets and Taxes for Climate Mitigation
Carbon pricing, taxes, and markets are powerful tools for managing climate risk and driving the transition to a low-carbon economy.
This blog has been written by Phillip Parrott, ESG Manager, and Simon Tucker, Managing Director: Group Commercial Services
Climate change is one of the most pressing global challenges, and managing climate risk requires a mix of policy, market mechanisms, and investment strategies.
Among the most effective tools are carbon pricing, taxes, and carbon markets, which create financial incentives to reduce emissions and accelerate the transition to low-carbon energy systems.
How do these mechanisms work? What is their impact on energy generation? How do they drive investments in renewable energy, emission reduction projects, and resilience planning?
Carbon Pricing and Taxes: Turning Risk into Action
Carbon pricing assigns a cost to greenhouse gas emissions, making polluters financially accountable for the role they play in climate change. This approach transforms climate risk into a tangible economic factor, influencing decisions across industries. Two common forms of carbon pricing are:
- Carbon Taxes: A fixed charge per tonne of CO₂e emitted.
- Emissions Trading Schemes (ETS): Cap-and-trade systems where companies buy and sell allowances for emissions.
By attaching a price to carbon, governments and regulators create a clear signal: emitting carbon is costly, and reducing emissions is financially advantageous. This mechanism encourages businesses to invest in cleaner technologies, improve efficiency, and shift towards renewable energy sources.
The UK Example: Carbon Price Support and Coal Phase-Out
One of the clearest demonstrations of carbon pricing and taxation in action is the UK’s rapid decline in coal-fired power generation. In 2013, the UK introduced the Carbon Price Support (CPS), also known as the Carbon Price Floor, to complement the EU Emissions Trading Scheme (EU ETS). The CPS was designed to provide greater certainty and stability in carbon pricing, as ETS prices were often volatile.
The tax applies to fossil fuels delivered to power stations, adding an extra cost per tonne of CO₂ emitted. Initially set to increase over time, the CPS rate has been frozen at £18 per tonne since April 2016. Despite the price freeze, the CPS created a price differential of around £10/MWh between coal and gas generation. Combined with ETS prices, this made coal significantly less profitable compared to gas and renewables.
As a result, UK coal plants closed far faster than their European counterparts. By September 2024, the last coal power station in the UK shut down, having operated only as a backup for several years prior.
This policy shift drove a dramatic reduction in emissions from power generation. In 2013, average emissions were around 450gCO₂/kWh, with coal responsible for a majority of that figure. By 2025, emissions have fallen below 200gCO₂/kWh, thanks to coal being replaced by lower carbon alternatives.
Carbon Markets: Driving Global Investment
Carbon markets, such as the EU ETS and the UK ETS (introduced after Brexit), allow companies to trade emission allowances. These markets create flexibility: firms that can reduce emissions cheaply do so and sell excess allowances, while others buy allowances if reductions are more expensive. This system incentivises innovation and cost-effective mitigation strategies.
Globally, carbon markets have spurred billions in investment towards:
- Renewable Energy Projects: Wind, solar, and hydro installations benefit from higher carbon prices, making them more competitive against fossil fuels.
- Emission Reduction Initiatives: Industrial efficiency upgrades, carbon capture and storage (CCS), and methane reduction projects are increasingly viable.
- Nature-Based Solutions: Reforestation and soil carbon projects generate tradable credits, linking environmental restoration with financial returns.
Resilience Planning and Risk Management
Carbon pricing doesn’t just reduce emissions; it also influences corporate risk strategies. Climate risk is now a material financial risk, affecting asset values, supply chains, and insurance costs. Organisations are responding by:
- Integrating Carbon Costs into Investment Decisions: Companies assess future carbon liabilities when planning new facilities or acquisitions.
- Building Climate Resilience: Investments in flood defences, drought-resistant infrastructure, and energy diversification reduce exposure to climate-related disruptions.
- Scenario Planning: Firms model carbon price trajectories to stress-test business models and ensure long-term viability.
Lessons for Policy and Business
The UK experience shows that combining carbon taxes with market mechanisms accelerates decarbonisation. While the EU ETS alone influenced emissions, the CPS tax provided the certainty and price signal needed to make coal uneconomical. This dual approach demonstrates that:
- Stable and Predictable Carbon Pricing is essential for driving investment.
- Complementary Policies, such as renewable subsidies and grid upgrades, amplify the impact of carbon pricing.
- Global Coordination matters: linking carbon markets and harmonising tax regimes can prevent carbon leakage and ensure fairness.
Carbon pricing, taxes, and markets are powerful tools for managing climate risk and driving the transition to a low-carbon economy. They reshape investment decisions, accelerate renewable deployment, and encourage resilience planning.
The UK’s coal phase-out is a clear example of how these mechanisms work in practice, turning climate policy into measurable progress. As carbon prices rise and markets expand, businesses and governments must continue to innovate, collaborate, and invest in sustainable solutions to meet global climate goals.
If you have any questions or would like to discuss how our experts could best support you, please contact our ESG consultants today.
