British Prime Minister Gordon Brown recently required that all Ministers account for the cost of carbon when making policy and investment decisions. This new policy covers the transportation, construction, housing, planning, and energy sectors.

As a way to internalize the costs of environmental damage caused by large-scale projects, the price of carbon has been set by government economists for every year through 2050. For 2008, one ton of carbon equivalent emissions must be factored at a cost of £26.0. By 2050, that price will increase to £59.6. This means that, for a construction project with a cash cost of £100 million, which is calculated to emit £20 million of carbon, the government will treat the project as it if actually cost £120 million.

This calculus is intended to alter the incentives for investing in energy-intensive projects. If more expensive alternative-energy sources are available, the additional costs up-front can be justified by reducing the overall price of the project when the environmental impact is accounted for.

With this unilateral action, the United Kingdom is taking a significant risk. Companies that contract with the British government are placed in a position of making difficult choices about energy usage. If low-carbon alternatives cannot be found, some projects may be rejected as too costly. This could lead to myriad problems, from degraded infrastructure to policy gridlock to harming Britain’s economy.

This also has the potential to cause disputes over the amount of carbon emissions generated by any single project or policy. Because the costs of emissions have real currency attached to them, there is a critical need to standardize and certify the way that emissions are calculated, or else there could be a race-to-the-bottom among Ministers to make projects appear more viable.

If this policy is successful, however, and is adopted by other governments, multilateral investments banks, and the private sector, it will revolutionize the way investments are valued and projects are priced, setting a new, sustainable course for project finance in the 21st Century.

(Hat tip to Sustainablog via Warming Law.)

For further information about this topic, please contact Akin Gump.