European Cap-and-Trade Experience Suggests a U.S. Carbon Market Would Find Great Success

Pricing Carbon, a new book co-authored by Denny Ellerman with contributions from Felix Matthes, Tuesday's presenters, image courtesy of Cambridge University Press

Pricing Carbon, a new book co-authored by Denny Ellerman with contributions from Felix Matthes, Tuesday's presenters, image courtesy of Cambridge University Press

The European Union’s Emission Trading Scheme (EU ETS) has been an effective mechanism for reducing greenhouse gas emissions and helping the EU meet its commitments under the Kyoto Protocol. At an event entitled “Towards a Low-Carbon Economy” on Tuesday sponsored by the Heinrich Böll Foundation, EU ETS experts, former MIT economist Denny Ellerman, and Felix Matthes of the Öko Institut, described the successes and lessons learned from the European experience and urged the United States to adopt a similar cap-and-trade program.

The EU ETS covers more than 12,000 major stationary emitters including power plants and industrial facilities in all 27 Member States, accounting for about 45 percent of total European carbon dioxide (CO2) emissions. It began operating in 2005, starting with a pilot phase that ran through 2007. The system came under early fire for initial struggles, most significantly data uncertainties regarding emission levels which led to the over-allocation of emission permits and a carbon price collapse in April 2006. However, the 2005–07 pilot phase was just that—an opportunity to test the waters of the new carbon market and work out any major problems that might arise.

The current 2008–12 ETS phase, which coincides with the EU’s Kyoto commitment period, has experienced much greater success in maintaining a relatively stable carbon price of around €15 (US$18.50) per ton of CO2 equivalent. Emissions in 2009 dropped significantly due to the economic crisis, but the carbon market was able to avoid another price collapse because of a 2008 revision to the ETS framework that extended the program through 2020 with a reduction of the capped emission level of 1.74 percent per year. This revision sent a clear signal to covered emitters that the scarcity of emission permits will continue in the long term, thus maintaining the viability of the ETS despite current economic conditions.

Lawmakers in the U.S. have been reluctant to enact a cap-and-trade program due to fears of extensive economic repercussions. However, the European experience reveals reasonable costs for meeting emissions cap reductions, averaging €46 (US$57) per person annually. Just as with the successful NOx and sulfur dioxide cap-and-trade programs in the U.S., the EU ETS has had few, if any, of the negative side effects on trade and the economy that some had feared before the scheme’s introduction. Notably, Ellerman stated that the threat of “carbon leakage” (i.e., the flight of industry to countries without greenhouse gas regulation) has been vastly overstated, as it affects only a handful of industries and can be addressed effectively through countermeasures such as free allocation of emission rights or direct compensation for financial losses.

The success of the EU ETS should alleviate U.S. concerns about the effectiveness and economic viability of a cap-and-trade program. As Ellerman said Tuesday, the European experience has served as a laboratory for other countries and regions in testing how the carbon market should function, and has demonstrated that there is no basis for failing to adopt a cap-and-trade program in the U.S. The U.S. Senate should benefit from the lessons learned from the European system and pass a comprehensive climate and energy bill.

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