Once celebrated as the best policy instrument for curbing harmful greenhouse gas emissions, emissions trading seems to be attracting new critics every week. Europe’s cap-and-trade scheme, the EU Emissions Trading System (EU ETS), has come under particular scrutiny. With carbon prices falling from around EUR 30 in 2008 to lows of under EUR 3 in April 2013, voices from within and outside of Europe are challenging not only the region’s choice of instrument, but also its willingness to take ambitious climate action.
Is all the criticism of Europe’s flagship policy justified? And are cap-and-trade schemes still the go-to climate policy that we should be promoting globally?
Critics are wrong to pronounce the demise of the EU ETS, but policymakers should go beyond small adjustment measures, such as the decision to temporarily hold back the sale of allowances, to fix its carbon price. Internationally, the importance of emissions trading is growing as new schemes emerge. Discussions of the benefits of emissions trading should make way for efforts to ensure the optimal design of new systems that can ultimately be interlinked.
Critics should remember that the most important job of cap-and-trade schemes is to ensure the reduction of greenhouse gas emissions. The EU emissions target is enforced through a mandatory emissions cap, a tightly controlled monitoring system, and heavy fines for non-compliance. The cap is declining by 1.74 percent year by year for the sectors covered under the scheme. Other policy initiatives—such as feed-in tariffs, renewable quota obligation, and energy efficiency laws—also contribute to emission reductions, but only the EU ETS can guarantee that the actual environmental target is met. The scheme serves as the backbone policy instrument to ensure that the EU remains on a predefined path of decarbonization.When setting interim targets, emission reductions from additional measures should be factored into the cap.
It is also wrong to claim that the carbon market is broken. Market forces determine the costs of reaching the emissions goal. Prices result from the balancing of demand and supply for allowances. Low prices are not synonymous with a malfunctioning scheme, but are rather the result of low demand for emission allowances—a signal that achieving the agreed target does not require much work. Europe’s economic recession and the resulting decline in production led to an unforeseen drop in emissions. Combined with an over-allocation of allowances to protect domestic industries from international competition, demand and thus prices collapsed.
The EU is still on the emission reduction path it envisioned in 2008, when it agreed on its 2020 targets. But this doesn’t mean that policymakers shouldn’t intervene. Fixing the carbon price today can prevent the “wrong” investments from taking place and a lock-in of carbon-intensive technologies and infrastructures that are incompatible with low-carbon development paths. Moreover, adjusting Europe’s cap-and-trade scheme to address the current oversupply of emission allowances is an opportunity to secure more ambitious climate action at low costs.
On July 3, the European Parliament approved an initial measure to revive the carbon price. The measure, known as “backloading,” paves the way for a delayed sale of 900 million permits to create greater short-term scarcity. After the proposal initially failed to pass the Parliament in April, the vote has achieved symbolic importance as proof of the EU’s continued ambition to address climate change. Prices have recovered slightly—from below EUR 3 to over EUR 4.20—but they are still far from where they need to be to successfully manage a transformation of the region’s energy system. More importantly, the vote raised hope that more fundamental reforms will follow.
The EU should be encouraged to tighten the current cap and to formally enforce its 2050 target to reduce emissions by 80 percent from 1990 levels. The current cap falls short of this ambition. Adopting a longer time horizon would have the additional benefit of forcing companies to question the long-term impacts of their investments.
Globally, we should continue to learn from Europe’s experiences and ensure that the many cap-and-trade schemes emerging in places such as Australia, California, China, and South Korea are well designed. California, for example, is doing just that. It is capping more than 80 percent of greenhouse gases—and not simply carbon, as in the EU. It also implemented a minimum price as a safeguard from the price collapses we have seen in Europe. Ultimately, the goal should be to link all schemes in order to come as close to a global carbon price as possible. This would allow more ambitious carbon emission reductions to take place in the most effective and cost-efficient way.
Michael Weber is Research Coordinator with Worldwatch’s Climate and Energy Program.