The European Emissions Trading Scheme is having a rough time. An auction in Germany had to be abandoned because bids for the emissions certificates did not meet a minimum price. The traded price collapsed to below €3 a tonne, way off what is needed to stimulate new low carbon investment. As a result, there is only a feeble counterweight to cheap coal from the US, which is getting burned more quickly.
Does this matter and what should policymakers do about it?
It is useful to explore why the price is low. Firstly, the dire state of EU economies means that demand for the things that fall under the ETS – mainly power and energy-intensive industry – has fallen sharply. Secondly, there has been an influx of cheap emission offsets from countries like China and Russia, many from projects of dubious environmental integrity. Thirdly, most of the permits were given away for free, not auctioned. Fourthly, and uncomfortably for some greens, the EU’s Renewable Energy Target depresses the price. By mandating that we do expensive things to decarbonise now, rather than the cheapest things first, it pushes down the traded price (see here for an explanation). It is the system’s current design that is the problem, not the principle of a market mechanism.
As a result, Europe has effectively already achieved its 2020 carbon targets seven years early. Perhaps it is surprising that the carbon price is not already zero.
It is worth pointing out that a low carbon price is not necessarily a bad thing. We are often told that decarbonising, through measures like energy efficiency and conservation, is pretty cheap. If that is the case, then a low carbon price should be expected. It will not incentivise expensive technologies, but then that is not the job of the ETS. But this argument only holds if a cheap price is the outcome of a sufficiently rigorous cap – it is far from clear that the current cap fits that description.
The resurgence of coal in Europe is made more likely by a low carbon price. That should be enough to jolt policymakers into action, and the current discussion over tightening the cap in the short-term or delaying auctions is an important one.
However, what is more important than short-term tinkering is that the ETS or any carbon pricing mechanism provides a long-term carbon signal, to give necessary confidence to investors and developers of low carbon technologies. Not only does the current cap increasingly look unambitious, having not been adjusted to the effects of the recession, but it is also far too short term. With no clarity beyond 2020, it is hard for investors to judge what impact it will have for their projects for most of their operating life. Policy Exchange is currently looking at options to improve the ETS and provide a stronger, longer-term signal.
The UK debate is caught up in paroxysms about whether to have a 2030 decarbonisation target for the electricity sector. Such localised squabbling is a sideshow (not to mention utterly irrelevant to the climate under an EU-wide cap). However, people on both sides of that debate should be able to agree on one thing; until we have a credible carbon pricing regime in place across the EU, then Europe is not really serious about tackling climate change.
Economists like to argue about whether a carbon tax or a cap-and-trade system offers the best instrument. While interesting, the more important debate is about whether we want a system that prices pollution and allows the market to discover the cheapest technologies, or one that sees government supporting the mass roll-out of favoured technologies. At the moment, policy is drifting towards the latter. This risks pushing up electricity prices unnecessarily for consumers and businesses.
The ETS should be the backbone of European efforts to tackle climate change, and provide a cost-effective example to the rest of the world. Unfortunately, its current problems means it risks becoming seen as a feeble back-stop, unable to even halt the use of coal.
This article originally appeared on BusinessGreen’s website