Earth to Brussels: Fix the Carbon Emissions Trading Scheme Now

Earth to Brussels:  Fix the Carbon Emissions Trading Scheme Now

European leaders gathered last week for informal meetings about the record low carbon prices – about €6 per allowance in early April – in the world’s largest emissions trading scheme, the EU-Emissions Trading Scheme (ETS). Danish climate Minister Martin Lidegaard was quoted in the Financial Times saying that he “just wanted to see if member states think we have a problem or not.” The answer, to paraphrase an American astronaut, is “Brussels, we have a problem.”

The EU’s ETS was the first large international emissions trading scheme in the world, and it is a key instrument in Europe’s efforts to curb climate change emissions. It covers a wide range of large emitters – over 11,000, in fact. Most of these are electricity and industrial producers. It is designed to price carbon emissions, and thereby give economic incentives for emitters to emit less. Based on historic emissions, companies report their annual emissions and (in theory) the system’s total emissions ceiling is lowered over time as emission allowances are reduced. Companies that emit more than they are allowed can buy extra emission allowances on the market. Increasingly efficient companies can sell allowances they do not use.

The ETS sytem is currently over-allocated – meaning that the supply of allowance permits is greater than the demand, thereby leading to a fall in allowance prices. With the phase-out of German nuclear power plants and economic recovery across the continent, many expected emission prices to go up. Why did they go down, instead? First, many European economies are, in fact, not recovering and some are slipping back into recession. Less economic growth means less production and less energy demand, and that equals a declining need for emission allowances. Second, renewable electricity generation grew substantially faster than many experts predicted, thanks to generous financial supports for renewable energy development. Third, and most importantly, the repeatedly identified and well-known structural inefficiencies in the carbon market have not been addressed by Euopean policymakers. European leaders have repeatedly put off the politically difficult decisions required to fix the ETS and make carbon allowances scarce, and higher in price.

Yes Brussels, you have a problem.

In policy circles, as was seen at the meetings last week, three alternative solutions to the record low carbon prices are under discussion. First is the “set-aside,” meaning removing many “excess” carbon permits from the market to ease the existing oversupply. Though necessary in the short-term and well- intentioned, most analysts expect this could drive up prices no higher than roughly €20 in 2020. At such levels, there is little or no incentive to stimulate large investments in energy efficiency and technical or process changes, nor to develop and commercially apply technologies such as carbon capture and storage (which likely requires minimum carbon prices at least €30-€50). Second, tighter emission targets for after 2020 are proposed. This option leaves prices low for 7-8 more years and, at any rate, seems unlikely to overcome opposition of coal intensive EU countries like Poland. Finally, some have called for a minimum price floor to be installed. Since opponents of high prices seem unlikely to agree to set a minimum price high enough to substantially alter incentives, this option likely leaves the price well short of that needed to change behaviors and investments.

Even if all of these options were to be agreed upon and implemented – which does not appear likely in the near term – none fixes the systematic flaws that have been hindering the system from functioning properly since its 2005 launch. From the start, emission permits have not been auctioned, but given away. Though the third trading phase, starting in 2013, intends to have some industries buy all or some of their emission allowances by auction, roughly half of the permits will still be freely allocated. These free allowances mostly go to industries claiming that carbon prices would subject them to an unfair disadvantage when competing globally. The fact remains that free allowances depress the prices and thereby distort market functioning. And EU member state leaders have generally made the problem worse by insisting on national emissions estimates and ceilings that simply have been too high to constrain the supply of permits. The continental market for carbon needs to be a single market, with a single price paid by all of the buyers. For the leaders in individual member states, this means telling some national industrial interests they must act in accordance with the European interest – and operate within the single market for carbon emission to make the emissions trading scheme work properly. It is time to do the same for carbon. If energy intensive industries such as chemicals or cement manufacturing are to become much more energy and carbon efficient, they must bear the costs of emitting carbon. The EU excels at creating single, competitive and well regulated markets in Europe. This is its primary mission and it is past time to apply the logic of economic Union to carbon.

Policymakers and citizens failing to solve manifest problems because of the political challenges involved is, sad to say, all the rage on both sides of the Atlantic. One need look no further than the total failure of the United States Congress to address climate change in law (as only one example) and the “groundhog day” series of Euro-crisis summits that seem to issue the same press release at each and every closing press conference. For the EU-ETS, partial auctions from 2013 do not fix the system’s price and over-allocation problems. The patchwork solutions discussed by some European leaders in Denmark last week may well be necessary in the short term, but they fail to fix the systemic problems now, or in the future. For permanent, predictable and significantly higher carbon prices, structural flaws in the system must be addressed. Industry, electricity producers and consumers would benefit over time from clarity, instead of uncertainty. Politically tough choices are, by definition, difficult to make. But it is time to make them, if carbon emissions are to come down and the European Union is to build and sustain credible global climate change policy leadership. Yes Brussels, you have a problem.