European carbon market doesn’t need a supply fix

January 29, 2013

By Kevin Allison

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Policymakers racing to prop up the European Union’s carbon market should focus on the long term instead. Proposals to boost record-low carbon prices show a confusion about what cap-and-trade systems such as the EU’s Emissions Trading Scheme can achieve. Even if the carbon price fell to zero, greenhouse gas emissions would stay within an agreed 2020 limit. To ensure the scheme’s future, authorities should focus on the cap, not juggle permit supplies.

In theory, “cap-and-trade” schemes are an elegant way to meet emissions targets at the lowest possible cost. Governments set a maximum level of emissions, then issue tradable permits that add up to the cap. Polluters that are better at curtailing emissions can then sell excess credits to those who need them. Emissions will hit the target if the market is left to run.

In practice, Europe’s scheme is overly complicated. Instead of launching in a single go, the Emissions Trading Scheme proceeded in phases, with too many permits issued in the early stages. That, plus the emissions-sapping effect of the financial crisis and recession, has created a glut of permits to pollute.

The resulting carbon price crash has frustrated backers who want a price signal to encourage investment in cleaner energy. Cap-and-trade is supposed to be technology-agnostic, but there is a legitimate worry that today’s low prices might encourage short-sighted utilities to invest in dirtier fuels, leading to a price spike later. One proposed fix – shifting the timing of permit auctions – would raise carbon prices at a time when economies are struggling.

If the authorities feel they must act, they should rethink the cap. The current target of a 21 percent drop in emissions from 2005 to 2020 is meant to be an intermediate step towards further reductions in later decades. It could arguably be tightened. That might take longer to negotiate than fiddling with permits, but the time would be worth it if the result was a more robust scheme.

Just as economies fluctuate, the scientific consensus about the level of greenhouse gas reductions required to avert damaging climate change will shift over time. Ensuring that long-term emissions reduction targets can be tweaked accordingly would be a better use of EU authorities’ political energy.

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