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Can Europe's Carbon Market Turn It Around?


In an opinion piece for the Financial Times yesterday, the Environmental Defense Fund’s vice president and its senior economist defended the EU’s carbon cap-and-trade system. The EU’s Emissions Trading Scheme has fallen on hard times; carbon permits were over-allocated, leading to an extremely low price of carbon (the current price for a permit is roughly one-seventh its price when the scheme launched five years ago. But Nathaniel Keohane and Gernot Wagner of the EDF insist that this doesn’t mean the carbon market is broken.

Keohane and Wagner credit Europe’s carbon market for its recent curbing of emissions. That’s not a very convincing argument; we’ve written about this before. The authors themselves even admit that the recession in Europe had a lot to do with the lower emissions. But even if the market’s bargain-basement carbon price somehow is responsible for declining emissions—something we remain very skeptical of—it has to be because companies are going after the “low-hanging fruit” like energy efficiency measures.

Keohane and Wagner are optimistic about the emissions trading scheme’s future as well, pointing to the incremental reductions of the scheme’s cap as a sign that the system can still work:

[B]ecause the EU has established a mandatory declining cap, emissions will continue to go down by 1.74 per cent a year, every year—even if politicians take no further action. That path achieves about 70 per cent reductions below 1990 levels by 2050.

This is one of the stronger defenses of the trading scheme that we’ve seen: a low price doesn’t mean the whole system is kaput, given the fact that the cap is set to shrink over time. Over-allocation and a slowly contracting supply are smart ways to push through a policy that has been and will continue to be a political football. The politicians passing it initially won’t be in office by the time it becomes onerous, so they’ll vote it through.

But the real test comes when the price of carbon starts going back up as that cap comes down, and European industry is saddled with a cost that their non-European competitors won’t have. It would be fairly easy for a politician to campaign on walking back the trading scheme because the cap’s contraction has been fixed to an artificial time schedule (a schedule, incidentally, informed by climate science that’s a lot less “settled” now than it was five years ago). In fact, just today EU regulators approved exemptions for energy-intensive companies in a bid to keep the continent’s heavy industry happy.

Keohane and Wagner cite “reducing chlorofluorocarbons under the Montreal protocol, getting lead out of gasoline and cutting sulphur dioxide from smoke stacks” as evidence that market-based approaches to environmental problems can work. But in each of those cases there was a relatively cheap and easy-to-install/replace solution to the problem. Technology will likely give us more of these green goodies down the road, but that still leaves the fruit that’s higher up on the tree. We’re skeptical that this piecemeal approach—different cap-and-trade systems in California, Australia, Europe, China, etc.—can hold up in a globalized world when the going gets tough.

There’s a real value in the whole cap-and-trade system in putting a price on externalities that corporations wouldn’t otherwise give a second thought to. But environmental economists seem to forget that human beings are still the ones who set these goals.

[Emissions image courtesy of Shutterstock]

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  • Andrew Allison

    Have you considered thumbscrews? (“. . . carbon market is broken isn’t broken”.)

    • Jamie Horgan

      Fixed that. Thanks for the heads-up!

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