Pricing Emissions
Brussels Sets Date for Fixing Carbon Market

The European Parliament took an important step towards shoring up its beleaguered carbon market in Strasbourg this week. If member states sign off on the fix, the EU will institute a corrective mechanism in 2019 that would allow the bloc to fine-tune the number of carbon permits within its trading scheme a bit more carefully. Reuters reports:

Ivo Belet, from the centre-right European People’s Party, who has steered the debate in parliament said the vote was “an extremely important step” and had strengthened the credibility of the European Union ahead of climate talks in Paris at the end of the year. […]

It involves setting up a Market Stability Reserve to store surplus carbon allowances that have piled up due to oversupply and economic slowdown. The reserve also could release the pollution permits in the event of higher demand.

Europe’s carbon market—its Emissions Trading System (ETS)—has had a fatal flaw in its makeup from its inception. The key for any carbon trading scheme is to find a way to set a market price high enough to encourage firms to cut emissions, but not so high that firms look to outsource production to other regions that lack such restrictions. That outsourcing is called carbon leakage, and it’s a nightmare scenario as it causes economic harm without achieving any environmental good.

Europe, fearful of that too-high carbon price scenario, generously over-allocated carbon permits to firms from the outset, with the intention of slowly constricting the amount of permits in the system over time. But shortly after the creation of the EU ETS, the 2008 financial crisis decimated the region’s economy and, by extension, lowered its emissions. The ETS was left with a glut of permits and accordingly a bargain basement carbon price, too low to incentivize green behavior.

This proposed Market Stability Reserve would give the EU ETS the ability to react to circumstances like the financial crisis and, in theory, make it easier to find the Goldilocks carbon price—not too low, not too high, but just right.

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