Pricing Emissions
It’s Tinkering Time For the EU Carbon Market

For the second time in a week, the EU released plans to start trying to a fix its broken carbon market. The WSJ reports:

One of the key measures was a legislative proposal to remodel the region’s carbon-emissions trading system for the period after 2020, by speeding up the reduction of the number of emission allowances the EU doles out.

Under the new measures, the EU wants to shrink the overall number of emission allowances at an annual rate of 2.2%, faster than its current rate of 1.74%. This measure is intended to drive up the price of allowances, which currently trade at €7.74 a metric ton of carbon dioxide emitted, and reduce overall emissions.

Any carbon market faces a significant challenge in alighting on the “right” carbon price: make it too high and firms outsource intensive industry (a process called carbon leakage), but make it too low and companies aren’t incentivized to cut emissions. Europe’s market has run afoul of the latter problem. Sluggish economic growth in the wake of the 2008 financial crisis has kept industrial emissions below levels anticipated by the market’s planners at its inception. And, in an abundance of caution, Brussels overallocated permits, choosing to err on the side of ineffectiveness rather than throttling growth.

Last week the EU outlined a plan to implement by 2019 a corrective mechanism called the Market Stability Reserve. This tool would remove extra permits from the carbon market during periods of slow growth and, in so doing, help keep the price of carbon up. It would also release permits into the system if demand for them spiked.

And now Brussels is addressing its overallocation problem in a different way, by drawing up plans to accelerate the phasing out of these carbon permits after 2020. It will also cut “free” allowances given to certain heavy-emitting industries, hoping to only make exemptions in those cases where the sector would truly face a crisis if forced to buy into the carbon market.

This is still very much a work in progress, and finding the right balance between green goals and the imperative for economic growth will always be a concern. That said, the EU seems to have figured out that it’s gotten the balance wrong to this point and, encouragingly, is developing a tool to allow its carbon market to stay sensitive to its economic health.

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