Market Failure
Europe’s Decrepit Carbon Market Gets a Grim Prognosis

The European Union’s Emissions Trading System (abbreviated as the EU ETS) is in shambles, and it doesn’t look like there’s enough political will in Brussels to fix it. The carbon market’s problem today is the same one it’s struggled with during its entire 12-year life span: the price for carbon permits is too low to incentivize heavy emitters to change their behavior. And, as Reuters reports, that problem stands to get worse as the scheme’s projected carbon price over the next decade is expected to be significantly lower than was sketched out even one year ago:

Average carbon prices are likely to be almost 9 percent lower than forecast last year, a survey of 135 companies published by the International Emissions Trading Association (IETA) on Wednesday showed.

“Once again IETA members have highlighted the yawning gap between current prices and what’s needed to achieve the Paris objectives,” Jonathan Grant, a director at PwC which carried out the survey, said in a statement. […]

The expected average price is less than half the 40 euros per tonne that respondents said last year is needed to help incentivise investments to help the bloc meet goals set under the Paris Agreement.

Brussels is trying to navigate a dangerous situation here: if it sets its carbon price too high, businesses will close up shop and move elsewhere, bringing their jobs and attendant emissions with them. That phenomenon is known as carbon leakage, and it’s generally considered a worst-case scenario, as it would hurt the European economy without actually reducing global emissions. Conversely, if the EU sets its carbon price too low—the side on which it has erred thus far—then businesses will continue on, well, business as usual.

But the EU ETS’s carbon price hasn’t even come close to that Goldilocks price. Much of the blame for that can be laid at the feet of the 2008 financial crisis—the recession that affected Europe in its aftermath ended up reducing the continent’s emissions in a way that the carbon market’s planners hadn’t accounted for, and even now, nearly a decade later, the bloc hasn’t been able to reduce the number of carbon permits in circulation enough to bump prices up to levels where they’ll actually matter.

It’s a hard sell for politicians to reduce the number of those permits, too, as it will almost certainly result in higher compliance costs for industry. And, as Reuters points out, “two-thirds of respondents to the IETA survey said the rise of populist political movements are a threat to action.” In other words, the prognosis for this ailing green scheme is downright grim.

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