Advocates of carbon-trading schemes in the United States like to point to Europe’s cap-and-trade program as a model worthy of emulation. The European Union’s Emission Trading System, which has been in place since 2005, puts a price on carbon dioxide pollution for the purpose of inducing industry to cut emissions of greenhouse gases and reduce the effects of climate change. European governments set annual caps on total carbon dioxide emissions that may be produced by a group of energy-intensive industries. They then hand out a number of allowances to each company, allotting them on the basis of past emissions. Each allowance, called an EUA, permits the company to release a ton of carbon dioxide into the atmosphere. Companies whose emissions exceed their allowances for a given year must buy more; those with fewer emissions can sell their allowances.
While other governments and authorities (including a consortium of U.S. states) are experimenting with carbon trading, Europe’s system accounts for more than three-quarters of such trading on a global scale. The trade in EUAs has amounted to more than 140 billion euros ($196 billion). Yet Europe has vanishingly little to show for all this.
In theory, limiting the supply of the pollution allowances helps to establish a price for the emission of carbon dioxide. That, in turn, is meant to provide industrial manufacturers and power producers with financial incentives to develop cleaner technologies. The reality has played out very differently, however. A glut of pollution credits, distributed without cost during both the first, transitional phase of the program and the current working phase, drove down the value of the EUAs. As a result, Europe’s carbon dioxide emissions remain priced well below 20 euros per ton. With the price of pollution so low, economists say, industries that generate and consume energy have no incentives to change their habits; it is still cheaper to use fossil fuels than to switch to technologies that pollute less.
“It is hard to tell if any investment decision in the last three to four years has really been shaped by the carbon price,” says Sophie Galharret, an energy economist with the French-Belgian power utility GDF Suez and a research fellow studying European energy and climate markets at Sciences Po, France’s elite university of political science and economics in Paris. “The perfect market should provide such incentives,” says Galharret, “but today’s real market does not.”
Indeed, many doubt that Europe’s trading scheme will drive innovation forward anytime soon. The European Union has vowed to cut greenhouse-gas emissions by at least 20 percent–relative to 1990 levels–by 2020. That translates into a 1.74 percent annual reduction in allowances available to companies covered by the trading system. But companies can easily meet the emissions goal without deploying new technologies. The trading rules allow the companies to receive “offsets” to their own pollution if they invest in projects that reduce or prevent greenhouse-gas emissions in developing countries outside the EU. The other half of the necessary reductions will be achieved if EU members make good on mandated increases in renewable energy. In other words, though the carbon market is described as the centerpiece of EU climate and energy policy, energy investors may ignore it for at least the next decade.
Such problems explain why, even as the United States looks to Europe for a market-based approach to controlling emissions, critics there are clamoring to further tighten the EU emission trading system, or to scrap the carbon market altogether.