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Europe’s Carbon Trading Problems May Influence U.S. Climate Policy

A flooded carbon market could help make the case for carbon taxation in the United States.
December 7, 2012

Europe’s carbon trading market is stuttering, and its problems could help guide attempts to curb carbon emissions in many other countries.

Recent efforts by the European Commission to bolster its Emission Trading Scheme (ETS) have served only to highlight its weaknesses, further eroding the price of a ton of carbon dioxide emissions permitted under the system. Economists and political scientists say this could help swing the pendulum in favor of carbon taxes in countries, including the United States, that are currently seeking to create their own domestic carbon pricing schemes.

The European Commission recently announced it would delay an auction of 900 million carbon credits, previously set for next year, until 2019. The idea was to tighten near-term supply and thus bump up the price for each credit, which permits a polluter to release one ton of carbon dioxide. Instead, the price per ton—which traded in the eight-euro ($10) range in October—dropped last month to about seven euros as traders who had been holding credits in anticipation of stronger action dumped them on the market.

That price will not motivate polluting industries to change their behavior. When MIT Technology Review profiled the ETS in 2009 (see “Carbon Trading on the Cheap”), the price was 13 euros per ton, and even at that rate economists said European industries that generate and consume fossil fuels were better off buying permits than switching to technologies that pollute less.

Economists predict that only carbon prices above 20 to 30 euros will provide a strong enough incentive for capital investment in low-carbon technologies. “Market actors are approaching the ETS with a high discount rate. They’re not receiving that forward signal as credible,” says emissions trading expert Spencer Thomas, a research fellow at the sustainable-development institute at Sciences Po, France’s elite university of political science and economics in Paris.

Europe’s trading scheme suffers from oversupply and low demand, explains Thomas. European use of fossil fuels has fallen in the face of an industrial slowdown and renewable-energy installations driven by other government incentives. As a result, the ETS has issued permits for more tons of carbon than major industries are producing. Offsets from emissions reductions recorded in developing countries are also in oversupply.

Thomas predicts that the European Commission’s auction delay will ultimately boost the price of carbon, but by no more than three to four euros. And the price should slump again when the delayed permits get auctioned. In other words, he says, the delay “will do almost nothing for the market.”

No wonder Italy’s environment minister, Corrado Clini, called the Emissions Trading Scheme “irreparable.” Clini said he would propose replacing the ETS with an EU-wide carbon tax when he meets with his European counterparts in mid-December. Several EU member states, including the U.K. and Germany, have already established their own domestic carbon taxes.

There is some hope for the trading scheme, however. Thomas argues that it could be fixed by extending the EU’s goals for carbon reductions beyond 2020; he argues that the current eight-year investment timeframe is far too short for power generators and other capital-intensive industries. “Utilities look at what prices could be in 10 to 15 years,” he says.

That view is shared by experts at the Environmental Defense Fund, the strongest advocate of a similar cap-and-trade program in the United States. “Policy uncertainty has a huge effect on price because investors are not sure that they’re going to be able to get their money out. The solution to that is stronger cap setting,” says Annie Petsonk, the group’s international counsel and coauthor of a report issued last month on lessons the United States can learn from the ETS.

Jane Burston, who runs the Centre for Carbon Measurement at the U.K.’s National Physical Laboratory in Middlesex, points to the growing experimentation with carbon trading worldwide in countries such as China, South Korea, and Australia, and she says the United States should get on board or risk being left behind. “By 2016 there’ll be emissions trading schemes in countries covering more than 50 percent of the world’s greenhouse gases,” she says. “If the U.S. is to be part of a globally linked carbon market in 10 years, the best thing it can do is to start now—or risk learning its own lessons when there is a lot more at stake.”

Some sort of action in the United States began looking more likely after President Obama signaled in his election-night victory speech that he would seek once again to take action on climate change. And California is already implementing its own carbon trading program.

Still, some analysts foresee a move in Washington to implement carbon taxes in 2013 rather than an economy-wide cap-and-trade measure like the one that failed to clear Congress three years ago. 

University of Wyoming economist Edward Barbier, an outspoken advocate for taxing what he calls “societal ills” to fund solutions to global problems, says carbon tax legislation is looking more and more politically feasible. “There is more of a possibility as it becomes apparent that more revenue sources are required to reduce the U.S. budget deficit and overall debt burden,” he says.

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