Critics argue that Europe's carbon tax is dead in the water: not so. The project will stay alive as long as politics doesn’t smother it

(Image: Andrzej Krauze)

THE world’s biggest carbon market, the European Union Emissions Trading Scheme, is now widely regarded as a basket case. The price of a permit to pump carbon into the atmosphere has collapsed. Europe’s parliament is to vote on an emergency rescue imminently – though few expect it to succeed. Yet new carbon trading schemes are being set up around the world, from Australia to Kazakhstan. Even China, the world’s biggest emitter, has just set up a pilot. If the EU market is such a shambles, how come?

To its critics, this crisis in the European market looks existential. The scheme, set up in 2005 to reduce carbon dioxide emissions from 12,000 power stations and other high-emitting industries such as steel and cement, has a history of controversy and price volatility. But the price of a permit to emit 1 tonne of CO 2 , which peaked at around €30 in 2008, recently slumped to under €4, too low to deter even the most polluting activities. Coal-fired power generation, for example, has risen sharply. If this can’t be curtailed, say environmental bodies, why bother?

Schemes must be getting a better press further afield. States in the eastern US have had a system running since 2008, Kazakhstan launched a pilot in January, and the first of seven pilots was launched in China this month, which might develop into a national scheme after 2015. California launched full carbon trading this year, and is planning to link up with Quebec in Canada. South Korea is finalising details for an apparently ambitious version to be launched in 2015, and Australia plans to link its system to Europe’s in the same year. Even Russia and Ukraine are thinking about carbon trading. Clearly many countries still believe it has something to offer.


Could it be, therefore, that the European carbon market is not the abject failure many claim it to be? Prices are low for a good reason – the industries the scheme covers are almost certain to cut emissions by 21 per cent compared to 2005 during the current phase, which runs from 2013 to 2020. Encouraging such cuts is the very purpose of the scheme. There is less demand for permits and the price drops.

“Unless there is a big economic recovery the EU scheme will have no problem hitting its 2020 emissions reduction target,” says Konrad Hanschmidt, carbon analyst at Bloomberg New Energy Finance. So the scheme’s objective looks assured eight years ahead of schedule, and there is no need for a high carbon price to achieve it. “Low prices are not a sign of failure but a sign of success,” says Trevor Sikorski, carbon analyst at energy commodity consultant Energy Aspects.

That is not to say there are no downsides. If Europe’s carbon tax has done what it said on the tin, it is largely because of the unexpected windfall provided by the recession, which has cut energy demand dramatically. While the scheme’s 2020 target looks almost guaranteed, there is a catch – a carbon permit price of less than €4 gives industry almost no incentive to keep investing in low-carbon technologies. If the recession windfall is to benefit the climate, rather than just creating a decade-long pause in the transition to cleaner factories and power stations, reform is needed.

One proposal is to shore up the cost of permits by making less available now and more in later years when economic recovery and higher demand kick in – what’s called back-loading. The European Parliament narrowly rejected this in April, but its members will vote on a revised proposal in early July. It could raise prices to €10 or €15 in the short term – but that’s still too low to deter coal burning. Additionally this would do nothing to further reduce total emissions long term.

Another, more fundamental, approach would be to reduce the number of permits permanently, so-called structural reform. There are several proposals, including one to strengthen Europe’s 2020 emissions reduction target from 20 per cent to 30 per cent, and tighten up the supply of permits to match. This would absorb roughly three-quarters of the current glut at a stroke and substantially increase cuts in emissions this decade. Prices would again rise only modestly, but this may prove the better bet.

Either way, however, it is easier said than done. Targets to reduce emissions and the price of carbon have always been highly political because of the potential economic impact. Members of the European Parliament threw out back-loading amid the worry that if carbon prices rise too high, European industry will be undercut by imports, and might even move abroad. That worry is compounded by recent shifts in energy markets, again threatening competitiveness against imports. Energy prices in Europe have risen substantially since the trading scheme started in 2005. They are now 20 per cent higher than those in Japan and 37 per cent higher than those in the US, according to figures from the European Commission.

Can these concerns be addressed? The Centre for European Reform thinks so. The think tank argues for carbon tariffs at the EU’s borders, with the money raised returned to the country of origin on condition it is used for emissions reduction. This would protect domestic industries from unfair high-emission competition, reduce the risk of trade wars and encourage low carbon investment abroad.

All of which provides lessons for those behind new carbon trading schemes. Carbon trading will only be truly effective when it is global; we need more of it, not less, and it must be interconnected. Until then it cannot be the sole solution, nor used as an excuse not to pursue other policies such as renewable subsidies.

Carbon trading will only be truly effective when it is global; we need more of it, not less

The politics are difficult; the European Commission faces battles over both back-loading and structural reform. And if in the end the system fails to deliver, it will not be the fault of the price mechanism but of politicians.