An Europe-wide emissions trading system (EU-ETS) puts a limit on emissions for the long term. It aims to lower greenhouse gas emissions in industry, the power sector, and most recently the aviation sector.
The EU-ETS has been criticized, however, for a lack of ambition and too many loopholes – an outcome that comes as no surprise, given that policy makers had to make concessions to strong electricity and industry lobbies to get the system launched at all. These concessions include offsets, not ambitious targets, and a lack of adjustments to economic downturns.
The EU’s main climate policy instrument for the industrial and power sector is its Emissions Trading Scheme (EU-ETS), which covers roughly half of the greenhouse gas emissions within the European Union. It is the world’s largest carbon market, including more than 11,000 power stations and industrial plants.
Overall, the goal is to cap the emissions for different sectors. Each year, the amount of carbon that can be emitted is reduced, putting pressure on firms to lower their emissions by investing in efficiency measures or buying allowances from other emitters.
This system thus produces a price for carbon. Proponents of emissions trading point out that the least expensive solution will always be chosen. For example, it might be cheap for a utility firm to shut down a very old coal plant and switch to natural gas or renewables to replace that capacity. As a result, that utility might not emit as much carbon as it holds in carbon certificates, so it could sell the unused certificates to another utility firm, which has a relatively new coal plant in operation but needs to purchase a few allowances nonetheless.
In order for a carbon price to impact German coal, a 2017 study found, carbon must be priced at around 25 euros per ton of CO2. This is the price that French President Emmanuel Macron proposed as a carbon floor price for the EU, but was roundly rejected in Germany.
Absolute cap, but bumpy start and design flaws
The EU-ETS got off to a bumpy start. Launched in 2005 in a pilot phase, it was comprehensively revised in 2009/2010. The price of carbon remained low, thus giving little financial incentive to switch from coal to low carbon fuels. Nonetheless, the platform does put a ceiling on emissions, which is why Germany’s nuclear phase-out will not lead to more emissions. The ETS caps the power sector, so Germany’s carbon emissions cannot rise above that level with or without nuclear power.
A number of design flaws have kept the system from being more successful. When the pilot phase began in 2005, a generous volume of certificates was handed out for free to major emitters. The result was nonetheless higher power prices because the firms charged consumers for the value of the certificates they had received for free.
Since 2013, certificates in Germany have no longer been allotted for free but have instead all been auctioned off for the power sector; major carbon emitters will finally have to pay for all of their carbon allowances. The founders envisioned that carbon prices would rise to 30-50 euros per ton, which would have made a fossil fuel phaseout necessary in Germany and other coal countries.
The economic downturn since 2008 and other, partly unknown factors, meant that too many allowances were in circulation. In 2014, the EU had already reached its target for 2020 on the European trading platform, which sounds like good news but in fact reflects the inability of the platform to react to the success of renewables and the economic downturn in Europe. In 2014, the “back-loading” of certificates was passed in the EU, postponing the sale of 900 million carbon allowances to the period of 2019 to 2020 to stabilize current carbon prices.
In mid-2018, emissions prices have skyrocketed: in May of 2017, carbon cost 5 euros per metric ton. By September of 2018, that cost was over 20 euros per ton. This has had the effect of making new builds of solar and wind cheaper than existing coal and gas in Germany. Fossil fuels will get even more expensive in 2019, when the amount of auctioned allowances will be reduced in case of excess emission allowances (market stability reserve).
Nevertheless, offsets remain a major problem.. They basically allow European companies to reduce their emissions not at home but in developing countries, with the Clean Development Mechanism (CDM).
Unfortunately, the requirement that offsets be “additional” (meaning that the project would not have taken place anyway to fulfill existing environmental laws) may be preventing environmental regulations from being made stricter; after all, stricter rules would require more action, and the CDM then has to go even further. In other words, the stipulation that a project be additional may provide an unintended incentive to keep other regulations lax. Steps must therefore be taken to ensure that offsets are not barriers to stricter environmental regulations.
Overall, criticism of offsets centers on the question of whether developed countries “outsource” too much of their emission reduction responsibilities to the developing world, thus avoiding structural changes in their own economy.
Outside of Europe, emissions trading has been struggling even more up to now. Nonetheless, the policy will likely pick up not only in the EU, but also worldwide. California started its own cap and trade program in 2013, and its carbon price is higher than the EU’s; it is complemented by the voluntary emissions trading platform along the East Coast of the US (RGGI). China has also implemented a pilot platform in seven provinces.
Emissions trading and feed-in tariffs
Emissions trading has sometimes been viewed as in conflict with feed-in tariffs. While the ETS aims to reduce emissions in the traditional power sector, feed-in tariffs promote investments in renewables. Some analysts argue that if the only goal is lowering greenhouse gas emissions, the ETS would deliver this goal most efficiently because market members would choose the cheapest way to reduce emissions; they charge that many types of renewable energy are only economically viable because of feed-in tariffs.
In fact, renewable power primarily offsets gas turbines and electricity from hard coal plants in Germany, thereby reducing carbon emissions dramatically. Rather than viewing feed-in tariffs and emissions trading as competitors, most Germans understand that feed-in tariffs allow us to reduce the ceiling on carbon emissions for emissions trading faster than we would otherwise be able to do. In reality, as the upturn in demand for German coal power from 2011 to 2013 shows, both renewable energy and emissions trading is needed.