The EU Emission Trading Scheme: An American Perspective

Europe’s too-intricate-for-just-one-blog-post carbon market

The European Union Emission Trading Scheme (ETS) is a multinational carbon market. Policymakers created the ETS to economically incentivize cost-effective reductions in climate-warming emissions among over 11,000 of Europe’s biggest climate polluters.

This cap-and-trade system serves as an exemplary model for climate policy, right? Shouldn’t climate activists in the United States demand Congress adopt something similar? Even better, the U.S. could enact parallel legislation and then integrate the top American greenhouse gas emitters into the European trading system, setting the foundation for a global carbon market!

As Lee Corso would put it: Not so fast, my friend. Europe’s ETS can hardly be considered the prototype for a functioning market-based climate change solution.

Cheap to pollute

European companies must have permits for their emissions, but the price is not steep. *Source*: European Commission.

European companies must have permits for their emissions, but the price is not steep. Source: European Commission.

For one, the current price to purchase a permit sits just under €5. Each permit, or allowance, is good for the release of one metric ton of carbon into our atmosphere.

For the corporations that own the large industrial facilities and power plants of the European emissions trading market, that’s pocket change. Five Euros per metric ton will not drive investment in the technologies necessary to create a low-carbon energy system.

Outsourcing emissions

Moreover, the smokestacks covered by the ETS account for less than half of total greenhouse gas emissions from the 28 European Union countries. And even if a cap-and-trade system could hypothetically include every emitter in the EU, carbon leakages would remain an intractable issue without an all-inclusive international market.

Put simply, if the climate pollution emanating from one region is subject to a predetermined limit, and in this way a price is placed on emissions, then high-emitting activities like steelmaking will simply relocate to areas outside of the system — places where emissions remain uncapped and thus free.

Side effects

The EU Emissions Trading Scheme has even more shortcomings: The system has brought about massive fraud as well as windfall profits for huge emitters. More importantly, it has indirectly caused human rights abuses to some of the world’s most vulnerable people thanks to the fundamentally flawed concept of carbon offsets.

Total ETS emissions have fallen sharply since the system was put in place in 2005, but how much of that decrease is related to the 2008 dip in economic output? Chart: Environmental Defense Fund. GDP data: World Bank. EU emissions: A. Denny Ellerman, “The EU ETS: Path to the Future or Dead-end?” European Environment Agency. 

Total ETS emissions have fallen sharply since the system was put in place in 2005, but how much of that decrease was caused by the economic recession? Chart: Environmental Defense Fund. GDP data: World Bank. ETS emissions: A. Denny Ellerman, “The EU ETS: Path to the Future or Dead-end?” European Environment Agency. 

Yet the system seems to be working from a perspective focusing narrowly on industrial climate pollution. Total emissions from the installations regulated under the ETS have fallen since the system was first implemented in 2005. In fact, greenhouse gas emissions among participants in the system have decreased even faster than the cap has tightened.

This drop in emissions within the system has led to an oversupply of allowances. Consequently, the ETS price to emit greenhouse gases has plunged far below the level that might reflect such emissions’ cost to society. In technical terms, the externality is nowhere near ‘internalized’ into the market price of goods whose production entails significant climate pollution.

Even with an emissions trading system in place, Europeans don’t pay for the global warming costs of the things they buy.

An American perspective

For an American like me, it’s worth taking a look at Europe’s complicated carbon market.

The day will arrive at last when climate legislation becomes politically feasible in Washington, DC. Before we rush to the conclusion that complex cap-and-trade systems will successfully reduce greenhouse gas emissions in the most cost-effective way possible, as prevailing economic theory promises, we should evaluate every aspect of the European scheme in place, from efficacy to unintended consequences.

Assessing the world’s largest illustration of the most popular policy solution to global climate change warrants thorough examination. Which means more blog posts — a series on the economics, narratives, and divergent views of the EU ETS.

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