There is broad consensus that carbon pricing should be one of the key measures to deal with global warming, yet there has been no effective emission trading scheme anywhere in the world, writes Stig Schjolset, who this week is leaving his job as head of carbon analysis at Thomson Reuters Point Carbon to become special advisor on climate policy and green growth to the Norwegian government. According to Schjolset this is not because there is anything wrong with carbon trading but because governments lack the resolve to implement ambitious climate schemes.
Few dispute that polluters must pay for the carbon they put into the atmosphere, while money should be saved for those who are able to cut their emissions. Without much stronger economic incentives it will likely be impossible to get anywhere close to the ambitious global targets everyone signed up to in the Paris Agreement.
Currently, around 13 percent of global emissions are facing a carbon price, either as carbon taxes or mandatory emissions trading schemes, according to the latest State and Trends of Carbon Pricing report from the World Bank. This will go up to between 20 and 25 percent if the Chinese national Emission Trading System (ETS) will be implemented this year as planned. Of the 189 countries having made emission reduction pledges for the Paris Climate Agreement, currently 40 countries are putting a price on carbon and some 60 more are considering carbon pricing schemes.
Carbon pricing can be done by taxes or through emission trading. A carbon tax will set a fixed price on emissions (but not a maximum emissions limit), while an emissions trading scheme sets a maximum level on pollution (but not a fixed price on emissions). Both taxes and emissions trading schemes will reallocate resources to the less carbon intensive sectors of the economy.
The picture is pretty depressing and it is hard to argue that emission trading in any meaningful is pushing the world closer to the targets that were adopted in Paris
Most of the countries that have implemented or expanded carbon pricing in recent years have chosen to use emissions trading: Korea, New Zealand, states and provinces in Canada and the US. The EU chose emissions trading rather than a carbon tax ten years ago. China aims to have a nation-wide carbon market that will cover most of its emissions in place within the next few years.
However, in spite of increasing coverage and the obvious theoretical benefits, we have yet to see a truly effective carbon market. And yes, we can have endless debates about what “truly effective” actually means, but let’s skip that. To me it simply means that the emissions trading schemes we have seen so far have failed to price carbon at a level that has triggered substantial emission reductions. It has simply not become the tool it could have been to drive abatement in Europe and other regions that have implemented emission trading schemes. Taking 2016 – the first year after the adoption of the Paris Agreement – as an example, we had an average carbon price of €5.36/t in the European carbon market (EU ETS). That is a 31 percent drop from the previous year and far below the €20-30/t needed to trigger key abatement measures like fuel switching from coal to gas in most countries.
Other regions had only marginally higher prices than Europe and carbon markets around the world are to various degrees oversupplied with allowances. Overall, the picture is pretty depressing and it is hard to argue that emission trading in any meaningful is pushing the world closer to the targets that were adopted in Paris.
So should we scrap the whole idea of capping emissions and use the market to identify the cheapest abatement options? I don’t think so, and here is why.
Modest ambition
Blaming emissions trading for not cutting emissions is in many ways the equivalent to killing the messenger of bad news. The fundamental problem is of course that policy makers have been afraid to set ambitious reduction targets and/or to implement policies to achieve them. Without ambitious targets you will not have large emission reductions – regardless of whether the preferred policy tool is taxes, direct regulations or emissions trading.
No policy instrument, be it emissions trading, subsidies or hard regulations, will ever be more effective than policy-makers allow it to be
The oversupply we observe in carbon markets around the world is a perfect illustration of this point. Modest policy ambition has resulted in a generous allocation of carbon allowances and there is no need to implement a lot of abatement measures. Why spend money on cutting emissions when you can buy cheap allowances in the market (or even better get everything you need for free)?
The Korean emissions trading scheme has in recent years been the only market without a significant oversupply. The verified emissions for 2015 showed that the scheme was marginally short, at least before the option to use offset credits from non-trading sectors was taken into account. However, the Korean government did recently announce that the allocation will be increased in 2017 in order to avoid significant costs for industry. Although this has been taken as just another example of a failed carbon market, I would argue that the problem is more fundamental. It shows that countries around the world are still reluctant to implement ambitious climate policies, and that no policy instrument, be it emissions trading, subsidies or hard regulations, will ever be more effective than policy-makers allow it to be.
When will the market catch up?
On top of the modest ambition, non-climate related factors like the financial crisis have of course contributed to the oversupply in carbon markets. Taking Europe as an example, emissions in the EU ETS dropped with more than 10 percent from 2008 to 2009 and remained at low levels for several years. Without a corresponding adjustment of the supply of allowances the surplus was piling up these years. This is one reason why the oversupply in the EU ETS is currently in the order of 2.5 billion allowances – much more than the total annual of emissions from all installations covered by the scheme.Â
With the current policy it is not unlikely that there could be another lost decade without an effective carbon price in Europe
Another reason is that the EU has implemented policies on other areas such as renewable energy and energy efficiency that have led to emission reductions in the EU ETS. The more ambitious member states are also putting in place national climate polices for example to phase out coal in the energy sector. From a climate perspective it can hardly be a problem that some countries are moving ahead with more aggressive policies, but if you want to have an effective carbon market as the main tool in the climate policy mix it is clearly a problem that other – and less cost effective measures – are doing the job.
In Europe and even other carbon markets we are to some extent in the middle of a “perfect bearish storm” where falling costs on renewable energy and improved energy efficiency are just extending the lingering oversupply from the financial crisis. This gives persistently low prices, and the more impatient member states are moving ahead with domestic climate policies – which again are cutting emissions and thus keeping the carbon price at a low level.
At some point this will likely turn around and the EU ETS (helped by reforms like the Market Stability Reserve and a steadily declining cap) will consume the oversupply and force installations to make deeper emission reductions. However, exactly when this will happen is still very uncertain and with the current policy it is not unlikely that there could be another lost decade without an effective carbon price in Europe.
The real test is yet to come
In spite of the real life failure, I do believe that carbon markets can be an effective way to cut emissions of greenhouse gases. From a regulatory perspective, the hard cap on emissions gives a high degree of certainty that a specific emission reduction target can be met. From the industry perspective, flexibility and efficiency is provided by the market that will help realize the abatement options with the lowest cost first and that there is a carbon price signal to guide the longer term investments.
If China gets it wrong it is bad news for everyone who believes in carbon markets, but even more so for the global efforts to solve the challenge of global warming before it’s too late
However, the real test of the effectiveness of carbon markets will only come when policy makers put in place ambitious reduction targets and trust emission trading schemes to a key measure to deliver the required cuts. This test could come in Europe or other existing markets that currently are in the middle of reform processes that in a best case scenario could make many of them much more effective and relevant within the next years.
Yet, the most critical test will likely come in China where a federal emission trading scheme is currently under implementation. The potential to achieve huge emission reductions with a well-functioning market and even modest carbon prices is enormous in China. If the world’s largest emitter gets it right it can be the ultimate proof that emissions trading schemes can deliver results in line with the theoretical benefits that are well known. If China gets it wrong it is bad news for everyone who believes in carbon markets, but even more so for the global efforts to solve the challenge of global warming before it’s too late.
Editor’s Note
Stig Schjølset has been head of carbon analysis at Thomson Reuters for ten years. He has previously worked in the ministry of environment in Norway and as a researcher at the Fridtjof Nansen Institute.
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Frank says
I agree with much of this article. Carbon markets still represent a cost effective way to cut emissions, in theory, using price discovery to identify lowest-cost options. But the carbon price is only as strong as the ambition built into the cap. And trying to combine a market-based approach with non-market based approaches, as the EU has done, is completely toxic for the price signal. The low carbon price in Europe simply tells us that the EU emissions targets are being met, in this case by a combination of a carbon market, other climate/energy policies and the legacy effects of the global financial crisis of 2008-2009. Cheap offset credits and free allocation of allowances, for good or for bad, also contribute to this effect. Another critical and often overlooked point is that politicians are more comfortable with higher carbon costs, so long as they are hidden, than with a lower cost that is explicit. Hence expensive renewable energy subsidies are being used, raising Europe’s decarbonisation costs to unnecessarily high levels, while at the same time weakening the price signal under the EU ETS. This causes the most polluting plants to run while preventing a meaningful carbon price from developing. The proposed post-2020 EU ETS reforms seek to address some of these issues. There is still scope to make these systems work, but there is a real risk that this will be another example of ‘too little, too late’ by the EU, leading to another lost decade in the decarbonisation effort.
Yoshi Nishimura says
Dear Stig Schjolset,
I was Japan’s ambassador for the COP negotiation, used to work with Harald Dovland, my good friend.
I read your article and can’t agree more. Because of the problems you are raising, we (me and my Japanese friend) have long argued we must go to a global carbon market at upstream level. Please see my paper here.
“A new market-based climate change solution achieving 2°C and equity”
http://onlinelibrary.wiley.com/doi/10.1002/wene.131/abstract
Wiley Online Library
I share completely your urgency and even angst. We must save the planet in time. I’ve been in the thick of the UN climate negotiations and discussions among experts. But, really, a game change is needed. With Trump in office, things look even more difficult. But we should never give up.
My global market at upstream level is easy to manage and most effective to achieve 1.5-2.0C target as the science based carbon budget for temp target will be owned by the COP and sold as permits to the global carbon consumption. Polluters pay in my scheme. My pricing is globally uniform pricing and provides strongest explict price signal without competitive distortions. The revenue from the sales of permits would represent new robust form of climate financing.
IF ONLY WE GO GLOBAL!!! I know this is radical. People are so accustomed with each sovereign nation reducing their emissions…but this is an economic case of disposing the limited amount of resources. The PA decided to aim at 1.5-2.0C target which means that the carbon budget is now limited finite resources. Market is the best instrument for disposing any finite resources.
Yes, it’s a drastic game change. I need people like you look at it. A global market can be a plausible option as we’ll soon see new era where only about 30 countries (not 189) would seek obtain fossil fuels as others are leapfrogging to renewable energies. An upstream market for 30 countries where firms would be consuming limited resources called the carbon budget for 2C can be a practical new option.
Since I like to stay in contact, I would be most grateful if you could send me a mail to my address above. I like to send you my power point for easy look.
Thank you and most sincerely.
Yoshi
Richard Folland says
Hi Stig, I agree with practically everything you say – and broadly adopted that line when I was speaking about the EU ETS to the European Gas Conference in Vienna last week. In the EU, it is entirely about political will and the radical reform needed to make the ETS the effective instrument it can be – but that won’t come until the fundamental east/west divide on climate in Europe can be resolved. i also strongly agree with you that the success (or otherwise) of the Chinese national scheme will be defining for emissions trading.
Good luck in your new job!
Regards
Richard Folland
Mike Parr says
Carbon markets might work in China – for a range of reasons, but I have great doubts Europe will ever sort ETS out. Poland is still fixated on jobs (for miners) – I understand the jobs bit – but there could be good jobs in, for example, the energy rennovation of buildings – in Poland, funded by the ECB (it’s what banks do – isn’t it? – fund things?). But as long as the Bundesbank’s place man (hi Mr Scheuble) calls the shots nothing will happen. The East Euros and their antipathy to renewables (& EUA prices that price in carbon) is an investment = money problem.
The ” perfect storm” of low wholesale prices/falling RES costs is unlikely to abate. Even if wholesale prices rise the only thing this will do is price in more subsidy free RES. Economists such as D. Helm have argued since 2009 that econometrically, carbon taxes are the way forward, ditto WTO in its Border carbon tax paper of (I think) 2010. Even CEPs, if you get them in a quiet corner admit that ETS was chosen because the politicos could not find the political courage to take the taxation route.
Looking at recent spot market prices – most of them were higher than, for example, the bid price for Borssele 3 & 4 – which is bad news for the fossil guys & could be a reason for the low bids – the off-shore players see higher prices in the future & want to bag off-shore real-estate – almost at any cost – while the going is good. Word in the UK is that prices in 2 – 3 years will hit ÂŁ60 – ÂŁ70/MWh – this won’t price in costly UK off-shore – but it will price in – with no subsidy – on-shore.
Emil Dimantchev says
You make excellent points, Stig. Indeed any climate policy will be only as good as lawmakers have the will to make it. It’s also instructive to consider an interesting phenomenon that you allude to – lawmakers globally have shown greater ambition when implementing “second-best” policies (e.g. subsidies, and standards) than carbon pricing. Such second-best policies have been reducing more emissions than carbon prices pretty much everywhere you look (EU as you point out, California, Canada, even British Columbia with its $30/t carbon tax is reducing more emissions through its clean energy standard).
This suggests that the level of ambition depends on the policy being implemented. As Frank said, politicians are more comfortable when costs are hidden (as with subsidies) than explicit (as with pricing). I think there’s another element too: it is easier to implement a policy when the benefits are concentrated and costs are spread out (subsidies) than when the benefits are spread out but costs are concentrated (carbon prices). As Machiavelli would say: losers cry louder than winners cheer.