climate change
Weak Carbon Prices Threaten the EU’s Environmental Leadership Simon Tilford Chief Economist, CER
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he EU’s Emissions Trading Scheme (EU ETS) works by capping the output of carbon dioxide and then distributing allowances to emit the gas to large energy users. The tighter the cap, the more expensive it is for firms to produce carbon dioxide. The European Commission is relying on carbon pricing to encourage companies to invest in new green technologies. It also hopes that the ETS will form the basis of a global carbon market. However, carbon prices under the scheme have fallen by two-thirds in just over six months. At December’s UN conference in Copenhagen, the EU wanted to persuade big emerging economies such as China and India to take action to curb their own output of greenhouse gases. This was a tough task, given that Europe’s flagship environmental policy is not working.
Firms will only invest in new technology if they are confident that carbon prices will be high enough to justify the cost. In early November 2009, the carbon price stood at €14 per tonne. Although this represents an improvement on the low of €10 reached in February 2009, prices are too low to make such investment worthwhile. Back in July 2008, the carbon price stood at €30, a sufficiently high level to provide a strong market signal. The current state of the carbon market poses a bigger risk to the future of the ETS than the previous collapse of carbon prices. Prices fell to just €1 in 2007 because too many allowances were distributed for the first phase of the ETS (from 2005 to 2007) and firms were not permitted to hold on to surplus permits for use in the subsequent phases (2008-12 and 2013-20). However, the price of carbon for use in phase two remained above €18 per tonne during 2007 (and hence well above current levels), because investors were confident that emissions caps in the latter phases would be tighter. In terms of encouraging investment, it is the future price that matters. There are cyclical and structural reasons for the current weakness of carbon prices. The cyclical reason is the decline in Europe’s industrial activity, and hence energy use, since the middle of 2008. With the supply of carbon allowances fixed and emissions declining, carbon prices have inevitably fallen. The EU economy was on course to shrink by around 4% in 2009. The release of carbon dioxide by industries covered by the carbon market could
PART II – Energy and climate change challenges
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