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Europe should learn from California’s carbon trading

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Now that the U.S. has dropped the ball on climate leadership, the world is counting on Europe to lead the way even more.

Europe’s main climate-policy instrument, the Emissions Trading Scheme (ETS), aims to reduce emissions 40 percent below1990 levels by 2030. But the ETS has a serious design flaw — it lacks a minimum price. As a result, it has delivered a highly volatile carbon price that is often too low to encourage low-carbon investments.

{mosads}Yes, the EU in late 2017 passed some useful ETS reforms to regulate the number of carbon allowances in circulation. But the reforms are overly complicated and incomplete. And they still allow the price of carbon fall too low.

A floor price on carbon is a simpler, better and more direct way to get a stronger price signal. It would offer “policy insurance” to European businesses making low-carbon investments.

Ironically, Europe could learn about the merits of price floors from carbon markets in the United States. California’s ETS has such a minimum price, which currently stands at around $15 per ton of carbon dioxide but increases by 5 percent above inflation every year. Another U.S. carbon market, the Regional Greenhouse Gas Initiative for power generators in the Northeast, also has a price floor, but it is currently too low to have real bite.

The idea has not escaped European leaders such as French President Emmanuel Macron, who has advocated for an EU-wide price floor. But the sad news is: This is not going to happen by waiting until all countries are ready. Agreeing on EU-wide policy has been notoriously difficult and slow, given that individual member states view climate policy with different domestic urgency. So how do we get to a carbon price floor?

Climate leaders within the EU should begin by introducing a national carbon price floor on power generation. Electricity needs to be decarbonized more quickly than heating or transport. Carbon emissions can be reduced quickly and cheaply by switching away from coal to cleaner natural gas and renewable technologies. 

Proof of concept already exists within the EU: In 2013, Britain introduced a price floor that currently tops up the EU ETS price by £18 per ton of carbon dioxide; since then, the share of coal-fired generation has fallen dramatically, from 41 percent to 8 percent in 2017. The Dutch government is planning to introduce a similar price floor, beginning at €18 in 2020 and rising to €43 by 2030.

Other major European countries such as France and Germany should follow to create a regional price floor for power generation, and hence the momentum needed to push for an EU-wide price floor in the early 2020s.

The first step is for these countries to adopt policies — with similar carbon prices and similar fine print — that will be easy to fold into a common policy with a coalition of first movers. The next step is to exert political pressure on other countries to join. 

A critique of price floors is that the EU ETS carbon price may in the future rise above the floor level anyway. If so, the floor would have no effect. This is true but not an argument against a price floor. The very reason to adopt a price floor is to insure against the — also likely — scenario that carbon prices continue to be volatile and sometimes drop unexpectedly. If the ETS’s carbon price ends up being high, so much the better.

Recently agreed EU ETS reforms strengthen the case for action. The old critique is that national policies operating alongside the EU ETS suffer from a “waterbed effect”: if an individual country, region or sector cuts emissions further, then – given the fixed EU-wide emissions cap – this just leads to these emissions resurfacing in another country or sector.

The new Market Stability Reserve will, from 2023 onwards, cancel surplus carbon allowances and thereby avoid the bulk of this waterbed effect. Hence most of the emissions reduction achieved by a floor price will translate into a global reduction.

Given that an EU-wide price floor isn’t gaining any traction, the climate front-runners in the EU should follow the Anglo-Dutch lead and move ahead with national and regional price floors. Imperfect a solution as they are, they will provide the much-needed impetus for an EU-wide price floor of at least €30 in the early 2020s.

Europe should seize this opportunity to exert positive influence in the world — and thereby grab back the lead in the fast-growing, multi-trillion clean technology market that U.S. policy seems to be giving up on.

Robert Ritz is assistant director of the Energy Policy Research Group at the University of Cambridge. 

Arthur vanBenthem is assistant professor of Business Economics and Public Policy at the Wharton School, University of Pennsylvania.

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