In 2005, the European Union put in place a carbon trading market that was the first – and is still the largest – of its kind in the world. But the price of carbon has so far failed to reach sufficient levels to send a meaningful signal to greenhouse gas emitters.
The European Union Emissions TradingThe buying and selling of products in financial markets... System (EU ETS) covers more than 11,000 industrial facilities across 31 countries, as well as airlines. These facilities belong to the highest emitting industries, including powerIn physics, power is the amount of energy supplied by a system per unit time. In simpler terms, power can be viewed as energy output... and heatIn the field of statistical thermodynamics today, heat refers to the transfer of the thermal agitation of the particles making up matter... generation, refining, minerals (cement, lime, glass, and ceramics), metallurgy and paper. Together, they account for nearly 50% of the European Union's carbon dioxide emissions. For some industries, the system also includes two other greenhouse gases: nitrous oxide (N2O) and perfluorocarbons (PFC)1.
€5: the price per metric ton of carbon on the European carbon trading market at its lowest level in 2013.
A Cap and Trade System
The system is founded on the principle of cap and trade. A cap is set on the amount of greenhouse gas (ghg) Gas with physical properties that cause the Earth's atmosphere to warm up. There are a number of naturally occurring greenhouse gases... emissions the companies or institutions involved may generate and the participants are granted a certain number of emissions allowances. They are subject to heavy fines if their emissions exceed these annual allowances. This is where trading comes in: the system allows companies with excess emissions to acquire credits on the market from companies who don't need their full allowance. Participants can also offset emissions using the Clean Development Mechanism (CDM) defined in the Kyoto ProtocolInternational agreement linked to the United Nations Framework Convention on Climate Change... (See Close-up: "Carbon: From the Kyoto Protocol to National and Regional Commitments").
The price of carbon per metric ton fluctuates depending on supply and demand. The cap can be lowered over time to steadily bring down emissions. The European system's target is to achieve a 20% reduction in emissions by 2020, based on 2005 levels. In addition, these allowances will eventually have to be purchased by companies that are not subject to global competition. Overall, emissions should be reduced by 43% by 2030 under this system.
Plummeting Price per Metric Ton
While the European system looks good on paper, the collapse of the price of carbon has proven to be a stumbling block. The price per metric ton fell from almost €30 in mid-2008 to €15 in mid-2011 then bottomed out at around €5 in 2013, before recovering to €8 in the second half of 2015.
This is primarily a result of a drop in emissions since 2008, which has led to a surplus of emissions allowances and not enough buyers in the market. The decline in emissions can be attributed to various factors including, in order of importance:
- Local policies promoting the development of renewable energyEnergy sources that are naturally replenished so quickly that they can be considered inexhaustible on a human time scale... and energy efficiencyIn economic terms, energy efficiency refers to the efforts made to reduce the energy consumption of a system... .
- The rise of natural gas and decline of coalCoal is ranked by its degree of transformation or maturity, increasing in carbon content from... in the energy mixThe range of energy sources of a region. , at least up until 2013.
- The economic crisis, which slowed the pace of growth.
So far, the carbon price signal has only had a secondary effect.
Some 11,500 industrial facilities participate in the European carbon trading market.
Regulating the Market
This poses the question of whether measures should be taken to push the price of carbon back up and restore its role as a meaningful price signal, thereby encouraging businesses to work harder to reduce their emissions. Alternatively, Europe could consider that it is reaching its emissions reduction objective, without the need for drastic change.
Opinions vary considerably. Those who think that the European Union should lead the way in the fight against climate change advocate implementing measures that would automatically increase the price per metric ton of carbon, for example by taking large quantities of allowances – those considered as surplus – off the market. In 2015, Europe started setting up a stability reserve that will be operational from 2019. If the surplus goes above a certain threshold, allowances will be automatically taken off the market and placed in the reserve; conversely, if supply falls below a certain threshold, allowances will be released back into the market.
Other experts argue that artificially increasing the market price of carbon will make European businesses less competitive than their unfettered foreign counterparts, and have very little impact in the fight against climate change. Indeed, the European Union's contribution to global greenhouse gas emissions is only 11% today and is projected to fall to 8% in 2020 and 6% in 2030.
Some analysts have also raised the issue of "import emissions". Although Europe has reduced its territorial emissions, those related to the consumption of finished products (manufactured in Europe or imported) have increased in 2015.