Alain GrandjeanFounding partner of the consulting firm Carbone 4
"The objective is to encourage operations that emit less carbon dioxide, such as power plants that run on natural gas rather than coal."
Carbon Markets: A Global Movement That Needs To Be Interconnected
The carbon market concept emerged when international climate negotiations began. Its first applications date back to the Kyoto Protocol in 1997. The European Union, followed by other countries and regions around the world, started implementing carbon trading systems in 2005. Alain Grandjean, founding partner of Carbone4, explains the related challenges.
In 2005, the European Union set up the most integrated, if not the most efficient, carbon market known as the Emissions Trading Scheme, or ETS. Many other such systems sprang up in the following decade, notably in California, New Zealand, Switzerland, Quebec (now linked to the Californian market), nine states in the eastern U.S., two regions in Japan and, importantly, in several of China's economic zones. These last schemes are slated to merge into a national market in 2017.
The mechanism is simple: companies that emit CO2 are granted credits that they can trade, and a price emerges based on the law of supply and demand. If the company emits more than its credits allow, it can buy more, thereby incurring a cost. The objective is to encourage operations that emit less carbon dioxide, such as power plants that run on natural gas rather than coal.
In Europe, the market concerns sectors with significant emissions such as the electric power, chemicals, steel, cement and paper industries. It does not include households, small businesses or large companies with low emissions. As a result, the market covers half of Europe's CO2 emissions, and electric power generation accounts for 50% of this half.
Of course, a scheme like this can only work if the price is high enough. In 2016, the carbon price in Europe hovered at around €5 per metric ton, which is much too low. It would have to rise to at least €30 to make coal sufficiently unattractive in relation to gas and encourage a switch from one energy source to the other.
The first explanation for the low price of carbon in Europe lies in the large number of credits allocated. To be fair, it was difficult to anticipate the global economic crisis that sent growth plummeting. The governance system is less than satisfactory as well, as the market is not regulated by an independent agency or "central bank". There are ways, however, to lift the price to more acceptable levels by introducing a floor to make the system more efficient and a cap to reassure the market's participants.
The issue of fair competition among global companies cannot be overlooked. Industries like steel and cement compete with players in other parts of the world, notably China. Absent a carbon tax at the border, which would be impossible to implement today, the different markets need to be interconnected if we don't want carbon pricing to penalize European industry. If China unifies its national carbon market and Chinese steel makers pay the same price per metric ton of carbon as their European counterparts, carbon pricing will no longer distort competition. Of course, we don't want to be naive: many other factors give China a competitive advantage, but at least there wouldn't be a penalty for Europe being more "virtuous" than China when it comes to climate.
The same problem exists with the United States. As 2016 draws to a close, no one can predict what Donald Trump's climate policy will be, but coal states and oil companies will clearly be reticent about extending carbon pricing measures. In addition, a switch from coal, which represents many jobs, will raise difficult labor-related issues in many countries including South Africa, India and, closer to home, Poland.
Alain Grandjean graduated from Ecole Polytechnique and received a PhD in Economics of the Environment. He is a founding partner of Carbone 4, the leading consulting firm specialized in low carbon strategy and adaptation to climate change since 2007. With Gérard Mestrallet and Pascal Canfin, he co-authored a report on ways to implement carbon pricing within the framework of the Paris Agreement1 that was submitted to the French government in July 2016. He has also written several books, including "Financer la transition énergétique" with Mireille Martini, published by Editions de l'Atelier in 2016. Since 2007, Alain Grandjean has been a lecturer and leader of training sessions on climate and energy issues, and on the energy transition.
(1) Read the report (in French only)