Losing the lead? Europe’s flagging carbon market

Very recently I participated in the launch of a new report on the state of the EU Emissions Trading System. The event took place in the House of Commons and featured Secretary of State for Energy and Climate Change, Ed Davey. The report was compiled by UK NGO Sandbag, an organization which focuses on carbon pricing and the role of market based systems in delivering such a price.


 The report highlights in stark terms the problems facing the ETS today and calls for even more drastic measures than those currently under consideration by the European Commission.

Sandbag argue:

There remains a serious disconnect between the crisis facing the ETS and the solutions tabled to rescue it. The scheme was intended to deliver a significant shortage of allowances against business-as-usual emissions and thereby oblige ETS installations to pollute less. But the debate has focussed on the surplus allowances sitting above the revised emissions projections rather than restoring the levels of scarcity originally envisaged.

Even those stakeholders who have argued for a return to the intended levels of scarcity have been handicapped by a dearth of analysis and consistently invoked inadequate quantities to achieve their stated aim.

The business-as-usual emissions baseline against which both the EU climate target and the ETS caps were set are totally obsolete. Expectations of Europe’s GDP growth out to 2020 are down by a third since the climate package was agreed. This has left the ETS caps with 2.2 billion tonnes less demand than was anticipated.

We recommend this 2.2Gt in European Union Allowances be removed to restore the original scarcity envisaged for the ETS cap. This will also help restore domestic effort proportional with the level of expected offshore abatement in the offsetting provisions.

We identify a further 900 million excess allowances in the scheme against the original emissions forecasts, resulting from industrial overallocation. A full correction to the cap would require withdrawing 3.1Gt of allowances from the scheme.

 They use the chart below to illustrate the issue.


This report is a worthwhile contribution to the current debate over the ETS, but it doesn’t really pinpoint the other lurking issue in the EU. Much of the surplus that has built up in the system can be attributed to the Renewable Energy Directive, which forces a certain renewable energy build rate to meet a 2020 goal. Climate Strategies recently published a report which argued that up to 0.9 billion tonnes of emissions will be removed from the power sector by 2020 as a result. They point out that although the recession has further fueled the issue, the surplus problem would likely have appeared anyway, albeit somewhat later. A further contributing factor would be the impact of the proposed Energy Efficiency Directive (up to another 0.9 billion tonnes). While it may be laudable that these reductions have taken (or will take) place, what is not clear is the cost of doing so. It almost certainly isn’t the lowest cost pathway for the economy.

Carbon price driven reductions are entirely cost transparent and we can know simply by looking at the carbon price over time what it has cost society to reach a certain emissions reduction goal. But today the CO2 market is effectively at zero (in my view the €7 price does not reflect any current abatement opportunity, rather it is simply the price that the market is putting on allowances on the understanding that some emitters are buying them and sitting on them for much longer term), which means we have no idea about the cost of reaching the 2020 reduction target. That cost is now hidden in the capital investment required to develop renewable energy, but of course reappears buried in the overall cost of our electricity in the years to come.