In spite of what you may have heard, Europe’s carbon market is working beautifully. The EU’s Emissions Trading Scheme (ETS) has been operational since 2005 and we’re now getting a good look at how it functions. It turns out, it’s a remarkable success story, both environmentally and economically.
Let’s briefly review the major pieces of evidence.
1. European Environment Agency. A November 2009 report finds that the continent is well on its way to meeting its Kyoto targets thanks in large part to its cap-and-trade program. In fact, by 2007,14 countries had already exceeded their reduction goals, including the wealthy industrial giants of France, Germany, and the United Kingdom. To wit:
EU‑wide policies are expected to contribute towards most of the planned emissions savings by the end of the period 2008—2012, in particular the European Union Emission Trading Scheme (EU ETS), the promotion of renewable energy sources, policies targeting the energy performance of buildings and internal energy market policies.
Here’s a nickel summary from Joe Romm:
…the Europeans are poised to surpass their targets under the terms of the Protocol. It is no longer plausible for those who don’t want a U.S. cap-and-trade system to point to the European Trading System (ETS) as a failure. Quite the reverse.
…the EEA analysis concludes the EU-15 will not need to rely on offsets to meet their Kyoto target
(There’s more good stuff at Treehugger.) Importantly, the reductions analyzed in the EEA report do not include the effects of the global economic downturn, which has unintentionally provided much steeper reductions.
2. The German Marshall Fund of the United States. A July 2009 report is a goldmine of valuable lessons from the European experience, but for now I’m going to focus just on the carbon market aspects.
From the executive summary:
1. Emissions trading works
MIT estimates that the EU ETS has cut European emissions by 120—300 million metric tonnes of carbon dioxide (MtCO2) during its first, highly imperfect phase—up to 5 percent of emissions from the covered sectors, despite excessive allocations of emissions allowances. It captured private sector attention like no other climate initiative, and its rapid introduction and impact contrasted with a decade of dispute over (failed) attempts to introduce a European carbon tax.
Recommendation: Develop an emissions trading system that learns from and improves upon the EU experience.
This is a hugely important point. The EU’s cap-and-trade program was, indeed, highly imperfect. It relied on inaccurate estimates of emissions, it distributed too many carbon permits, and it distributed permits in a way that conferred windfall profits on polluters. But here’s the kicker: it still worked! The ETS is ironing out its flaws and a future US program stands to benefit from Europe’s lessons.
There’s more good reading on this report at Climate Progress and Treehugger.
3. Pew Center on Global Climate Change. A May 2008 report provides additional context for understanding the ETS. There’s too much in the Pew report to fully explicate in a short blog post, but I want to highlight some of the findings about the carbon markets:
The EUA market has exhibited the same characteristics as markets for tradable permits in the U.S., such as those for SO2 and NOx. Notably, a market developed relatively quickly without special effort on the part of the government beyond creating the scarcity, distributing the permits, and enforcing compliance. In all cases, there has been no lack of intermediaries to facilitate trading among parties with either long or short positions and to create a single price at any one moment in time for trading instruments with similar attributes.
In other words, Europe’s carbon markets are functioning relatively smoothly. Despite the fact that Europe had virtually no experience with implementing a cap-and-trade program, and despite the fact that the program includes numerous sovereign nations, the cap-and-trade program works. It reduces emissions—and it does so inexpensively and efficiently.
The success of the EU’s cap-and-trade program shouldn’t be surprising. It’s entirely consistent with what we’ve seen in the US. Carbon markets working in the northeast states and cap-and-trade programs have worked across the nation for reducing air pollution.
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Two updates (11/19/09): Jill Duggan at World Resources Institute has a good blog post on the subject.
Back in February, my colleague Clark also had a smart post about about the ETS. In fact, it’s worth repeating the quote that Clark pulled from the New York Times:
In a boost for the system on Monday, however, a prominent research company, New Carbon Finance, said its calculations showed that the largest cause of a reduction in emissions in the European Union last year was attributable to the trading system—because it had encouraged greater use of gas in power generation rather than dirtier fuels like coal.
David Silverstein
It is good news that European countries have made progress towards thier required Kyoto targets, but it has nothing to do with cap-and-trade and the emissions trading system (ETS). In 2008, free allocations exceeded emissions in all countries! They don’t even know how many were given out. And futures contracts? December 2007 futures went to almost zero and stayed there 6 months before becoming due. December 2009 and 2012 futures have higher prices, but you have to wonder who is buying them when allowances are being given away. Less than half of industrial emissions are covered by the cap they are trying to define and whatever that is won’t start to drop until 2013. So, how exactly can ETS be “working”?Emissions have dropped, but for other reasons. If you remember, fuel prices were very high globally in 2007 for still unexplained reasons (speculations?) and then a global financial crisis (from mortgage-backed securities) set in. Yes, still some people want to give global financial firms control of carbon emissions. The EU has been actively switching from coal to natural gas, insulating homes, promoting biomass and providing solar tax credits – particularly in Germany. Sweden, Finland, Norway, the Netherlands and Italy have a carbon taxes and France just passed one. Some industry has moved to Asia. According to some, UK emissions have actually gone up considerably if you include imported goods from China.The rest of those reports are self-serving hearsay. It is just amazing how vested self-interests can try to spin the truth. But, don’t take my word for it – take a look at the European Agency report yourself – particularly chapter 5 – and see if you can find any proof that ETS is “working”.
Oregon Michelle
As always, a fascinating discussion.Eric and David, both, thanks for helping us North Americans put the EU’s cap-and-trade lessons in perspective. It truly is heartening to see the EU’s fledgling efforts grow healthier and stronger wings as it takes flight. Though, where exactly it’s going has yet to be seen…But, I did want to add some enthusiasm for America’s tentative efforts, with Al Gore’s response to a question from a recent Seattle Times’ interview, in which he was asked:Q: Do you think whatever climate legislation the [U.S.] Senate passes will work?A: I’m one who believes that the House legislation, though much weaker than I would have wanted, nevertheless BEGINS THE PROCESS OF POWERFUL CHANGE that I think would prove to be UNSTOPPABLE. And if the Senate legislation ends up as good … it will be criticized as too weak, but it will be a VERY IMPORTANT STEP FORWARD. The truth is, ONCE THE BUSINESS COMMUNITY AND THE POLITICAL COMMUNITY SEES THIS PROCESS UNDER WAY, they’ll find—as they’ve always found in these pollution reduction efforts—THAT IT’S CHEAPER AND EASIER THAN THE NAYSAYERS SAY. [emphasis added.]Eric, your ETS post certainly emphasises this for Europe!(hat-tip to Sightline Daily for The Seattle Times’ link)
Eric de Place
David,If you can point me toward any credible published analysis showing that the ETS markets are being gamed or manipulated, I’d be very interested to see it. The problems with allocations in the ETS are well-known. They do not constitute fundamental flaws, but rather the sort of kinks that were to be expected in establishing the first trial phase of the program. What’s encouraging is that the ETS has created liquid allowance markets, convergence toward a single price point for permits, and a framework for industry to profitably participate in an emissions-reduction program. Most importantly, the ETS has shown that a large-scale carbon cap can work—even if the most meaningful cap-driven reductions are scheduled for the future. In fact, one of the benefits of a fixed declining cap is that it creates strong incentives for the sorts of complementary actions that you mentions: fuel-switching, efficiency investments, and so on.
Charles Komanoff
You report that “MIT estimates that the EU ETS has cut European emissions by 120-300 million metric tonnes of carbon dioxide (MtCO2) during its first, highly imperfect phase.” That’s between 1/80 and 1/200 of EU emissions over the period in question, yes? (I figure four years, in each of which European emissions were around 6 billion tonnes, roughly the same as the U.S. I hope I’m not too far off.) I just don’t see how such a puny impact qualifies as “a remarkable success story.” Aren’t you confusing expectation with experience? I’m also taken aback by your citing two ardent cap-and-trade proponents, Joe Romm and the Pew Center, without at least disclosing their stake in valorizing the ETS. For the record, I co-direct the Carbon Tax Center and am not supportive of cap-and-trade. I daresay I would require stronger proof before I branded any carbon tax a remarkable success.
David Silverstein
There is the case of HFC-23, a byproduct of manufacturing refrigerant gases. The destruction of HFC-23 as an offset became so profitable, a great deal of extra refrigerant was produced!http://www.newscientist.com/article/dn11155Some offsets have been shown to be vastly over-exaggerated, such as in the Bolivian forest project. This received investment, but offsets may not have been traded.http://www.greenpeace.org/international/news/carbon_scam151009http://www.greenpeace.org/raw/content/international/press/reports/carbon-scam-noel-kempff-carbo.pdfAnother obvious perversion is the movement of manufacturing to countries will lower caps. This would produce an increase in emissions because of additional global shipping of raw materials, parts and finished products to markets across the world.Still, it not easy to manipulate and corner a market on carbon credits when they are in oversupply and being given away. Perhaps some will try. However, limited manipulation thus far is not an indication what will happen in the future. For example, if you leave the keys in your car ignition and walk away, the fact that the car hasn’t been stolen yet does not mean it won’t be. I once left a bicycle in a crowded bike rack without a lock to see how long it would take to get stolen. It took one week. But, you know, it really depends on the neighborhood. The global financial firms are in stealth mode on carbon emissions markets. They are quietly setting things up, lobbying congress and slipping in legislation. If a cap-and-trade bill passes, what has happened up until then will have little bearing on what happens next. Congress cannot regulate the financial industry now, so what will happen after handing them control of the carbon emissions markets?What follows is predictable, because it has happened before on fuel, mortgages, currencies and other instruments. Carbon allowances and offsets will be pooled and securitized. Financial firms will charge transaction and management fees on the pools, buy the cheapest carbon allowances and offsets, and hide the source, effectiveness and compliance or hide behind a rating firm they hire to assert the instruments are effective. They will buy emitters to get direct access to the auction markets. They will make profits with momentum and arbitrage trades, which they will be able to get access to before anyone else can. Linking cap-and-trade markets around the world is all about arbitrage and speed of execution – a trader’s dream. They will effectively have their own tax on the cap-and-trade system. But what about using that capital to actually reduce carbon emissions, instead of making already obscene profits at financial firms even more obscene?We won’t know if cap-and-trade might be effective until after a cap starts to shrink beginning in 2013 in Europe, so that would be 2014 at the earliest. The Senate climate bill doesn’t significantly drop a cap below 2012 levels until 2022! So globally, cap-and-trade can’t really be validated until the mid 2020’s, which is much too late. Carbon taxes have been in effect for some time and have been shown to work. Sweden adopted a carbon tax in 1991 and reduced emissions 9% between 1990 and 2006. Indications are that emissions would have been 20% higher without this. Cap-and-trade has many additional risks that a simpler carbon tax would not have and it really doesn’t add any benefits, unless you are a special interest looking for a back-room deal on emissions, a politician looking for money or a financial firm looking for huge profits without producing anything of true value. Environmental certainty is an illusion with the inclusion of offsets which are easily corruptible and very difficult to validate. There simply isn’t time to play with cap-and-trade!
Oregon Michelle
Charles, good to hear from you! Please continue to keep our eyes open and our views balanced.David, in your comment directly above, you say:”…Linking cap-and-trade markets around the world is all about arbitrage and speed of execution – a trader’s dream.”I believe your comment in this post is an environmentalist’s dream: “…A global carbon tax can be the same across the world, removing the problem of corporations moving manufacturing to avoid lower carbon emissions costs. Then, carbon tax revenues of each nation can be used nationally for developing low-carbon infrastructure, research, adaptation and yes, purchasing offsets, but without the kind of market pressure likely to induce fraud.” [Emphasis added]Keeping a level-playing field across the world is the best way, if not the only way, to resolve this worldwide crisis as quickly as possible. Then, everyone profits!
Oregon Michelle
BTW, just to make it perfectly clear, (since one never quite knows how one’s “tone” translates over the Internet), I fully support a global carbon tax and think it’s a brilliant idea.
Eric de Place
David,In later posts, I’m going to dig in more to some of your arguments. For now, let me just say that you appear to be confusing offsets with cap and trade. As I’ve said, offsets are problematic—but they are likely to be a feature of any realistic carbon tax or regulatory scheme. (In other words, they’re not a problem only for cap and trade, but for any carbon policy.) In any event, cap and trade really is working in the EU. There are now at least 4 seperate analyses to support that conclusion: New Carbon Finance, Pew, the German Marshall Fund, and the European Environment Agency. Not only that, it’s really working in RGGI, as I blogged about earlier. Plus, it’s worked phenomenally well for the half dozen or so air pollution programs in the US over the last couple of decades (as I will blog about soon). By contrast, I still haven’t seen any credible published analysis showing that cap and trade markets have been manipulated. BTW, the Swedish carbon tax is good and we’ve written approvingly about it, here: http://www.sightline.org/daily_score/archive/2008/03/10/other-carbon-tax-shifts. But it’s also imperfect and partial. Industry gets a cut-rate deal on the tax and it exempts electricity generating fuels. Moreover, many of the reductions in Sweden can be attributed to regulatory policy and changing economic conditions, not solely to a carbon price. More to the point maybe a Swedish-style carbon tax is not supported by the president; it has not passed the US House; and it is not being hotly debated in the Senate. If all those things were true, I might be much more inclined to treat it as a legitimate alternative to cap and trade (though I’d still favor a legally-binding limit on CO2 emissions, which a tax doesn’t deliver.)
David Silverstein
Yes, Sweden’s fossil fuel emissions have dropped since 1990 through carbon taxes and regulations without the need for cap-and-trade or offsets. No, it hasn’t caused Sweden’s economy to fall off a cliff. This isn’t like what the US senate is suggesting, where the emissions cap doesn’t drop below 2012 levels until 2022 and any claimed reductions are entirely through offsets. That’s right, we don’t actually need cap-and-trade at all.I do understand the difference between offsets and cap-and-trade. My point is that offsets are much riskier and more prone to fraud under a cap-and-trade system than if funded with carbon taxes. Offsets funded by carbon taxes can be managed by municipalities, just like any other infrastructure such as roads or water supplies. The municipality can decide what is best for them, seek bids and choose what is cost effective. The people of the municipality have ownership of the offset, which will lower their own carbon taxes. This is much better than some faceless investor building windmills or whatever outside of town that everyone loves to hate. An investor will likely try to throw something up for maximum short-term profit with little regard for the community and flip it to financial firms to pool with other dubious offsets. Let the community be involved, with it’s own skin in the game and it will be much more vigilant on offset quality. Let offset development create local jobs. That is much more powerful and can apply at the town, city, state, federal and international levels, including in developing nations.There seems to be a self-fulfilling belief in Washington DC that cap-and-trade is politically pragmatic and carbon taxes are not. But guess what, unlike senators and special interests, nature won’t compromise, and political pragmatism is headed for environmental disaster. So the better question is, what is environmentally pragmatic?
Oregon Michelle
“…Offsets funded by carbon taxes can be managed by municipalities, just like any other infrastructure such as roads or water supplies. The municipality can decide what is best for them, seek bids and choose what is cost effective. The people of the municipality have ownership of the offset, which will lower their own carbon taxes. This is much better than some faceless investor building windmills or whatever outside of town…” Getting the community to take ownership of their own offsets is a priceless idea. This is stewardship at its best!
Oregon Michelle
Let me rephrase that…Using carbon taxes to fund offsets, and making those offsets community-owned, will keep the community’s environmental and financial interests at the forefront. THAT is environmental stewardship at its best!