Earlier this semester, Dr. Webber talked about the early failure of the European Union’s cap and trade system for carbon dioxide (formally known as the Emissions Trading Scheme, or ETS). This was the result of too many emissions permits being issued to market participants. While the problem was eventually fixed, the global economic slowdown has driven the price of CO2 downward in recent years. Unfortunately, it looks like the market may be in danger of collapsing once again.
What happened in the early days of ETS
When the EU’s Emission Trading Scheme started operating in January 2005, the price of CO2 emissions quickly reached a peak of near €30/ton. However, as early as April 2005, several countries reported that their emissions were below the number of permits that had been allocated. This trend continued into 2007, causing the price of a ton of CO2 to collapse to €0.10 by September . This collapse was not just caused by the fact that the regulators had issued too many emission permits in the first place, though that was a significant factor. The relatively high price on CO2 in 2005 and most of 2006 actually drove firms to reduce their emissions. As a result, overall emissions declined faster than expected, thereby exacerbating the oversupply problem. The price recovered in 2008 to an average of €21/ton as the EU began the second phase of the ETS program and all unused permits were reset to zero. Though the global recession has depressed the price over the last few years as economic output has dropped, the market for CO2 permits has remained relatively stable.
History repeating itself?
On April 21, 2013, The New York Times reported that Europe’s persisting economic and political difficulties had once again created another situation of too many permits being available for purchase by polluters (the EU began auctioning off the permits rather than giving them away at the beginning 2013). By April 16, the price had fallen to under €5. The situation got worse later that day after the EU Parliament refused to reduce the number of permits to shore up the price of CO2, citing concerns about increasing the cost of energy at a time of economic difficulty. As a result, the price of plunged further to €2.63 in the span of about 10 minutes. The price has crept up slightly since. However, the market is still perilously close to collapsing .
The Times notes that the current price of CO2 is too low to impact the behavior of entities that produce emissions. In addition, the current difficulties have further shaken the confidence of investors, traders, and banks in cap and trade, with as many as half of the early participants having already left the market . Furthermore, since the EU Parliament has refused to constrain the supply of permits, there is little else that can be done to shore up prices. It is also important to note that this problem is not just confined to the European carbon market. Many developing countries, including China, India, and Brazil, participate in the United Nations carbon market, where oversupply has caused the price of permits to plunge to €0.01 per metric ton of CO2 . This is even more alarming, as controlling the emissions of these countries is essential to combatting global climate change.
Despite all this negative news in recent weeks, there is still some hope for cap and trade schemes. Since European utilities and other large companies are now legally required to buy permits, it is unlikely the market for carbon will ever completely collapse. However, changes must be made to the forecasts used for permit allocation to eliminate the problem of oversupply. It should be noted that there is definitive evidence that the system can work. When the price of CO2 allocations was high in 2007-2008, many companies decided to install pollution controls or switch to cleaner energy technologies. As a result, emissions dropped over that period, which was the ultimate goal of the program. However, in order for the problem of oversupply to be avoided in the future, the forecasting must take into account that the system itself may cause emissions to drop faster than expected. As the past few years have shown, that is not an easy thing to predict.