European Carbon Market in Trouble

May 10, 2013

The European Union's (EU) carbon market, a "cap-and-trade" type system, could soon be the victim of its own success -- and politics. The system set emission limits on more than 11,000 companies and issued carbon credits that turned carbon emissions into a commodity that could be traded by firms to meet their pollution caps. The system has been successful, as have complementary policies, and now the price of carbon credits is so low that the entire system could fail, says the Washington Post.

  • A drop in industrial activity has led to a gradual decline in the price of carbon allowances -- the price has fallen below $4 in recent weeks as politicians argue how to fix the program.
  • The political difficulty in finding a fix for Europe's cap-and-trade system highlights how contentious and sensitive building consensus on climate change has become.
  • As the European Union and United States have become more environmentally conscious, investments in clean energies have reduced overall emission levels.
  • Many companies have also offset their emissions through global mitigation projects like planting trees in tropical rain forests.

Despite the measurable decreases in emissions, investments in clean energy have dropped off, leading critics of cap-and-trade to point out that low carbon prices remove the incentives for companies to take action.

  • Lower carbon prices mean that it is cheaper for a company to simply buy a carbon credit than it is for the company to engage in emission reducing activities.
  • Unlike the cap-and-trade scheme in California, Europe's system has too many carbon allowances and its designers never established a price floor that could have prevented a market collapse.
  • Free allowances to special interests are all too common and a recent attempt to temporarily tighten the supply of allowances to boost the price of carbon was defeated, sending the carbon price even lower.

Optimists claim that the low costs are simply a function of supply and demand and that given the economic downturn, lower industrial activity would naturally lead to lower prices. Others fear that if and when European economics recover, emissions will increase substantially.

The EU's inability to reach consensus and control the supply and price of carbon allowances could lead to a collapse of the entire cap-and-trade system and continued debate about the merits of carbon emissions and global warming.

Source: Anthony Faiola, "European Carbon Market in Trouble," Washington Post, May 5, 2013.

 

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