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How Carbon Markets Work in Europe

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by Eric de Place

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.

****

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.

 

This piece originally appeared in Sightline Daily

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