Thinking Again About the Crisis of EU Climate Policy

The demise of carbon markets has been predicted a number of times. The latest episode to provoke this claim was the failure of the European Parliament to strengthen the EU’s Emissions Trading Scheme (EU ETS) in a recent vote on what is called ‘backloading’, or withholding a number of emission allowances under the system from auction to create scarcity and drive up carbon prices. The Economist proclaimed ETS, RIP?, while the byline for George Monbiot’s piece in the Guardian stated that “the European emissions trading system died last week”.

But despite these recurrent predictions, emissions trading (ET) systems (also known as cap and trade) remain a centrepiece of existing and future climate policy development in many countries. They have recently been introduced in Australia, Québec and California, and are in various stages of planning in South Korea, China, Kazakhstan, and elsewhere.

So before we see the current problem of the EU ETS as a signal that ET has failed, think about the politics of the main overarching alternative—carbon taxes. 

In Canada and in some quarters in the U.S., recent opinion has tended to swing towards carbon taxes as the main system-wide alternative, at least within a broad ‘free-market’ ideology. Yet while ET systems already in place cover around 450 million people, carbon taxes are in place in only a handful of places, covering perhaps 20 million people.

The most recent crisis of the EU ETS is useful precisely because it underscores one of the major political advantages of ET over carbon taxes (for the general argument, see my “who and what are carbon markets for”). Thus it illuminates why they have gained so much more policy traction.

Most of the various commentaries (see, for example, Brad Plumer in the Washington Post) on the failure of the European Parliament to agree to backloading the ETS focused only on the low carbon price, and thus on the direct incentive to reduce emissions. These commentaries missed the really important political dynamic that the backloading debate showed: namely the lobbying behaviour of big business.

The point usually made is that the current low carbon price demonstrates the problem of relying on a cap that doesn’t change according to economic circumstances. In a recession, the stringency of the cap becomes laughably weak, since emissions are declining in any case, and with them demand for allowances. This would not be the case for a carbon tax, where the same price would have held through the recession, presumably having the effect of creating an even stronger signal to industry and consumers to reduce emissions further.

But let’s think politically about this for an instant. What has happened with the debate about backloading is that you have a substantial business lobby arguing in favour of making climate targets more stringent, which is in effect what backloading entails.

This is the case for the carbon trading firms, who benefit directly from the higher prices that generate hedging strategies by regulated firms. Their lobby organisations, the Carbon Markets and Investors Association and the International Emissions Trading Association (which also represents regulated firms), lobbied for backloading.

But it is also true for many of the firms regulated under the ETS. While not all argued for backloading, it is not the case, as George Monbiot has argued, that business as a whole lobbied against backloading. Business Europe, the main general European business organisation, did; but Eurelectric, the organisation for European electricity companies, argued in favour of backloading. They do so because they have become used to the benefits the ETS brings them in terms of offsetting other financial risks, as well as the direct windfall profits they have accrued. (Those profits were accrued notably as emissions declined in the recession—meaning they had surplus allowances, as pointed out by ETS-focused NGO Sandbag.)

Now think about the counterfactual—that is, if the EU had a carbon tax instead of an ET system. Sure, the carbon price would have remained high, but what would have happened politically? There would be no serious business lobby in favour of maintaining or increasing the carbon price. In all likelihood businesses would have lobbied tremendously powerfully to reduce the carbon tax rate. The same electricity generators, for example, who have argued for backloading, would have argued that the high carbon tax rate in the middle of a deep recession is nothing but a kick in the teeth. And the financial firms who make their money from carbon trading would have seen the carbon tax just as a macroeconomic risk. At the very least they have no vested interest in the system’s policy success. Business did lobby extremely strenuously and successfully against the introduction of a carbon tax in the EU in the 1990’s.

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So before we see the current problem of the EU ETS as a signal that ET has failed, think about the politics of the main overarching alternative—carbon taxes. In a recession, to be sure, the carbon tax would stay high, but the political pressure from powerful business players would go in exactly the opposite direction. In other words, with a carbon tax combined with a recession, you get political pressure from business for weaker climate policy. With ET combined with a recession, you get at least some business pressure for stronger climate policy.

There are many more serious problems with the EU ETS and carbon markets than this current one of the low price. The scams, injustices, weak regulation, financial risks (“subprime carbon”) and arguably inherent problems of such markets have been well-identified by the many critics of carbon markets (such as Carbon Trade Watch or The Cornerhouse). These problems are much more dangerous to the legitimacy of carbon markets, and need to be addressed much more urgently.

The low price problem in fact illustrates a strange and unanticipated but important political dynamic of ET systems: they can generate pressure for more, not less ambitious, climate policy. In the case of the backloading debate, this pressure hasn’t succeeded so far (although the Parliament will vote again in the coming weeks). But the policy has triggered pressure in the right direction.

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