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Experts unconvinced latest reforms will save the European carbon market

  • 29 Jan 2014, 12:00
  • Mat Hope

Credit: Karlis Dambrans

Policymakers have long asserted that making polluters pay is an effective way to reduce greenhouse gas emissions. But with Europe's carbon market floundering, the EU is having to rethink how to go about setting a carbon price.

Carbon pricing only works as a climate change policy if the cost of emitting carbon dioxide is high enough to make companies change their behaviour.

But the European carbon price has rarely been high enough to make that happen, and has plummeted in recent years. That means polluters have had little incentive to reduce their emissions.

With that in mind, the European Commission last week announced the next in a series of reforms it hopes will boost the carbon price and save the carbon market. But is it too little, too late?

Plummeting price

A year ago, the European carbon price hit a record low of €2.81, damaging the effectiveness of the scheme.

Companies buy credits to emit through a mechanism called the emissions trading scheme. If a company emits less than the number of credits it holds, it can sell them - setting a carbon price. In theory, the higher the carbon price, the more companies will do to reduce emissions.

The recent price dip is mainly down to the economic recession, which forced many European industries to rollback. That lowered demand for energy and therefore permits, and caused the carbon price to fall.

But despite decreased demand, the number of permits in the system stayed the same. As such, companies started to stockpile credits to use in later years in case the economy - and demand - recovers. If that happens, companies will be able to crank their emissions back up without having had to pay for the privilege.

The economic recession highlighted a fundamental flaw with the way the market is was originally designed. As there was no way to adjust the number of permits in the system, it meant companies' could effectively delay their emissions, rather than making efforts to reduce them.

To try and overcome this problem, the commission last year implemented a plan to temporarily take out 900 million carbon credits - known as backloading. The move helped boost the carbon price back up to around €5, where it has stayed since.

But the credits are set to be reintroduced in 2020, so the commission's plan is only a temporary adjustment.

New reforms

With the longer term health of the carbon market in mind, the commission last week announced plans for another reform: implementing a 'market stability reserve'.

Under the proposal, the commission would be allowed to tinker with how many permits are in the market. If there are too many permits, the commission will put 12 per cent into a reserve. If supply gets too low, the commission will slowly release these back into the market.

Permits will only be removed from the market if the there were more than one billion in circulation the year before. The permits in the reserve will then be released back into the market, one million at a time, if the number of permits in circulation dips below 400 million.

The commission will announce whether it will adjust the number of permits months ahead of doing so, to prevent companies panic buying. That way, the price should gradually increase, rather than unexpectedly spiking.

The reform should help the price stay at a reasonable level, without the commission having to directly adjust the price, says Damien Morris, from market reform campaign group, Sandbag. Market analysts, Reuters Point Carbon, suggest the reform could mean the carbon price rises to €12 euros higher than it otherwise would have been.

But while boosting the carbon price could make the scheme more efficient, there are downsides.

Speaking at an event organised by policy thinktank, Carbon Connect, Morris argued that the commission had given in to political pressure when it settled on the market reserve proposal. More effective mechanisms to fix the carbon price - such as price ceiling and floors, like the one in the UK - were overlooked as they were "politically unviable" to countries who want no interference in the market, he said.

More problematic, however, is the fact that the reform doesn't kick in until after 2019, he says. That means companies can continue to emit freely until then, with a carbon price hike - and emissions reduction efforts - potentially being put on hold for the rest of the decade.

And then there's the small matter of getting the European Parliament and member states to agree to the proposal, which proved to be tough last time the commission tried to reform the market.

Too late

Even if the proposal was fully implemented, it may not be enough to save the carbon market.

Speaking at the same event, Oxford University economist Cameron Hepburn said the reforms were "too little, too slow". He said the carbon market had been designed badly from the outset, and the commission was only just getting round to rectifying its original errors.

Unfortunately, it's doing so at a time when public scepticism of any measure which may push up energy prices is high - making long term reform of the market a hard sell, he argued.

Nonetheless, the commission's proposal shows European policymakers are still committed to making one of the EU's landmark climate policies function in the long run - even if the experts aren't convinced its tinkering will work.

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