The European Union's CO2 Emissions Trading Scheme cannot be viewed as a failure. That's according to Frank Convery, Denny Ellerman and Christian de Perthuis, who reveal the conclusions of their evaluation of the scheme.
As made evident at the recent climate change talks in Copenhagen, the leaders of all the nations of the world are aware of climate change and they all know that something must be done. There is little agreement on exactly what should be done, but all know that in some way, sooner or later, something will be expected of them. And since governments feel this pressure, corporate leaders must also start thinking about how proposed measures will affect their business and how to participate in the inevitable debate about what to do. As is often the case for contentious public policy issues, there is little to help corporate leaders seeking to get beyond the rhetoric in order to understand what may be involved.
In the climate change debate, one exception is a recently published book that examines the results of the only serious public policy experiment in unambiguously limiting CO2 emissions. Called Pricing Carbon: the European Union Emissions Trading Scheme, it reports the results of a multi-year, multinational research effort to evaluate the first three years of the European Union's CO2 Emissions Trading Scheme (EU ETS).
Its central finding is that the EU ETS has been a success. The sometimes-voiced argument that the EU ETS is a failure simply cannot be sustained on the basis of the evidence. This conclusion does not imply that there were no problems - there were many - however, they were overcome and none were fatal to the basic objective: reducing CO2 emissions.
Looking back at these three years with the benefit of hindsight and now-available data, it is clear that European CO2 emissions were reduced as a result of the carbon price created by the EU ETS. Moreover, reductions were obtained in cost-effective and, in some cases, unexpected ways with moderate implementation and transaction costs. Losses of competitiveness, a concern voiced by capped industries, did not materialise. This last finding is surprising in view of the many fears that are expressed in this regard. As one of the book's authors notes: "There are a lot of factors that determine where plants are built and how much they produce. A carbon price is only one of them and, to judge by the evidence so far, not a very important one."
The explanation for this least-cost reduction of emissions with few side effects is the price on the targeted emissions. This was done by imposing a limit or 'cap' on emissions and distributing permits, called allowances, in an amount equal to that cap, and requiring companies to obtain and surrender allowances equal to their own emissions. This cap-and-trade approach creates a scarcity and a market by imposing a very simple requirement on emitters that still leaves them great flexibility.
With a severe penalty for not 'covering' regulated emissions, companies have an incentive in the form of a price signal to manage emissions in the least costly way, just as they would with other inputs to production, nearly all of which are also priced in markets. This allowance price signal, which is continually updated according to participants’ expectations of future emissions, tells companies what their emissions will cost them and thus how much spending would be justified to reduce emissions. Unlike more conventional forms of environmental regulation, companies have complete flexibility in deciding how to reduce emissions and by how much, both presently and in the future through investment and innovation. The European experience with CO2 corroborates the earlier American experience with similar cap-and-trade systems for conventional pollutants. The result is both effective and efficient: emissions are reduced and at least cost.
European centrepiece
The book emphasises that the main accomplishment of the EU ETS was not the emissions reduction in the first three years, which was modest in keeping with the ambition of the cap in these first years, but the successful creation of the regulatory mechanism in the face of significant difficulties, by which later, more ambitious reductions can be accomplished. Equally important is the accompanying change of attitude and practice by the operators of the included facilities. For instance, the EU ETS has had a profound impact on European power markets where the cost of carbon is now a firmly established factor in determining investment and dispatch. The EU ETS has gone from being "a quixotic, and for some, dubious initiative" to being "an accepted fact and the centerpiece of European climate policy".
The EU ETS's multi-national character makes it even more of a success. While the participating nations are all members of the European Union, they remain sovereign nation states with significant differences among them, not only in economic circumstances and historical experience with markets but also in the degree of commitment to climate policy. While these differences are not as great as those existing on a global scale, the EU ETS demonstrates the practical feasibility of establishing a multinational trading system for reducing greenhouse gas emissions despite significant diversity among participating nations. As such, it provides the cornerstone for a potential global regime. In this respect, the EU ETS is "a path-breaking public policy experiment whose implications will extend far beyond the EU".
Ellerman, A. Denny, Frank Convery and Christian de Perthuis. Pricing Carbon: the European Union Emissions Trading Scheme. Cambridge University Press, 2010. In French, same authors, Le Prix du Carbone: Les enseignements du marché européen du CO2. Pearson, 2010.
