French President Emmanuel Macron is right: The European Union needs to put a minimum price on carbon if it wants to reduce emissions to 40 percent below 1990 levels by 2030. But Europe’s main climate-policy instrument, the Emissions Trading Scheme (ETS), has delivered a carbon price that’s too low and too volatile to encourage low-carbon investments.
Yes, the EU in late 2017 passed some useful ETS reforms to regulate the number of carbon allowances in circulation. But the reforms are overly complicated and incomplete. And they still allow the price of carbon fall too low.
A price floor on carbon is a simpler, better and more direct way to get a stronger price signal. It would offer “policy insurance” to European businesses making low-carbon investments. And it can be implemented within the existing EU ETS framework.
Agreeing on EU-wide policy has been notoriously difficult and slow, given that individual member states view climate policy with different domestic urgency. So how do we get to a carbon price floor?
Start with electricity
Our proposal is that climate leaders within the EU begin by introducing a national carbon price floor on power generation. Electricity accounts for over 50 percent of EU ETS emissions. It needs to be decarbonized more quickly than do heating or transport. A price floor of €25 to 30 ($29 to 35) per ton of carbon dioxide would have a significant and quick impact. This should then increase gradually and predictably until at least 2030.
Proof of concept exists: In 2013, Britain introduced a price floor that tops up the ETS price; since then, the share of coal-fired generation has fallen dramatically, from 41 percent then to 8 percent in 2017. This yielded a cheap and rapid decrease in carbon emissions by inducing a switch from coal to cleaner natural gas and renewables.
The Dutch government is planning to introduce a similar price floor, beginning at €18 in 2020 and rising to €43 by 2030. Outside of Europe, California’s cap-and-trade program already has a price floor, currently about €12 and increases by 5 percent plus the rate of inflation every year.
Other major European countries such as France and Germany should follow to create a regional price floor for power generation and push for an EU-wide price floor in the early 2020s.
Getting everyone on board
The first step is for these countries to adopt policies — with similar carbon prices and similar fine print — that will be easy to fold into a common policy with a broader coalition of the willing. The next step is to exert political pressure on other countries to join, most notably on members of the Powering Past Coal Alliance — including Belgium, Denmark, Finland, France, Ireland, Italy, Latvia, Lithuania, Luxembourg, Portugal and Sweden.
Over time, the price floor can be extended to cover other sectors such as cement, steel, aviation and aluminum. Unlike electricity, these sectors are exposed to international competition from outside the EU.
However, many other jurisdictions around the world are already introducing carbon-pricing schemes of their own, so competitiveness concerns will diminish over time. These include China, parts of the United States as well as countries like Canada, Japan, South Korea, Mexico and Ukraine.
So long to the waterbed effect
If a price floor is such a simple solution, why hasn’t it happened already? The old critique is that additional policies operating alongside the ETS suffer from a “waterbed effect”: If an individual country or sector cuts emissions further, given the fixed EU-wide emissions cap, these emissions just resurface in another country or sector. Hence there is no overall climate benefit.
The good news is that recent ETS reforms will fundamentally change this. The Market Stability Reserve will cancel surplus carbon allowances from 2023 onward. In the medium term, this will ensure that most unilateral emissions reduction will translate into an overall EU-wide emissions reduction. This provides a unique opportunity to avoid the bulk of the old waterbed effect.
The EU as a whole should now seize this opportunity if it wishes to remain a global leader in climate protection. President Macron is right that an EU-wide carbon price floor is the way to go. Now is the time to put words into action. Germany, France and others should follow Britain and Holland’s lead and place a minimum carbon price of at least €25 on power generation.
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