Guest post: The price of EU's CO2 emission allowances has increased dramatically in recent years. In this guest post, Daniel Spiro discusses whether this higher price is something to celebrate or not.
Hi Marcell. Thanks for good comments.
- I agree about this point. Though note that the ETS price started increasing already 1.5 years ago and reached almost today's level already before the war started and the gas price soared. So I really think the tightening of the cap is they key explanation (though ultimately this is an assertion). That said, as is the point of the post, given the tighter cap it would have been better news if the price turned out low.
- I too, am a little bit worried about how tighter borrowing and investing may affect the transition. And if you cannot fund green investments, the ETS cap may become a serious production constraint. I wrote a paper in 2020 about what policies would help alleviate the corona economic crisis while being good for climate. https://link.springer.com/article/10.1007/s10640-020-00451-y
One of the motivations was that investment would at that point in time be abundant while "later" it would be more scarce. "Later" turned out to happen earlier than we thought.
- Hm, could be. But again, the tighter cap is probably the main reason. I would not conclude that the learning rates observed in history are not relevant for the new green tech. Would be interesting to study this.
hi Daniel, very interesting and eye-opening perspective, a few questions, and points:
- how much do you think this is transitory given much higher gas prices and potentially lower hydro and nuke availability in the sector in the shorter term? or flipping the question, polluters are now just realising that coal-to-gas switching will be more expensive even in the medium, long term, would that be one of the factors for point B?
- similarly, for the above point, it is not only that known abatement technologies per se got more expensive through higher fundamental energy prices, but financing the abatement tech will be more expensive through higher rate expectations, as free central bank money might be ending? (again still has nothing to do with whether solar, wind, or CCS equipment is more expensive or not)
- Finally, this might just underline my hypothesis that all those H2 and CCS projects and tech stacks (including all value chain parts!) were cheap(ish) in academics' techno-economic studies that applied to learning rates on the Nth of the kind plant similar to solar and wind. Those maybe have been just overly optimistic.
Hi Daniel. An interesting article, thanks.
On point A I agree. As long as there is political commitment in place that the cap is enforced, no matter how low it goes. The EU ETS cap will approach zero in the late 2030's, which means that covered industries won't be able to emit a single tonne of CO2!
Point B I would say that the market is not simply pricing in the current year, but the next 5-10 years and beyond. Given the issues raised in the paragraph above, an efficient market should move quickly up to the levels that account for that challenge.
The price is partly reflective of markets view as to how the marginal cost abatement curve will evolve, but it also reflects the perception of emission allowance scarcity. Remember that obligated companies are legally obliged to purchase sufficient EUAs to cover their emissions or risk paying a penalty price, and still having to comply.
On point C you suggest that a high carbon price is economically damaging. Is that actually correct? The carbon price is only an issue for those obligated emitters that have not sufficiently decarbonised. For others it provide an incentive to invest in decarbonise, which in itself will have positive economic impact on GDP.
On point E I understand there is little if any actual evidence of so-called "carbon leakage" actually occurring. Although that hasn't stopped industries from highlighting it as a risk in the past. High energy prices in Europe appear to have prompted some companies to move their investment to China, US, but companies haven't mentioned high carbon prices as an issue.
The introduction of the CBAM will incentivise countries that export carbon intensive products to the EU to introduce their own carbon pricing scheme, or equivalent to avoid paying for certificates linked to the EUA price.
If countries share the burden of decarbonisation then the cost - in terms of how high carbon prices need to go - is likely to be less than if they do not. For example, the US IRA could help Europe if it results in technological breakthroughs or a surplus in green hydrogen for example that the EU can then exploit.