ETS, RIP?

THE world’s largest carbon market has been holed below the water line. On April 16th the European Parliament voted to reject an attempt to bolster Europe’s flagship environmental programme, the Emissions Trading System (ETS). Carbon prices, already low, plunged. The emerging network of global carbon trading and European climate policy as a whole could sink.

The ETS has long been a mess. It is a cap-and-trade scheme in which permits to emit carbon—about 16 billion tonnes-worth in 2013-20, or roughly half the European Union’s total carbon emissions—are allocated to firms and can then be traded between them. Partly because recession has reduced industrial demand for the permits, and partly because the EU gave away too many allowances in the first place, there is massive overcapacity in the carbon market. The surplus is 1.5 billion-2 billion tonnes, or about a year’s emissions. Prices had already fallen from €20 ($30) a tonne in 2011 to €5 a tonne in early 2013.

So the European Commission, the EU’s executive arm, hatched a plan to take 900m tonnes of carbon allowances off the market now and reintroduce them later, when—it was hoped—demand would be stronger (the proposal is referred to as “backloading”). It was this plan that the European Parliament rejected by 334 votes to 315, sending the price lower still. On April 17th it stood at just €2.75 (see chart below).

In theory the backloading proposal is not dead. MEPs also voted to send the issue back to the parliament’s environment committee for more debate. That committee had approved the proposal in February; it is possible that the same idea could pop up again. The commission could suggest new reforms. In the words of one supporter of backloading, the idea was “damn silly” in itself but “the only way of testing the waters for necessary structural measures”—such as slimming the list of industries exempt from the requirements to buy ETS carbon permits.

The trouble is that neither the parliamentary committee nor the commission can do anything unless significant numbers of MEPs change their minds. That seems unlikely in the short term, not least because of opposition to reforming the trading scheme from Europe’s largest companies, especially energy-intensive ones such as chemicals firms. They complain that the ETS is imposing higher costs on them and they do not want carbon prices artificially raised.

More profound reforms—even assuming they could be negotiated—would take years because they would have to be approved by all 27 EU governments. (One of the reasons for trying to reform the ETS though backloading was that this could be done by administrative order.) For the time being, therefore, carbon permits seem set to remain, in the phrase of the secretary-general of EURELECTRIC, an electricity providers’ association, “junk bonds”.

That will have profound consequences. Over the past few years more than a dozen countries and regions have followed the EU in establishing or proposing cap-and-trade schemes. They include Australia, South Korea, California and several Chinese provinces. The travails of the ETS will not stop this process: China’s new leaders are committed to reining in their country’s vast carbon emissions and think a cap-and-trade scheme is essential.

But the European Parliament’s vote might change the design of new schemes. China might (for example) keep price fluctuations within a narrow band by setting floor and ceiling prices, as California does. “It [the ETS] may well become an example of what not to do,” says Jeff Swartz of the International Emissions Trading Association, a lobby group. Where China leads, countries like Brazil and Turkey will follow. In a new world of carbon trading, the ETS will not be the scheme that others copy.

The vote will also make getting a world carbon price harder. Carbon does harm globally. There is a logic to having a global price for it. You could inch towards such a price by linking together the various cap-and-trade schemes, allowing permits issued by one market to be traded in another. But California’s most recent auction (in February) sold carbon allowances at $13.62 a tonne—three times the current European price. If EU prices stay low and California linked up with the ETS, the state would get a lower “pollution price” than its scheme is designed to provide. More likely, carbon markets would remain separate, denying firms a single price signal.

In Europe itself cheaper carbon makes heavily polluting coal more attractive than cleaner gas. This is encouraging power generators to switch from gas to coal, and to build more coal-fired power stations than they would otherwise do. According to World Resources Institute, a think-tank in Washington, DC, European countries are planning 69 new coal plants, with a capacity of over 60 gigawatts, almost as much as France’s nuclear-power capacity.

The broader question is what effect the travails of the ETS will have on European climate policies generally. The ETS is the only EU-wide environmental instrument. This week’s vote sends a signal that Europeans are more concerned about the costs of that flagship policy than about its benefits—and that signal will influence national climate policies, too, on things like renewable energy. That does not mean the whole edifice of EU climate policy is about to crumble, as some environmentalists fear. But it does mean policymaking will shift more to the national level, making “European” policy, and perhaps prices, less European and more German, British or Spanish. Europe has long claimed to be leading the global debate on climate change. After the ETS vote, that boast rings hollow.

Clarification: Mr Swartz has asked us to make clear that he is referring solely to the European Union's Emissions Trading System as an example of what not to do. The International Emissions Trading Association strongly supports emissions trading in general. We are happy to do so.