Can a minimum price on carbon accelerate the adoption of clean technologies?

Summary:

The EU Emissions Trading Scheme (EU-ETS) is one of the world’s largest carbon markets, covering 40% of greenhouse gas emissions in the European Union (EU). Established in 2003, the EU-ETS is a ‘cap and trade’ scheme that sets a limit on the amount of CO2 emissions, within which companies can trade emission allowances. The supply and demand for these allowances results in a carbon price which can fluctuate due to changing market dynamics and extraneous factors, in a way that can create uncertainty for long-term investments.

The EU-ETS market opened at approximately €84/tCO2 price at the beginning of 2022, with the price going up to €97/tCO2 on February 7, 2022, before crashing to €58/tCO2 on March 7, 2022 in the aftermath of Russia’s second invasion of Ukraine on February 24, 2022. At the time of writing this paper in June 2022, the price is back to around €80/tCO2. These fluctuations have once more indicated that political events and other exogenous shocks change expectations of the future price of carbon, resulting in price instability. Similar price shocks can be observed in the aftermath of the 2008 financial crisis, and in the first half of 2020 due to measures taken in response to the COVID pandemic. After the 2008 financial crisis, it took almost a decade for prices to recover to previous levels.

This instability has an effect on the decarbonisation of sectors covered by the EU-ETS, since investors are unable to rely on a predictable price to base decisions on. In this context, a minimum price or a price floor in the EU-ETS could provide the stability necessary to accelerate investments, especially those in breakthrough clean technologies needed for this transition. Although the EU-ETS currently does not envisage a price floor, the idea has been pushed recently by Germany, which has advocated for a price floor of €60/ tCO2.

In this paper, we make the case that the EU should implement such a carbon price floor to provide a clear and reliable price signal that can boost investment in clean technologies and accelerate the decarbonisation of ETS sectors.

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