Climate Policy after Copenhagen: Managing Carbon Price Risk in an Uncertain World

Key points in Briefing Paper:

While the Copenhagen Accord may represent a step forward for US climate policy if it helps the passage of cap-and-trade legislation through the Senate, it obscures European companies' forward view of international carbon markets.

The policy environment remains very uncertain. Europe has to decide between a 20% and a 30% emission reduction target by 2020 relative to 1990. Member states are likely to be divided on this decision, which will have strong effects on the carbon price.

Strong carbon prices are needed to stimulate markets for low-carbon technologies. Other policies will also be needed because markets tend to under-deliver on longterm investment. Portfolios of multiple policies will, however, need careful coordination. Emissions caps need to be made tighter whenever other climate policies are introduced in order for the emission reductions to be achieved.

Accumulation of price uncertainty in carbon markets leads to discount rates being higher for the long term. Emissions caps are therefore best suited to playing a medium-term policy role, and should be set 10-15 years ahead.

Greater emphasis is needed on public investment to develop long-term solutions to climate change. This is necessary in order to bridge the gap between private discount rates that rise over time and socially optimal discount rates that decline over time.