Macroeconomics

08 January 2014

Europe's Carbon Permit Glut 

The best efforts of the European Union to limit greenhouse gases through financial incentives, by giving carbon emissions a monetary value and enabling them to be freely traded, have been derailed by the continent’s economic slowdown.

Companies receive a number of emissions permits free, but if their carbon output exceeds a set limit, they are obliged to buy more either from the EU or on the open market.

The idea is that companies that clean up their production processes or switch to cleaner fuels can turn a profit by selling emission permits they do not need. Industries responsible for high levels of carbon emissions should pay a heavy cost if they don’t do the same.

When the “cap-and-trade” system was established in 2005, EU policymakers expected permits to trade between €25 and €30 per tonne of carbon. But the recession and its effect of depressing industrial production has left emission prices languishing below €5 – a level that has given companies little incentive to invest in climate-friendly technology.

In December, EU ministers authorized the European Commission to delay the planned auction of up to 900 million permits for emissions over the next three years while governments agree a longer-term deal to reduce the oversupply. They hope to reach a deal this month that would cut the number of new permits to be put on the market.

Policymakers say the planned deal should lift prices and restore incentives for companies to cut emissions. But the experience so far shows that real-world economics have a way of undermining the cleverest theories.