Higher carbon prices could prove benign for the global economy. That is, if Germany and the UK offer any guide.
Both the UK and Germany are pushing domestic energy market restructuring now by creating their own higher carbon prices.
In the UK, this has been done through instituting a carbon ‘price floor’ of roughly US$30.
In Germany, it’s been done through requiring lignite-burning coal plants to buy additional European Union Emission Trading System (EU ETS) carbon permits.
In both countries, the aim has been to discourage coal-fired power and encourage a shift to cleaner, primarily renewable, energy.
Germany emits roughly 30% of the EU power sector’s greenhouse gas emissions covered by the EU’s ETS. The UK accounts for about 15%.
Both countries are committed to aggressive national greenhouse gas reductions: the UK of 35% fro 1990 levels by 2018-2022 and Germany by 40% from 1990 levels by 2020.
In both countries, applying higher domestic carbon prices for coal-fired power is shifting energy production toward cleaner energy.
In both countries, solar and wind energy is now cheaper than coal-fired electricity. In the second quarter of 2015 — for the first time — more electricity was generated in the UK from renewables than from coal.
In Germany, meanwhile, the production of renewable energy has risen while carbon emissions and wholesale prices have fallen.
If these trends continue, the UK may eliminate coal-fired power from its domestic energy production mix by 2023. In Germany, dirty lignite power plants may all be forced offline as early as 2021.
Emboldened by this, both countries want to see market reforms enacted to the EU ETS to drive carbon prices higher — ideally to around 20 Euros (roughly US$22) — by 2020 and higher thereafter. At present, surplus permits dog the EU ETS. This has caused carbon prices to fall and stay below 10 Euro (roughly US$11).
Administrators are now negotiating reforms to the market with a implementation target date of 2020. Two reforms could be applied.
The first would be a a ‘price floor’ (say 20 Euros). Below that level, a carbon tax would be applied, putting a lower limit on prices. Another method would be to allow market managers to withdraw permits from the market when prices fall too low (as they have now).
Either change would work. Or both could be applied.
For its part, the UK already has instituted a domestic carbon price floor of 23 UK pounds, or about US$30.
This is achieved through imposing a fluctuating domestic carbon tax on top of participation in the EU ETS. Under the UK scheme, the domestic carbon tax fluctuates inversely to EU ETS prices.
This creates certainty about UK domestic carbon prices regardless of what occurs with prices in the EU ETS. The only unknown variable is the amount of carbon tax revenue the UK government gets. Business, however, gains future price certainty. This increases confidence for future investment.
What’s novel in the UK and Germany is how they have applied domestic carbon policies as a supplement to participation in the EU ETS. These allow both countries to configure domestic policies to optimize the benefits.
For instance, the UK has good wind resources its long coastline on the North Sea. Higher, predictable domestic carbon prices encourage building wind farms to replace coal.
While this raises domestic energy prices, it also encourages the growth of a wind industry, a long-term national asset. One side effect, however, is that UK power prices are now higher than those in mainland Europe. But these are partially offset by the anticipated lower future health costs caused by coal burning.
In Germany, meanwhile, the situation is a bit different. While Germany has wind resources in its portion of the North Sea, these aren’t as extensive as in the UK. Germany’s problem, by contrast, is its VERY dirty lignite coal industry.
As a result, Germany now requires her dirtiest lignite-burning coal-fired power plants to buy extra EU ETS carbon allowances from 2017. This effectively raises the cost of lignite-powered electricity.
The benefts are two fold. It creates a market incentive in Germany to close down its dirtiest plants. But it also helps soak up excess carbon permits now keeping prices weak in the EU ETS.
And all this indicates markets can work when properly designed. This can take time. While the process of finding the right policy mix hasn’t been flawless to date in either the UK or Germany country, the positive results look increasingly clear.
This has great implications for other carbon markets, most notably in China and North America. China plans to being a nation-wide ETS in 2017 based upon extending the reach of several urban and regional pilot markets now operating on an experimental basis.
In North America the two major carbon markets — the Western Climate Initiative (WCI) of some US western states and some Canadian provinces and the Regional Greenhouse Gas Initiative (RGGI) of US northeastern states are likely to progressively integrate over time.
As they do, both can learn from the flexible, experimental and apparently successful efforts of the UK and Germany to complement localized, domestic carbon policies alongside participation in larger, regional markets.