The European Union Emissions Trading Scheme (ETS) is currently the largest cap-and-trade scheme in the world. Covering 11,500 installations and countries with a combined population of around 500 million, the scope of the scheme is truly enormous. Before Americans adopt a cap-and-trade scheme of their own, it is vital that they take a serious look at how things have gone in Europe. I hope that my study, released at the end of last week, can demonstrate some of the huge risks that the United States will face if cap-and-trade advocates get their way.
The first thing to note is that the scheme has cost European consumers a fortune. There was a total bill of €93 ($123) billion between the introduction of the scheme in January 2005 and the end of 2008. That is €185 ($245) for every man, woman, and child across an area where average incomes are considerably lower than they are in the United States. That bill is expected to rise in the years to come.
And the people who pay the heaviest price are those least able to bear it. A large part of the bill to consumers will come through higher prices for electricity. When you combine the ETS with other policies, such as renewable energy mandates, which may well form part of a cap-and-trade bill, they amount to 14 per cent of household electricity bills in the U.K. That will be felt most by the poor and elderly. By contrast, energy companies make big windfall profits. Scarce allowances are given to them for free, but the need to hold them still pushes up their production costs. Even in the most competitive market, they will charge customers for free allocations. This is a policy that takes money from the poor and gives it to big companies. But even if the allowances are auctioned, it is still a regressive tax.
Manufacturing firms also suffer. Electricity is a big part of the costs for many industries, and British climate change policies now make up 21 per cent of the average industrial electricity bill. You can’t add a fifth to a major cost for industry and not expect to see jobs and prosperity leave the country. Government will step in and try to help, but their assistance will be clumsy and make industry uncompetitive.
Moreover, in return for this significant burden, we still haven’t got a stable price on emissions. The price has collapsed repeatedly. The basic problem is that the scheme puts a cap on emissions, which means the supply of allowances is fixed, and that means any change in demand is reflected entirely in the price. That instability in the price is bad news for consumers as it makes it much harder for them to plan. It also makes investing on the basis of that price a lot riskier and undermines the efficacy of the ETS; it particularly weakens the incentive to install nuclear power. Environmentalists and energy companies in Europe are calling for the price to be fixed, calling into question the whole point of the scheme.
So far, volatility in the carbon market has taken the form of collapses in the price. But there is no reason to assume that that will continue. The price could just as easily spike upwards if economic growth is faster than the politicians running the scheme expect or if improving emissions intensity is harder. As cap and trade doesn’t balance the costs and benefits of cutting emissions overall, there is nothing at all to stop it imposing a cost-per-tonne-abated far higher than the social cost of carbon. Arguably, it is already imposing an excessive price. Respected researchers like Nordhaus and Tol put the social cost of carbon at under $10 per tonne, yet the current price in the EU ETS is nearly €15 (€22) per tonne.
The ETS has been an expensive failure, and the heaviest price has been paid by those least able to bear it. The last thing America should do is follow such an example.