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Emissions trading: establishing a price for CO2

Emissions trading is a particularly important instrument to be drawn on for German and European climate policy. The aim is to give stimulus for climate-friendly investments by pricing CO2 emissions and gradually reducing the cap on the volume of emissions. A reform is needed to significantly improve the efficiency of a system that has so far proven mediocre.

Studies show that if we keep carelessly burning fossil fuels, even the plants will no longer be able to halt global climate change.

Emissions trading is an important instrument to be drawn on for German and European climate policy. Emissions trading aims at promoting investments in climate protection by using market mechanisms – price and quantity – and therefore reducing the emission of greenhouse gases. In Europe, the introduction of the emissions trading system dates back to 2005 but so far its success has been modest. A reform should significantly improve the system’s efficiency.

The German government recognises effective emissions trading as a key climate action instrument of the EU for the energy sector and (some areas of) industry. Therefore, at EU level, Germany will advocate strengthening the ETS (the German government’s Climate Action Plan 2050 .

The principle: cap & trade

European emissions trading works according to the “cap & trade” principle:

  • The upper limit (cap) defines how much greenhouse gas participating plants such as power plants, refineries and steelworks are allowed to emit in total. The corresponding emission certificates are transferred to the plants, in some cases for free.
  • Emission allowances can be traded freely on the market (trade). The price for the right to emit a tonne of CO2 is determined on the basis of supply and demand. Companies that reduce their CO2 emissions by investing in, for example, energy saving measures can sell their excess emission rights on the market. The higher the price for emission rights, the more attractive measures to reduce emissions become.

Oversupply has impaired success so far

In recent years, a significant oversupply of emission rights has arisen in the European trading system, resulting from a generous allocation of emission rights, the extensive use of emission rights from international climate protection projects as well as the reduction of emissions during the financial crisis.

The prices for the rights fell as a consequence. For plant operators it was therefore more attractive to purchase emission rights than to reduce their own emissions. As a result, the expected benefits of emissions trading did not fully materialise.

Reform of EU emissions trading

In February 2018, the European Council approved a reform of the emissions trading system, which will take effect after 2020. The main goal is to rectify its deficiencies and to turn emissions trading into an effective tool for climate protection. The key points of the reform are as follows:

  1. It will be applied in all 28 EU countries plus Iceland, Liechtenstein and Norway;
  2. It will incorporate about 12,000 energy-intensive plants and aviation companies that provide services between the above mentioned countries in order to cover about 45 percent of greenhouse gas emissions in the EU;
  3. A linear reduction factor will be introduced: the cap on the total volume of emissions will be cut by 2.2 percent annually;
  4. It will double the number of certificates withdrawn from the market every year due to oversupply to 24 percent. They will be stored in a market stabilisation reserve.