How to avoid history repeating itself: the case for an EU Emissions Trading System (EU ETS) price floor revisited

Abstract

ABSTRACT Several years of very low allowance prices in the EU emissions trading scheme (ETS) have motivated calls to introduce a price floor to correct potential underlying distortions and design flaws, including (i) the political nature of allowance supply and related credibility issues, (ii) potential myopia of market participants and firms, and (iii) waterbed and rebound effects resulting from policy interactions. In the wake of the recent EU ETS reform, allowance prices have sharply increased. This raises the question of whether the case for introducing a price floor in the EU ETS remains valid. We argue that such a price floor, also adopted in several other greenhouse gas cap-and-trade systems worldwide, remains an important improvement in the design of the system, as long as the above-mentioned distortions and design flaws persist. An EU ETS price floor can safeguard against these issues and provides more explicit guidance on the minimum allowance price policymakers consider acceptable. Either as a complement or substitute to the current Market Stability Reserve (MSR), a price floor would thus make the EU ETS less prone to future revision in case of unexpectedly low prices. We identify and confront four prominent arguments against the introduction of an EU ETS price floor. Key policy insights An EU ETS price floor would be an important institutional innovation enhancing political and economic stability, and predictability of the EUA price The recent Market Stability Reserve (MSR) reform has not removed the need for a carbon price floor. Introducing an element of price responsiveness into the so far purely quantitative design of the EU ETS would help to preserve its integrity In contrast to conventional wisdom, legal analysis reveals that an EU ETS price floor can be legally feasible Political support for a carbon price floor is gaining traction across Europe