EU ETS at the heart of managing climate change, Stern Review shows

6th November 2006
By EBR Staff Writer
The recently published Stern Review has given a detailed economic analysis of the impact of climate change. The report states that a stable and high carbon price is the key to tacking climate change, and that an expanded and gradually more stringent EU Emissions Trading Scheme can form the basis for a global carbon market that has similarities to the global market for oil.

UK economist Sir Nicholas Stern's review of the economic impact of climate change has a stark and simple conclusion: action to tackle climate change might be expensive, but not as expensive as suffering the consequences. Mr Stern concludes that tackling climate change and limiting CO2 in the atmosphere to less than 550ppm will cost 1% of the world's GDP, but allowing CO2 to rise above this level will be far more expensive - up to 20% of world GDP.

Refreshingly, Mr Stern also sets out a vision of how the world tackles climate change from an economic perspective. A key leg of his strategy is to develop a global, liquid traded market for carbon. He also forecasts a price of $85/tonne as able to drive investment in low-carbon infrastructure by pricing carbon-intensive infrastructure out of the market.

He cites the EU Emissions Trading Scheme (ETS) - along with other carbon trading schemes such as the soon-to-begin Regional Greenhouse Gas Initiative in the Northeast US - as providing the starting point for a global carbon market. Currently, the EU ETS is not liquid, and is highly volatile and low in price - presently around E11/tonne.

That said, traded volumes have been growing steadily and Mr Stern sees the introduction of new volumes from the Clean Development Mechanism, which allows EU companies to generate carbon credits by reducing the amount of carbon produced in developing markets. He also believes that the introduction of new countries and industries, such as air travel, into the scheme will add liquidity over time and stabilize the price.

The price of carbon also needs to rise, and this is down to super-national bodies and individual governments gradually rationing carbon allowances in their territories. This will be the hard part politically, and the first round of national allocation plans for the EU ETS were met with a chorus of disproval for giving up to many allowances to industries in the schemes and producing windfall profits for power generation companies in particular.

This criticism is undeserved as the system must be up and working in a gentle fashion at first, otherwise it would have definitely fallen at the first hurdle. By being generous with credits at first and then gradually tightening, the EU ETS is able to function without a major corporate or political shock that could lead to its collapse.

Mr Stern states that the EU must have a long-term vision for the ETS for phase III beyond 2012, to enable companies to invest in long-term infrastructure. The model for this market already exists: oil is an internationally traded commodity with a high, stable price that is respected across boundaries and within corporations. Indeed, if the traded price of carbon feeds through into the public consciousness - in the way the traded price of oil feeds through into prices at the pump - much of the battle will be won.


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