How does it work?
A great tool that the EU has been making use of since 2005 is Carbon Pricing (which they have been doing through the European Union Emissions Trading System). Carbon Pricing forces large polluters (such as energy companies) to internalize the cost of their carbon emissions by putting forth a cap and trade system. This is done through placing a cap on the total amount of greenhouse gases that can be emitted by covered industrie, which include power plants, factories, and airlines. These respective industries are allowed a certain number of emission allowances, with each one representing one ton of carbon dioxide emitted. There are only a certain amount of these emissions allowances between all the covered industries (which is what the “cap” in cap and trade refers to). If a company emits more than its allocated allowance, it is able to buy more allowances from the market. Additionally, if a company emits less than their allocated allowances, they can sell the allowances to other companies (this buying and trading of allowances is the “trade” part of cap and trade).
Recent Developments
In July 2021, the European Union made changes to the EU ETS to meet its climate targets, aiming for a 55% reduction in emissions by 2030 compared to 1990 levels. It also extends the EU ETS to cover additional sectors such as shipping and introduces a carbon border adjustment mechanism to prevent carbon leakage, which is when companies move their production to regions with less stringent climate regulations in order to get around the allowances put into place by the EU ETS. These changes will also help to drive innovation and investments in cleaner technologies, as energy companies (for example) will need to be able to produce more and more electricity as the population increases and industry grows while still emitting carbon within the limits of their allowance. The carbon pricing mechanism creates a financial market for trading emission allowances, leading to new investment opportunities in carbon markets.
Potential Issues
While the regulations that keep the EU ETS’s restrictions are doing their job in the sense that overall carbon emissions have decreased a decent bit, LEDCs (Low Economically Developed Countries) take issue with the Carbon border regulation that is used to keep the cap and trade system going. They argue that they do not have the means to comply with the CBAM (Carbon Border Adjustment Mechanism), as they do not have the means to move away from carbon technologies in the restricted industries at the pace at which the rest of Europe is. In response to these concerns, the EU has begun taking both short and long term approaches to fixing this issue. Firstly, by 2027, the European Commission will conduct a complete review of the CBAM, focusing in part on its impact on the exports of LEDCs. And currently, the EU are helping LEDCs stay on pace with the rest of the member nations by providing technological assistance to help LEDCs decarbonize at the same rate as other nations. One additional change that did not make it into the recent agreement (which was recently passed to help solve these issues) was donating a portion of CBAM Revenue (presumably gained through the trading of carbon allowances) to these LEDCs and using that money to help accelerate the decarbonization of those nations. Personally, I am not sure why this did not make it into the agreement, as it would definitely help accelerate the process of decarbonization at a very low cost, and might allow for even loftier emission reduction goals in the coming years.
Sources:
https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets_en
https://icapcarbonaction.com/en/ets/eu-emissions-trading-system-eu-ets , https://www.csis.org/analysis/analyzing-european-unions-carbon-border-adjustment-mechanism
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