The EU's main climate policy instrument for the industrial and power sector is its Emissions Trading Scheme (EU-ETS), which covers roughly half of the greenhouse gas emissions within the European Union. Overall, the goal is to cap the emissions for different sectors. Each year, the amount of carbon that can be emitted is reduced, putting pressure on firms to lower their emissions by investing in efficiency measures or buying allowances from other emitters.
This system thus produces a price for carbon. Proponents of emissions trading point out that the least expensive solution will always be chosen. For example, it might be cheap for a utility firm to shut down a very old coal plant and switch to natural gas or renewables to replace that capacity. As a result, that utility might not emit as much carbon as it holds in carbon certificates, so it could sell the unused certificates to another utility firm, which has a relatively new coal plant in operation but needs to purchase a few allowances nonetheless.
Absolute cap, but bumpy start and design flaws
The EU-ETS has, however, gotten off to a bumpy start. Launched in 2005 in a pilot phase, it was comprehensively revised in 2009/2010. The price of carbon remained low, thus giving little financial incentive to switch from coal to low carbon fuels. Nonetheless, the platform does put a ceiling on emissions, which is why Germany’s nuclear phase-out will not lead to more emissions. The ETS caps the power sector, so Germany's carbon emissions cannot rise above that level with or without nuclear power.
A number of design flaws have kept the system from being more successful. When the pilot phase began in 2005, a generous volume of certificates was handed out for free to major emitters. The result was nonetheless higher power prices because the firms charged consumers for the value of the certificates they had received for free. Since 2013, certificates in Germany have no longer been allotted for free but have instead all been auctioned off for the power sector; major carbon emitters will finally have to pay for all of their carbon allowances.
The economic downturn since 2008 and other, partly unknown factors, mean that too many allowances are still in circulation. In 2014, the EU had already reached its target for 2020 on the European trading platform, which sounds like good news but in fact reflects the inability of the platform to react to the success of renewables and the economic downturn in Europe. As a result, carbon prices are not expected to rise from the current level of around 7 euros per ton to the 30-50 euros originally envisioned in 2005. In 2014, the "back-loading" of certificates was passed in the EU, postponing the sale of 900 million carbon allowances to the period of 2019 to 2020 to stabilize current carbon prices. Starting in 2019, the amount of auctioned allowances will be reduced in case of excess emission allowances (market stability reserve).
A major problem continues to be the role of offsets. They basically allow European companies to reduce their emissions not at home but in developing countries, with the Clean Development Mechanism (CDM). Unfortunately, the requirement that offsets be "additional" (meaning that the project would not have taken place anyway to fulfill existing environmental laws) may be preventing environmental regulations from being made stricter; after all, stricter rules would require more action, and the CDM then has to go even further. In other words, the stipulation that a project be additional may provide an unintended incentive to keep other regulations lax. Steps must therefore be taken to ensure that offsets are not barriers to stricter environmental regulations.
Overall, criticism of offsets centers on the question of whether developed countries “outsource” too much of their emission reduction responsibilities to the developing world, thus avoiding structural changes in their own economy.
Emissions trading and feed-in tariffs
Emissions trading has sometimes been viewed as in conflict with feed-in tariffs. While the ETS aims to reduce emissions in the traditional power sector, feed-in tariffs promote investments in renewables. Some analysts argue that if the only goal is lowering greenhouse gas emissions, the ETS would deliver this goal most efficiently because market members would choose the cheapest way to reduce emissions; they charge that many types of renewable energy are only economically viable because of feed-in tariffs.
In fact, renewable power primarily offsets gas turbines and electricity from hard coal plants in Germany, thereby reducing carbon emissions dramatically. Rather than viewing feed-in tariffs and emissions trading as competitors, most Germans understand that feed-in tariffs allow us to reduce the ceiling on carbon emissions for emissions trading faster than we would otherwise be able to do.
During the discussions in 2009, Germany's leading economic research institute, DIW, came out strongly in favor of both instruments in a paper entitled "We need both," arguing that if renewable energy has the potential to reduce carbon emissions faster than the emissions trading platform, then the obvious thing to do would be to lower targets for emissions trading, not to get rid of feed-in tariffs.
In reality, as the upturn in demand for German coal power from 2011 to 2013 shows, both renewable energy and emissions trading is needed. A higher price for carbon would have encouraged a transition from coal to natural gas in the power sector.
Emissions trading internationally
Outside of Europe, emissions trading has been struggling even more up to now. Nonetheless, the policy will likely pick up not only in the EU, but also worldwide. California started its own cap and trade program in 2013, and its carbon price is higher than the EU’s; it is complemented by the voluntary emissions trading platform along the East Coast of the US (RGGI). China has also implemented a pilot platform in seven provinces.
Finally, it is worth mentioning that Germany is one of the few countries that not only met its Kyoto targets, but surpassed them with flying colors. The Germans had what sounds like a relatively ambitious target of a 21 percent reduction below the level of 1990 by the end of 2012, but 10 percent of that was related to the special situation of the former East Germany, whose decrepit industrial sector was shut down or revamped in the 1990s. Nonetheless, Germany overshot the target by a wide margin, reducing its emissions by 24.7 percent by the end of 2012. At the end of 2016, the reduction had reached 27.6 percent.