– This is cross-posted from Andrew Holland’s Power Policy blog at Energy Trends Insider – 

Europe’s Emissions Cap

Recently, there have been a spate of articles in the press saying that Europe’s increasing imports of coal undermines  their leadership on climate and their ‘green’ credentials.

This shows a fundamental misunderstanding of the European Emissions Trading Scheme (ETS) in particular, and the nature of a market-based emissions cap (AKA cap-and-trade) system in general.

Granted, the ETS is an imperfect cap because it only covers about 45% of total emissions in the EU – most notably it does not include emissions from home heating or automobile transportation. Importantly, though, it does cover major industrial emitters and utility-scale electricity production, which are the major users of coal.

However, the articles continually say things like this, in Friday’s Washington Post: “Green-friendly Europe has a dirty secret: It is burning a lot more coal.” The schadenfreude exhibited in these articles is unrelated to Europe’s actual record on climate policy.

The truth is that Europe is well below their targeted emissions levels, set both in UN negotiations and in their own Brussels-based policies. They are on their way to meeting their 2020 goals of reducing emissions by 20% below 1990 levels. Partially, they are meeting these goals because reduced economic growth has resulted in reduced emissions. But – in a parallel universe in which the euro crisis never happened and the EU had enjoyed a five year run of strong economic growth, the ETS would have ensured that they would still meet their target. That is because, for the 45% of the emissions covered by the ETS, it would be illegal to emit at a rate higher than the cap.

How Cap and Trade Works

A cap and trade operates under the assumption that the world’s climate does not care where emissions come from, or what fuel is burned to make them. On the other hand, in the U.S. – which does not have any limits on emissions – every energy choice involves a political and regulatory decision (do we build Keystone XL or produce biofuels? Invest in coal power plants or wind turbines?). In Europe, though, the energy choices are a business decision: given the price of an emissions permit, what energy choice makes the most economic sense? In Europe, the political and economic decision point is decided in Brussels when they set the overall targeted net reduction in emissions for the entire continent – and issue permits based on that. This is a more efficient method that allows businesses to do what they do best: invest to make money.

In the U.S., environmentalists fight against the Keystone Pipeline and new coal power plants because they know that more emissions from these are simply more emissions; they are not offset elsewhere in the economy. If, instead, Congress had passed a version of the Waxman-Markey legislation – which included a mandatory cap on emissions – that passed the House in 2009, these fights would have been entirely different. Businesses contemplating importing oil via the Keystone pipeline would have factored the cost of the emissions into the total profitability of the project.

The economics of cap-and-trade result in some strange conclusions when the cap is not universal. For example, American environmentalists should actually be pushing for their coal to be exported to Europe because that means that it won’t be burned in a country like China – or even the United States – where emissions are uncapped. Every ton of emissions from American coal burned in Europe means that a ton won’t be burned by something else – whether it’s Polish-mined coal or imported Russian natural gas. If, on the other hand, that American coal is exported to China or burned at home, then those emissions are additional to the global total of emissions.

Conclusion

Barring the unlikely decision to keep the coal in the ground, the best outcome for environmentalists – paradoxically – is to export American coal to Germany, where emissions are capped – rather than keeping it here in the U.S.

Ultimately, the role of governments should be to determine the overall impact of externalities like pollution and set broad rules under which the free market would work. Because that route was unfortunately blocked in Congress, all of us in America are left with a regulatory and political muddle that will inevitably be more expensive, more inefficient, and more prone to political meddling.

Maybe that’s the way we want it, as a recent poll implied. Or, maybe, once our political system realizes how destructive this regime will become, we can replace it all with a free-market alternative like a carbon tax? As Winston Churchill said about the Americans: “We can always count on the Americans to do the right thing, after they have exhausted all the other possibilities.”

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