Minimum carbon pricing is distortive and not needed – why free price formation should remain a cornerstone of the EU ETS’ volume-based cap-and-trade mechanism

Brussels, 30 November 2020 | The EU Emissions Trading System (EU ETS) is a cornerstone of the EU’s policy to combat climate change and the key carbon pricing instrument for reducing greenhouse gas emissions cost efficiently. While the main variant in terms of carbon pricing is a cap and trade system such as the EU ETS, other variants exist. The concept of a carbon price floor, for example, is regularly advertised as a way to improve investment certainty by reducing carbon price risk, decreasing the cost of capital and facilitating access to finance. Additionally, the price floor argument has been touted as a way of protecting against drops in fossil fuel prices and accelerating decarbonisation efforts by providing predictable long-term price signals. As such, a number of EU Member States have expressed their interest in considering the introduction of a carbon price floor, either by combining it with the EU ETS or in the form of a carbon tax.

The design of the volume-based EU ETS stands in stark contrast to these price-based approaches. Therefore, such a mechanism would seriously undermine the functioning of the EU ETS as a volume-based ‘cap-and-trade’ scheme, especially as regards the efficient and undistorted price formation and the interaction with the Market Stability Reserve (MSR).