Who Is Afraid of a Big Carbon Market? Three Future Scenarios for the European ETS System

Joseph Dellatte, an analyst at the Institut Montaigne, examines in his report entitled Qui a peur du Grand Méchant Marché Carbone? the future of the Emission Trading System (ETS), a mechanism that makes industries pay for CO2 emissions. It is about using money, rather than prohibitions, to reduce them; but today the system is increasingly working against Europeans. As shown by the author, the costs it generates put European factories into an untenable position vis-à-vis competition from the USA and China. He suggests three possible ways out.

Under the first scenario, Joseph Dellatte considers cancellation of the ETS. He admits that would give the industries short-term breathing room, but makes a reservation immediately: if the system were to be removed, Europe would lose billions earned at auctions and also compromise its reputation as a predictable regulator. And, most importantly, any reason for change would disappear: why invest in ‘clean’ technology if emissions needn’t be paid for any longer? He cites the precedent of Australia where emissions crawled up and investors froze in uncertainty for a long time after the carbon tax was cancelled in 2014. Another option is to keep the ETS in place but extend the free allowances and refrain from deploying a full-fledged CBAM. Dellatte calls it the worst solution: the industry will get no incentives to modernize while CBAM will lose its legitimacy without a real carbon price. In the first years of ETS operation, he recalls, excessive free allowances already proved inefficient as they only delayed decarbonization.

As for the third scenario, the author calls it the ‘carrot and stick’ one and apparently favors it. He suggests retaining a stiff ETS and a full-fledged CBAM but channeling all the system’s revenues to support the industry via Carbon Contracts for Difference (CCfDs) and an expanded Innovation Fund. He believes it will enable Europe to take the lead in clean technology. The ETS revenues are really high, amounting to EUR 38.8 billion in 2024, of which 24.4 billion went directly to Member States and the rest, to innovation and modernization funds.

Yet many of the author’s arguments are open to criticism. Research by Swedish companies showed that participation in ETS led to no growth in the number of ‘green’ patents. And it is the current electricity prices, not the ETS future, that is the main source of instability for investors today. Germany and Italy have already called for suspending the cancellation of free allowances until CBAM proves viable.[1] Poland, the Czech Republic and Slovakia demand lower electricity prices and point expressly to the allowance prices.[2] The countries of the BASIC bloc are challenging CBAM in the WTO and denouncing it as a discriminatory mechanism disguised as a climate policy. As for ETS auctioning revenues, the author overlooks the issue of their allocation: the money has been pre-distributed to national budgets and cannot be pooled in all-European funds without political wrangling.[3]

The scenarios proposed by Dellatte reveal the principal contradiction: Europe is trying to retain its climate leadership in a world where its competitors are playing to different rules. Even the third and most thoughtful option fails to address the internal conflicts among EU countries, remove external pressure or heed the industry’s call for revised rules.