Ratcheting up policy stringency through sequencing

While in the EU the past decade can be characterized mostly by getting climate policies into place and refining them, the challenge ahead for the next decade is to substantially increase their stringency. In the first decade of this century, many of the policies considered to become the backbone for achieving these targets were developed and implemented. First of all the EU’s Emission Trading Scheme became operational in 2005, although with very weak reduction targets and primarily to achieve the Kyoto protocol obligations. In 2008 the EU adopted the 2020 climate & energy package, which entailed relatively modest targets for GHG emission reductions, renewable energy use, and energy efficiency. Around ten years later the ETS is expected to have overcome its long lasting “prices crisis” (in the wake of the 2018 reform), CO2 emission standards for cars and trucks are being tightened, and a new governance mechanisms for renewable support with complementary EU mechanisms has been agreed upon as part of the “Clean Energy for All Europeans” package.

Yet the targets of the next decades are considerably more ambitious and require even more stringent policies. For the EU Long Term Strategy, a number of scenarios were developed that project the achievement of the 2030 targets as agreed in June 2018, and aim at long-term emission reductions of at least 85% by 2050 (from 1990 levels). While these scenarios are underpinned by a range of assumed policies, it is by no means clear that these policies can be implemented and ratcheted up as needed. For instance, the current price in the EU ETS – even though it has quadrupled in the last two years – still seems to be far away from driving decarbonization in the power and industry sectors at the rate required. A core question is thus: how must policies be designed in order to allow for such ‘ratcheting’?

Climate policies as sequences that can overcome barriers to higher ambition
In recent work (Pahle et al) we examined how climate policy today may be effectively designed to lay the groundwork for more stringent climate policy in the future—what we call policy ‘sequencing’. Such advance thinking is essential, because as the Roman emperor and philosopher Marcus Aurelius put it: “the impediment to action advances action. What stands in the way becomes the way.”

The core mechanism is illustrated in the figure below: the effects of policies implemented at an initial stage (t1) remove or relax stringency barriers over time so that policymakers can ratchet up stringency at the subsequent stage (t2).

In this work we also identify at least four categories of barriers: costs (both due to the cost of new forms of decarbonization technology, and due to the economic costs of more or less efficient policy choices); distributional effects (the winners and losers of any specific climate policy choice); institutions and governance (where capacity limits and veto points might prevent the enactment of more stringent policy) and free-riding concerns (where some jurisdictions may not adopt climate policies in the hope of free-riding off of the climate policy achievements of other jurisdictions). After exploring ways in which those barriers might be reduced or eliminated, we finally draw on the cases of Germany and California to provide specific examples of how sequencing works.

Applying sequencing to strengthen the EU ETS.
The concept of sequencing is not only a useful approach for explaining what has enabled ratcheting in the past – it can also be used strategically to design current and future policies. In the following we apply the sequencing framework to the EU ETS to illustrate the concept and discuss implications for policy choices. A first aspect is that strong myopia of market participants could lead to persistently lower ETS price, which eventually might rise sharply towards the end of the next trading period (“hockey stick”). Such a sharp rise would face strong political opposition, possibly jeopardizing the ratcheting up of the policy. A remedy could be a minimum carbon price, which would balance prices over time as described for example by Flachsland et al.

Overcoming the waterbed effect
In a similar vein, the EU ETS has long been challenged by the problem of overlapping policies on the national level, which reduce demand for certificates, thus depressing ETS prices, and thereby inducing the ‘waterbed effect’ that other countries emit more. Again, a minimum carbon price could alleviate this problem, an EU-wide minimum price seems to be politically infeasible at least in the near future. Suitable policy sequencing could over time reduce this barrier. For example, recent work (Osorio et al) with a focus on the German coal phase out, examined how a coalition of ambitious countries could implement such a price floor to reduce the short-term waterbed effect. In order to prevent leakage to future trading periods, they would have to cancel allowances equivalent to the level of additional mitigation the price floor would induce – an option that was made more prominent in the last reform of the ETS,. Such a coalition could grow over time and eventually create a majority to also implement a carbon price floor in the full EU ETS.

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