The COVID Carbon Crunch
Since global stay-at-home orders and government enforced business shutdowns began taking effect in early March, global carbon emissions have fallen precipitously—with the IEA projecting an 8% year-over-year decline. This would be the most dramatic drop in carbon emissions in modern human history.
Meanwhile, the global economy has to reach near-zero carbon emissions by mid-century or else face environmental catastrophes far more devastating and disruptive than the coronavirus. If IEA’s projections are correct, the current crash in emissions could get us almost a tenth of the way to this goal in a single year, but only if we are able to prevent emissions from rebounding as the global economy recovers from this tragic pandemic over the coming years. That might just be possible if governments act quickly to make emissions-neutrality a prioritized feature of the economic recovery process.
Following the Great Recession, many felt that the Unites States was too focused on the national debt and GDP and not sufficiently concerned about the persistently-high unemployment rate. In that case, priorities led to an extended period of suppressed employment even as stock prices and GDP reached new highs. Priorities matter during economic recovery, and it is essential that following the COVID outbreak we weigh our consideration of jobs and economic growth against increased carbon emissions.
Carbon markets could offer a reliable, market-driven tool to achieve this, but only if governments are willing to significantly lower, or newly impose, strict allowance caps in the wake of the COVID pandemic – admittedly, a tough ask during a time when any regulation will be seen as a potential drain on the recovering economy. Strengthening carbon trading systems would not only give us a much needed opportunity to catch up to where we should be in the fight against climate change, but would also offer a dedicated source of funding (progressive energy subsidies) to support consumers who are suffering from the financial fall-out of the COVID pandemic.
Had a national carbon market been introduced in the United States a year ago, an extremely limited supply of carbon allowances auctioned at exorbitantly high prices would have likely been needed to reduce national emissions to current levels. However, today an allowance system could be designed such that emissions are maintained at post-COVID levels while only imposing very minimal initial costs on producers. Allowance costs would only begin to increase as economic growth and emissions growth resumes, ensuring that the carbon market would not become a punitive burden on already struggling industries.
Carbon allowance prices in the European Union’s Emissions Trading System (ETS) collapsed more than 40% this March. This was because of lower fuel demand by aviation and vehicle transportation and reduced industrial activity brought about by the COVID pandemic and the resulting lock-down orders and travel restrictions imposed throughout the European Union. Europe’s market already has a system in place to deal with unexpected drops in demand, though it remains to be seen whether this Market Stability Reserve (MSR) will be sufficient to bring prices back to their 2019 high.
The MSR removes 24% of excess allowances that were not sold during the year in an effort to reduce surplus allowances and increase resilience to major shocks. Allowances in the MSR can be reintroduced into the market. However, beginning in 2023 the MSR will not be allowed to exceed the total allowance allocation of the previous year.
In order to balance supply and demand and take this opportunity to get a head start on emission reductions, the European Union should consider back-loading auctions and adding these allowances to the MSR (a strategy that was already successfully used to reduce allowances between 2013-2015) and instituting a one-time acceleration of annual allowance reduction rates from approximately 2% to instead reflect the proportional drop in emissions caused by the lasting economic impacts of the COVID pandemic. Because the MSR is uncapped until 2023, these allowances would offer a pressure release valve in the event that the economy surges back from the global pandemic.
The COVID pandemic has been an unprecedented economic and social catastrophe and it would be wrong to celebrate the emissions decline that it has precipitated. However, we also need to recognize the opportunity that this decline presents. Reducing carbon allowances in existing carbon markets and introducing new markets would embed clean energy as a major feature of the global recovery, and delay the need to impose punitive costs on producers.
More from the Kleinman Center:
- Policy Digest: Robust Carbon Markets
- Policy Digest: Why Carbon Pricing Falls Short
- Podcast: Getting to the Right Carbon Price