Two CO2 prices are better than one - for now: suggestions for EU climate policy

03/09/2021 - A new policy mix with a CO2 price as the guiding instrument is needed to ensure that the European Union actually achieves its declared goal of climate neutrality by 2050. Three elements, two CO2 prices, one target - that's what economists from the Potsdam Institute for Climate Impact Research and the Brussels-based think tank Bruegel are now proposing in a new policy paper. Since it is politically and institutionally challenging to quickly introduce an all-encompassing CO2 pricing scheme for all sectors, two different but linked pricing systems should initially run in parallel – and be supported by additional instruments. In the long term, these elements are to merge into a single comprehensive and robust CO2 price, with the single goal of reducing greenhouse gas emissions cost-effectively and to limit climate risks to people and the economy.
Two CO2 prices are better than one - for now: suggestions for EU climate policy
Photo: Alexander Tsang/Unsplash

The first element is the introduction of an emissions trading system specifically for the two sectors of transport and heat for buildings. The second element is the introduction of a maximum price and a minimum price for these two sectors as well as for the existing trading system for emissions from power generation and industry. This aims at giving companies certainty for planning so that they can invest in clean innovation – and to create convergence between the two systems. The two different CO2 prices for transport and heat on the one hand, and for electricity and industry on the other, are to be coupled via special mechanisms to avoid too much divergence between prices. The third element are additional technology policies that can act as price amplifiers, such as emissions standards in the transport or building sectors.

“It might sound a bit complicated, but at its core it's simple: CO2 prices can steer the transformation of our economy towards net zero emissions in 2050 better than regulation and subsidies, because prices work into all corners of our economy. Prices are the language that businesses understand," explains Ottmar Edenhofer, Director of the Potsdam Institute for Climate Impact Research and the Mercator Research Institute on Global Commons and Climate Change, one of the authors of the policy paper, which also builds on research from the Kopernikus project 'Ariadne'. "If we do not act and effectively price CO2, the costs will going up elsewhere: in climate damages. Many countries around the world are now looking to Europe to see how we are handling this.”

“Research shows: Because the costs of decarbonization are different in the transport and heat sectors compared to electricity and industry, and because there could be politically very challenging shifts in emissions and mitigation efforts between these sectors in the case of a single all-encompassing pricing system, the EU should first set up differentiated pricing systems,” says Michael Pahle of PIK, also an author of the paper. Around these pricing systems, explains Mirjam Kosch of PIK, another author of the paper, “flanking measures can then be built, for example, to ensure the social acceptability of CO2 prices – which then set the stage for future integration of the two systems.”

According to Georg Zachmann, senior fellow at Brussels-based think tank Bruegel, “there will still need to be policy instruments to give companies sufficient incentives to develop and test new emission-reducing technologies. To that end, we propose support instruments that phase themselves out as the emissions price grows.” Such 'carbon price amplifiers' would have less negative repercussions on the emissions market than today's instruments – and could also be more easily designed in a competitive way for all EU member states to reduce undesired market distortions.

Link to video "A new carbon pricing paradigm for the path to net zero":

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