For his next trick Lord Turner has turned his hand to solving climate change. The striking if obvious conclusion of this week’s Climate Change Committee report was the authors’ observation that: “Investment in low-carbon generation is risky and may not be pursued sufficiently under current market arrangements”. In essence this was an observation that the EU’s emission’s trading scheme allows too much CO2 emission. The result is a carbon price that’s way too low to make it worthwhile for the energy industry to expend the necessary effort developing alternatives to fossil fuels.
What to do? Well the report makes clear that the best solution would be to tighten the EU ETS cap. But crucially, it also argues that this should be combined with some kind of floor on permit prices. The need for the first part of the solution is clear, and would have been so even before the financial crisis tested everyone’s faith in market mechanisms.
But the second suggestion is more telling. What can be the justification for meddling with the market price by imposing an artificial floor? Back in the days of the efficient markets hypothesis - the quaint idea that liquid markets always price things accurately - received wisdom was that all you need to do is set the number of emissions permits and the market would bring home the emissions reduction beef in the most efficient way. Carbon prices would then provide the incentives for clean energy investment. But Turner’s latest report show evidence of a weakened faith in the market that’s now set to reverberate through many aspects of government policy.
By suggesting a carbon price floor, the authors implicitly admit that the emissions market fails to price accurately. Market price volatility creates uncertainty that leaves would-be investors in green technology cold. Indeed the fact that the committee’s very own analysts have slashed their forecast of the 2020 carbon price from E50 last year to E20 per tonne in this report proves the point. The market isn’t able to provide any kind of stable prediction of the carbon price in 2020. Ultimately, if we want investors to get their wallets out, they need to have some insurance against the huge investment risks that they currently face on returns in 10 or 20 years’ time. Only the state can provide that insurance: the free market version of the emissions trading system just isn’t up to the job.
