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The Power of the Purse: Finance Ministries and Reforming the EU’s Carbon Market

Klima - Et magasin om klimaforskning fra CICERO

Publisert 11.01.2018

Finance ministries get involved in environmental politics for several reasons. When it comes to the reform of the EU carbon market, they are interested both in the revenue from auctioning allowances within the market and in preserving the carbon market as the market-based flagship policy of the EU’s efforts to fight climate change.

In November 2017, the EU agreed to reform its Emissions Trading System (ETS) or carbon market. This was far from the first time the Union intervened in its carbon market. For more than six years, the carbon market has been plagued by a surplus of emission allowances and prices that are too low. How could this happen?

The carbon market works like this: the EU sets a cap for how many tons of CO2e the companies covered by the carbon market can emit each year, and the member states (as well as Norway) then sell and give away an amount of allowances to emit CO2e within that cap. The companies (mainly industry and power companies) can buy and sell allowances between themselves if they have more or fewer allowances than they need. This is why such a system is often referred to as cap-and-trade or emissions trading.

The problem is that in the EU emissions trading system the cap has been higher than the emissions and a surplus – at one time as much as all the companies covered emit in one year – has been building up. And when the supply of allowances is higher than the demand, the price drops.

In fact, the price has dropped as low as 3 euros. When the EU adopted its climate and energy package in 2008, it expected an allowance price of 30 euros. Over most of the last six years, the price has been between 4 and 8 euros.

When the EU adopted its climate and energy package in 2008, it expected an allowance price of 30 euros.

jakob skovgaard

Perhaps surprising to some, this low price has not only concerned environment ministries and NGOs, but also finance ministries. Perhaps finance ministries were not as concerned as the environment ministries and NGOs about the lack of incentive for companies to invest in low-carbon alternatives to current production. But they were concerned about the lack of revenue from auctioning allowances.

Because the EU finance ministries had operated with total revenues from auctioning allowances worth tens of billions of euro each year. Furthermore, several of them were concerned about climate change, which they perceived as a “gigantic market failure”. Since finance ministries view the world through an economic lens, they tend to prefer economic instruments such as emissions trading which place a price on emitting greenhouse gasses. This was particularly important, since the EU ETS is the EU’s flagship climate policy, and not one which is easy to reform.

Consequently, although environment ministries are still the most involved kind of ministry, finance ministries have also been actively involved in the efforts to reform the EU ETS.

Environmental policies may more likely survive in the long-run if they create revenue or save costs for the finance ministry.

jakob skovgaard

In a recent article, I studied the role of the Danish, Dutch and German finance ministries in the discussions of reforming the ETS in the period 2012-2014 that resulted in the decision to postpone member states’ auctioning of ETS allowances. While the Netherlands and especially Denmark supported such intervention, Germany blocked an EU decision on the subject for months.

In all three countries, the finance ministries were actively involved in the national discussions about how to address the low allowance price. The Danish finance ministry was one of the two most important ministries – the other being the ministry of climate change and energy –when it came to defining the Danish position, while the Dutch and particularly the German finance ministries had active but less central roles. In all three countries, environment or climate ministries were among the two most actively involved ministries, and in Germany and the Netherlands the ministries of economic affairs (responsible for business and industry) were also actively involved.

Finance ministries were actively involved in the national discussions about how to address the low allowance price.

jakob skovgaard

Environmental policy often pits environment and finance ministries against each other because finance ministries are afraid of spending too much money on environmental policies. In this case, all three finance ministries agreed with their environment ministries that the EU ETS should be saved. This was not just because the finance ministries worried about losing revenue from the ETS. They were also concerned about the future of the ETS, which was their preferred instrument for addressing climate change.

The economic worldview of the finance ministries also meant that they disliked proposals for constantly intervening in the market. They preferred structural measures, such as adopting an ambitious 2030 target, rather than one-off measures such as postponing the auctioning of allowances (known as backloading).

While the finance ministries shared the desire to keep the emissions price relatively high with the environment ministries, they were at odds with the carbon-intensive industry and in the case of the Netherlands and Germany also the economic affairs ministries. The opponents feared that a higher emissions price would increase the costs of producing carbon-intensive goods such as steel or plastics.

While the three finance ministries had roughly similar attitudes to ETS reform, their influence on their respective government positions differed.

The Danish finance ministry was the most influential one, with the Dutch and German finance ministries being more restricted by the influence of the economic affairs ministries, which are responsible for industry. The Netherlands and particularly Germany have large industrial sectors compared to Denmark, which translates into more powerful economic affairs ministries.

In Germany, the economic affairs ministry is as powerful as the ministry of finance, which is unusual compared to other countries. The 2009-2013 CDU-FDP government could not decide on a position on ETS reform due to the FDP minister of economics affairs Philipp Rösler being against reform and the CDU environment minister Peter Altmeier being in favour.

In Germany, the economic affairs ministry is as powerful as the ministry of finance.

jakob skovgaard

Both Germany and the Netherlands eventually came around in favour of ETS reform following elections that saw centre-left parties replace centre-right parties as members of coalition governments. Thus, although the finance ministries were important for all three countries’ positions, elections were decisive in these two countries.

The Danish support for ETS reform was decisively shaped by earlier commitments to more ambitious climate targets for the EU.

In conclusion, finance ministries are indeed capable of being interested in environmental issues. In the case of ETS reform, they wanted to protect both the revenue from auctioning allowances and the ETS' status as the EU’s flagship climate policy. The finance ministries want a market-based policy. Although factors such as the Dutch and German elections were more decisive, finance ministries were important in shaping the government positions.

The fact that finance ministries work to preserve the ETS, has implications for the future. Given the power of finance ministries, they are important in deciding which environmental policies are adopted and which survive profound crises, like the the ETS did. Other environmental policies may also more likely be adopted and survive in the long-run if they create revenue or save costs for the finance ministry, or if they fit the economic lenses that finance ministries view the world through.