A carbon floor price is a bad idea

Meddling in markets built on trust is rarely successful.

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Estimated reading time ~ 9 mins

Over the past couple of weeks calls for the EU to introduce a carbon floor price have become louder.

The last time that a floor price was mooted was in the autumn of 2021 following the German general election. At the time the Green Party was riding a wave of support from voters concerned about the climate. The coalition’s policy proposals included a national carbon floor price that would come into operation if the EU ETS carbon price fell below €60 per tonne, while the coalition partners signalled they would also push for an EU wide floor price.

Three years earlier a group of eight EU Member States led by France, and including the UK, called for enhanced measures “to strengthen the carbon price signal, to improve overall ambition, coverage, and predictability,” noting that this might include “carbon price floors for electricity generation to complement the EU ETS.” The French government led the proposal following presidential candidate Macron’s 2017 election pledge to introduce a floor price.

Alas, despite the bluster nothing ever came of the €60 floor price, or indeed any other level. In early February 2024 the EUA price scythed its way into the €50’s, barely skipping a beat on its way down (see German coalition proposals de-risk the path to higher carbon prices). Although the price has subsequently rebounded in line with stronger natural gas prices recent market history in addition to volatile prices has led to renewed interest in a floor price.

A cynic might suggest that support for a floor price from some quarters is less worry about the weak signal that a low carbon price presents, but rather more concern over the value of the vast stock of EUA’s they have acquired. Anyway, putting that aside, and notwithstanding that calls for a floor price might well be the perfect countercyclical indicator, lets dive into how a floor price might work, whether it really would incentivise more investment in decarbonisation, and what it might mean for ‘The Currency of Decarbonisation’.

The argument for a carbon floor price tends to centre on the certainty that it provides investors safe in the knowledge that the government have set a minimum price way out into the future. If firms know that the carbon price will gradually increase over time, so the argument goes, they are more likely to be able to access the long-term capital they need to invest in new low carbon technology. However, simply setting a floor price and an annual escalator does not eliminate political risk.