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Tackling climate change through market forces

Recently, the German Constitutional Court dropped a bombshell and announced that in their view, the German Climate Protection Act falls short. The judges obliged the legislature to regulate the reduction targets for greenhouse gas emissions for the period after 2030 in more detail by the end of 2022. Several climate activists, some of whom are still very young, saw their liberties violated by the previous regulations. The judges explained that the regulations would “irreversibly postpone high emission reduction burdens to periods after 2030,” adding that if the CO2 budget is already extensively used up by 2030, this exacerbates the risk of “serious loss of freedom” due to a shorter timeframe for necessary developments in technology and in the social sphere. For the environmental activists this was a groundbreaking ruling. They went as far as calling it a resounding slap in the face of the federal government. Now the ball is back in the court of German legislature to adapt to these findings. 

It’s a widespread fact that if we want to fight climate change, CO2 emissions need to be reduced, but how is this achieved? Most CO2 is emitted by heavy industry and power plants burning fossil fuels like coal, but you can’t just stop production of goods and energy overnight. In this article, we want to take a look at how CO2 emissions can be reduced most effectively by using a mix of free market principles and government intervention.

Pricing of CO2 certificates

A study by FAU Erlangen-Nuremberg, WU Vienna and the University of Applied Sciences Graubünden comes to the conclusion that current prices for CO2 certificates in Germany are too low to cause the desired effect. Making CO2 certificates more expensive would be the most efficient way to reduce greenhouse gas emissions in the electricity sector and would be much more effective than the promotion of renewables through government subsidies.

For their analysis, “Effectiveness of Climate Policies: Carbon Pricing vs. Subsidizing Renewables,” they compared the various control instruments for reducing greenhouse gas emissions in electricity production in Germany and the United Kingdom. With only about 10€ per ton of greenhouse gas, Germany was not making optimal use of the carbon pricing regulation tool. By analyzing different metrics and key indicators like daily emissions, CO2 prices, electricity from renewables, electricity demand and seasonal effects, the study concludes that with a CO2 price of about 35€ per ton, the UK has caused a 55 percent reduction in emissions since the introduction of the electricity tax in 2013, while Germany has been able to reduce its emissions from the power sector only relatively moderately.

The study suggests that if the price of those CO2 certificates is set too low, solar and wind power would first displace the relatively “clean” gas power plants, while coal power plants could stay profitable in the market. Taking into account the dynamics of the energy market, a higher tax on CO2 emissions would lead gas power plants to increasingly replace power plants burning coal. This would result in a more sustainable electricity production, as natural gas emits only about half as much CO2 as coal. The gas-fired power plants themselves serve as integrators for renewable energies until they can cover 100% of electricity production in the future.

Portugal’s early coal phase-out

This is exactly what is happening in Portugal, where the original plan for coal power plants to be phased out by 2030 was already moved forward to 2023. Now the shut-down of the biggest coal plants will come into effect even sooner by the end of 2021. “The decision was largely based on the lack of competitiveness of these plants,” says Helena Coelho, the press officer of EDP (Energias de Portugal – the biggest energy supplier in Portugal). The reasons for this were “higher CO2 costs, higher taxes and the planned rapid growth of renewable capacity.” Since as early as the beginning of 2020, Portugal’s coal-fired power plants have only been running on standby. The country recorded an all-time high number of days without power from coal, which will leave no other option but to close down the power plants for good. 

The emission-heavy coal plants first fell victim to the expensive CO2 certificate pricing. With shutting down these plants so soon and with the widespread implementation of electric cars, charging stations and even electrical heating, how will Portugal be able to meet the rising electricity demand? Portugal already produces more than half of its electricity needs through renewables, and this share is set to grow to 80 percent by 2030. The country is relying mainly on wind and water, but with the EDP Group now also focusing on green energy, it also wants to significantly expand the share of solar power. With a total nominal capacity of 1.5 GW, Portugal’s power supply will be guaranteed by this combination of renewable energy plants.

A sustainable vision

The pricing of CO2 emission certificates plays a key role in steering the energy market towards sustainable goals, so we will shortly see if German politics will find a compromise to raise CO2 prices to reach its climate goals by 2030. Considering what happened in Portugal, Germany may reach these goals far sooner than planned.  

Replacing coal power plants with gas power plants is a first step to reduce harmful emissions, but for a sustainable world that will be built for generations, all emissions need to be eliminated. A few decades from now, after the energy revolution, renewable energy sources will be the long-term state-of-the-art technology. We are curious as to what conclusions the German Constitutional Court will come to in the future to guarantee a sustainable future for generations.

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