The EU’s emissions trading scheme may have reduced emissions in the past, but the flagging price of carbon is eroding its attractions
A quick glance at recent headlines might give the impression that the EU emissions trading scheme (ETS) has been an abysmal failure. The Commission has already had to deal with a damaging attack of trading fraud in 2011 and is now engaged in a controversial attempt to raise the slumped carbon price. Add to that an ongoing diplomatic dispute with the rest of the world over the inclusion of aviation in the scheme and Europeans might be asking why we have this system at all.
But despite the negative headlines, the fact remains that in the first four years of its existence (2005 to 2009), the ETS was responsible for reducing the EU’s emissions by 480 million tonnes of carbon dioxide (CO2), which is greater than the yearly emissions of Mexico or Australia. This was revealed by a study released by the Environmental Defense Fund (EDF) last week. Moreover, this has been achieved at an estimated cost of just 0.01% of GDP – a fraction of predicted costs – with no evident negative effects on the economy.
“A number of people in Europe look at the low carbon price in the EU ETS today and say the ETS is failing,” says Annie Petsonk of campaign group the Environmental Defence Fund (EDF). “But if the purpose was to cut emissions and stimulate innovation and competition, it has done exactly that.”
The EU ETS is the world’s first and largest multi national cap-and-trade programme to limit global warming. Given that it has been around for seven years now, European industry has mostly come to accept it as a fact of life – despite dire warnings when it was first conceived that it would impede economic growth. Today, trade association BusinessEurope, known for being fairly conservative on environmental issues, says it supports “the central role played by the ETS in EU climate policy”.
The main issue causing anxiety and dividing opinion in industry now is what to do about the flagging price of carbon.
The ETS works by capping the amount of emissions allowed from distinct industry segments. But carbon ‘allowances’ can be bought in order to go beyond the cap. Each installation or company is given a certain amount of free allowances. Those able to lower their emissions and remain under their cap can sell their excess allowances and theoretically make a profit. This is done through a trading system known as the carbon market.
The ETS is now in its second phase, which has run since 2008 following a first pilot phase from 2005-2007. At this point in the scheme’s life, the carbon price was expected to be around €30. Instead, it has slumped to around €7. The reason for this is a matter of debate. Certainly, it is at least partially due to the slowdown in industrial activity caused by the economic crisis. Companies have not had to buy as many permits as anticipated, their value has fallen.
But the low price is also the result of an over-allocation of allowances during the system’s pilot phase. EU governments based the system’s initial caps and emissions allowance allocation on estimates of emissions rather than on historical emissions data. This has been remedied for this trading period, with caps set instead on the basis of measured and verified past emissions and best-practice benchmarks.
But the damage had already been done. EDF calculates that in 2006, midway through the system’s pilot phase, member states allocated 4% too many allowances. Whatever the cause for the excess allowances, politicians and industry say the price is now too low to stimulate innovation in low-carbon technologies.
In July, the European Commission proposed a short-term fix to this problem – backloading the allocation of allowances in the third ETS period (2013 to 2020) to starve the system over the next several years. The Commission had been urged to do this by the European Parliament earlier in the year.
But this proposal has been controversial. BusinessEurope is totally opposed to the set-aside. Earlier this month, it wrote to the European Parliament asking MEPs to reject the proposed short-term changes. It says the pro-posal “would create a precedent, resulting in greater uncertainty, and could have major repercussions for European business, which is already under strain from the economic crisis”.
Parliament is yet to approve the proposal, which suggests changing a line in the ETS directive to allow the Commission to intervene and make adjustments in the market in the event of an overly low price. Many MEPs and member states are concerned this will destroy faith in the free market system, allowing the Commission to intervene at any moment for political reasons, and making a company’s allowances worthless. “It is dangerous to give the Commission this kind of power,” says Holger Krahmer, a German Liberal on the Parliament’s environment committee.
However, several companies have rejected the BusinessEurope position and formed a grouping in support of the Commission’s proposal. They include Dong Energy, E.On, Alstom, Shell and GE. They want the Commission to withhold at least 1.4 billion ETS allowances, as recommended by the environment committee in a vote last year. The Commission’s proposal looks at the possibility of withholding only up to 1.2 billion allowances.
Most member states are reserving their judgement until the release of an impact assessment of how the backloading will affect the market, expected to be published on 14 November. Poland is the only member state that has taken a firm position against the proposal before seeing the impact assessment.
Along with the impact assessment, the Commission will reveal exactly how many allowances it intends to withhold. A stakeholder consultation on the issue closed last week.
It will also publish a carbon-market report that explores possibilities for more long-term reform of the ETS. This is expected to examine the idea that the backloaded allowances might eventually be permanently eliminated and never actually allocated.
Climate commissioner Connie Hedegaard has acknowledged that the temporary backloading measures will not be enough to fix the price problem, and many in industry agree with her.
But Petsonk of the EDF worries that too much attention is being paid to the carbon price and not enough to the caps the EU sets on emissions. “If the goal is to cut emissions then what matters is the cap, not the cost,” she says. “If you change the rules of the system midstream [by withholding allowances] investors that were counting on a certain set of rules become uncomfortable. But there is one aspect of the system that the EU has left open – what will be the level of the binding cap for 2030? If the EU, as President Hollande [of France] has signalled, strengthens the cap in 2030, it would communicate to investors that their emissions reduction investments are going to be valuable over the long haul.”
The most important factor that will determine how member states receive the short-term ETS fix proposal will be the impact assessment. But on the question of a 2030 emissions cap, member states remain in an uncomfortable gridlock. It may be that the short-term solutions to the slumped price are the only things they can agree at this time.
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