Do carbon markets really help the environment?Does cap-and-trade actually reduce emissions? Absolutely, insists European Climate Exchange CEO Patrick Birley, but forget the trades and focus on the cap.
Allianz Knowledge: You handle nine out of ten trades in the European Union Emissions Trading Scheme? How does it work?
Patrick Birley: The system is cap-and-trade—agreed in Kyoto in 1997. It applies caps on the amount of carbon people can pump into the atmosphere. You issue licenses to pollute—allowances—and over time reduce the number of licenses in existence.
By doing this you reduce the amount of carbon put into the atmosphere. You also create a synthetic shortage in a commodity—carbon—that people trade.
The cap is what delivers the environmental result. Trading does not reduce emissions one ounce. It would be more accurately described as ‘cap-and-reduce’.
Who gets these allowances and who allocates them?
The EU issues allowances to the member states and then those 27 countries distribute them to five industry groups—power generators, oil and gas companies, steel manufacturers, pulp and paper companies, and cement and glass firms. Those groups account for 46 percent of pollution in the European Union.
Why were some industries included and others excluded?
Try doing it for every industry and you just get bogged down. The EU was very pragmatic and started with the big guys. One huge polluting industry they let off was agriculture, which is so political in Europe.
Aluminum producers and airlines will be included from 2012 and the maritime sector from 2013.
The EU ETS had a rocky start and the carbon price crashed. What went wrong?
The first phase from 2005 to 2007 was flawed. It was an experimental phase ahead of the real Kyoto commitment phase from 2008 to 2012. It highlighted two major flaws.
One: they issued too many allowances. Member states asked companies how many allowances they needed. But companies said they needed loads of these allowances when in reality they didn’t.
Two: allowances couldn’t be banked. If you didn’t use your allowances by the end of phase one they were worthless.
The markets decided there was an oversupply of allowances that would be worthless which smashed the system. Very quickly the price went from 30 Euros to one euro cent. Nobody would buy them.Many people say the carbon price is still too low to encourage firms to go green. Do you agree?
Yes, but remember that the market supply is fixed by the cap. If you disapprove, protest to the politicians that set the cap.
Price really drives behavior at around 35 Euros a ton of CO2 and so we hear a lot of criticism that the price is too low now at around 13 Euros a ton.
But from a macro level, the price is absolutely irrelevant. The trajectory of carbon reduction will be the same because the supply is reducing, whether the price is 1 Euro or 300 Euros.
What factors influence the carbon price?
The carbon price is completely demand driven. If we return to economic growth and industries start turning their boilers back on I expect the price to go up, if we remain in recession I expect it to stay low. Micro factors include weather, the oil and gas price, exchange rates, and interest rates.
The caps were set during boom times. Should caps now reflect that we are in crisis?
Caps should be set at levels needed to save the environment. If you have flexibility, what is the next temporary event that will change the level.
What improvements have been made to the system?
In phase two they have been much more rigorous about allocating permits. And in the next phase, from 2013 to 2020, allowances will be auctioned. So far the vast majority of allowances have been given away.
Giving away allocations at the start and auctioning them later was a very clever way of getting industry buy-in. The EU has always been straightforward about it and so you don’t hear those five industry groups grumbling.
The EU has done an incredibly good job approaching this in a pragmatic way, evolving and fixing the system. Australia, New Zealand, and the United States all have shelves full of what a good scheme might look like. They are talking about it, but the EU has actually done it.
How does Barack Obama’s proposed cap-and-trade system compare with EU ETS?
It is much more ambitious. They are aiming to cover 85 percent of polluters in the first wave. What happens? There is a massive lobbying effort against it.
One big mistake Obama made was saying he was going to introduce cap-and-trade and then immediately announcing an 800 billion dollar forward-looking budget. U.S. industry guessed that it would have to pay for that budget so it became exceptionally resistant to cap-and-trade.
Cap-and-trade started with Kyoto. What happens if the Kyoto Protocol is replaced?
Kyoto was an international agreement and Europe started a market in the hope the rest of the world would follow. But the rest of the world decided it was too difficult.
Europe has said that it will continue until at least 2020 whatever happens. The bottom line: if we reach 2020 and Europe is still the only place doing something, the scientists will tell us we are all doomed anyway.