When pollution has no price, polluters get a free ride. After the world’s most ambitious carbon pricing project got off to a shaky start, the EU is trying again.
 | Clear, blue skies over Europe? Will the second try to install a European Emissions Trading scheme help make Europe more climate friendly? (Photo: Reuters) |
Technically, the European Union Emissions Trading Scheme (ETS) is as boring and complicated as a regulation scheme can be.
In reality, however, ETS has been a rollercoaster of ups and downs. Starting in 2005, the idea of reducing carbon dioxide emissions by turning them into a commodity appeared an instant hit. In 2005, 362 million tons of CO2 were traded on the European market for a sum of 7.2 billion euros. The scheme covered some 12,000 industrial plants across the EU – including power plants, oil refineries, and steel mills,- representing approximately 40 percent of all EU carbon emissions.
Polluting companies were permitted to emit a specific amount of CO2 annually. If they exceeded their pollution limits they had to purchase carbon credits; spare emissions credits could be sold for profit. It seemed to work, but brokers had not counted on the politics. Various national governments, anxious to protect their domestic industries, generously issued emissions credits for free. This flooded the European market with too many credits.
Free falling prices
The inevitable collapse came in the Spring of 2006, when the price for a ton of CO2 emissions plummeted from 30 euros to under 10 euros in a matter of weeks. By March 2007, carbon credits had fallen to 1.20 euros, eventually bottoming out at a paltry ten cents a ton in September. With emissions credits virtually worthless, companies had no financial incentive to reduce carbon or invest in cleaner technologies.
Such a meltdown would have killed almost any other project, but there is no viable alternative to emissions trading if the EU wants to live up to its Kyoto commitments. From 2008 to 2012, the Union has pledged to reduce its CO2 emissions by eight percent compared to 1990 levels. A big share of reductions will have to come from the private sector.
 | Infographic (click on the image to enlarge)Emissions Trading at a glance (Infographic: Allianz Knowledge) |
Trying to save the scheme, EU ministers decided to tighten regulations in the Kyoto phase that began in January 2008. Markets reacted at once. The mere anticipation of less carbon credits sent prices back up to around 23 euros per ton of CO2 at the end of 2007.
Brushing up for the Kyoto Phase
The big difference in the Kyoto phase of the ETS is how national allowances will be allocated. Firstly, there are significantly lower emissions ceilings for participating countries. Secondly, member states have to submit National Allocation Plans to the EU for approval to avoid inflated allowances and a glut of carbon credits.
Analysts expect the carbon price to rise to around 30-35 euros a ton this year. Unlike in the first phase, up to 10 percent of credits allocated to each country will be auctioned off, with the proceeds going back into research and development of cleaner technologies in member states.
However, most carbon credits will still be issued for free, and critics argue that this perpetuates the distorted market of the first try: large polluters like utilities that are allocated free allowances will pocket windfall profits once the price of carbon credits rises; meanwhile they pass on the nominal cost of carbon credits to their customers.
Several business leaders also argue that lowering European emissions ceilings could drive heavy industries and jobs out of Europe. According to a recent proposal by the European Commission, regulations planned for the so-called Phase Three, set to begin in 2012 after the Kyoto Protocol expires, will be even stricter.
Until 20020, the European Commission intends to reduce greenhouse gases by at least 20 percent, while increasing the share of renewable energies to 20 percent.
Deep cuts and big money
To achieve these ambitious goals, the post-Kyoto phase of the ETS may introduce caps on other greenhouse gases, not just CO2. The number of emissions allowances put on the market would also be reduced each year to create limited supply and higher prices.
The power sector – which produces the majority of EU emissions – would not receive any free allowances after 2013. All credits would be auctioned – a key demand from EU ETS detractors. Around 60 percent of all emission permits in other sectors would be auctioned, as well.
The auctioning process could lead to revenues of up to 50 billion euros annually by 2020, the Commission hopes. The money would help the EU to adjust to a low-carbon economy and assist climate adaptation in the developing world.
There are exceptions in the new regime. Industrial plants emitting less than 10,000 tons of CO2 will not have to participate. Exporting industries vulnerable to competition from countries without carbon reduction programs could be exempted, while firms outside the EU would have to buy carbon credits for their imports.
All these proposals still have to be debated by EU member states, and the negotiations will be intense. Nevertheless, after a somewhat shaky start, European emissions trading seems to be hitting its stride. After all the ups and downs, a boring but fine-tuned and effective scheme might be exactly what Europe has been waiting for.
editor: James Tulloch
publishing date: February 5, 2008
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