The much maligned EU-ETS

The EU Emissions Trading System (EU-ETS) started up successfully in 2005 and its critics haven’t stopped finding fault since. Unfortunately, these critics rarely tell the whole story and those who read the criticisms are probably not in a positon to know what is actually going on in the EU.

In a recent editorial, the Washington Post supports the arguement for a carbon tax by using the EU-ETS as “Exhibit A” in the case against emissions trading. Whilst the facts it presents are not incorrect, the context within which they are presented is questionnable.

  • Emissions targets were set too high. . . . . The value of a carbon credit plummeted.” At the start of the ETS the data on which the EU Commission based its initial allocation was of poor quality and the Commission also took a very conservative approach to the cap. After all, this was a learning phase during which they were looking for participants to learn to measure, manage, trade and account for emissions – all of which happened. By design, the phase was stand-alone, in that there was no facility to bank surplus allowances into future periods. This meant that when the market realised the three year phase was in surplus, the price plunged quickly to zero as surplus allowances would have no future value. But the phase was a success in that a large liquid market with well prepared participants resulted.
  • Companies made windfall profits by charging customers more for energy while selling allowances they didn’t need.” The Commission recognised that over time the CO2 price would be passed through to consumers and they indicated clearly that such pass through would trigger a shift to auctioning. That is exactly what has happened and in Phase III much higher levels of auctioning will be implemented – 100% auctioning for most of the EU power sector where price pass through is a reality. The lesson learned here, and picked up by the Regional Greenhouse Gas Trading System in the USA, is that a deregulated electricity sector can pass through the CO2 price very quickly and so should be subject to much earlier auctioning.
  • And the Europeans have not had much success reducing greenhouse gas emissions.” Emissions within the traded sector are within the cap that has been set and continue to be. Emissions will only fall by the amount the cap dictates, no more. It is not a question of “success” as such, but a question of where the cap is set. And we know that this was set conservatively in the first phase for the reasons given above.
  • Disputes on the next round of reductions led to the creation of a two-tiered system to appease Eastern European countries fearful of the cost to their industries.” A deal has been done between 27 sovereign states to move ahead with Phase III of the system. The cap is clear and is linked to the EU target of a 20% reduction by 2020. Most of the allowances in Phase III will be auctioned to participants, but some industries will still qualify for free allocation, but subject to a tough benchmarking process. Only only one in ten of these industries will actually get their full allocation for free and they will be the lowest emitters in any sector.

Put simply, the EU-ETS works. Yes, the first phase had its issues, but much has been learned from this. Others can put the learnings to immediate use. Phase III will be very different to Phases I and II. The EU now has a robust system in place that can and will deliver the needed reductions.

The editorial goes on to argue that “A carbon tax, by contrast, is simple and sure in its effects. Last summer, when gas prices shot up past $4 a gallon, average miles driven dropped significantly, as did energy consumption.” It is certainly true that a $2+ rise in the price of gasoline will change driving habbits, but that is equivalent to a tax of over $200 per tonne of CO2. Such a tax would roughly triple the price of cement for example. By contrast, the EU-ETS has traded in the range of $10-$40 per tonne of CO2 and that alone has resulted in a complete change in the way the power generation sector is operating. It has even been sufficient to get companies thinking hard about when they should start to implement carbon capture and storage.

David Presenting to UK Media

Presenting to UK Media

The policy solution is neither a blanket tax or a total reliance on cap-and-trade. The latter is ideally suited to the big emitters such as power generators and large industry. With a cap in place the power sector can begin its journey to zero emissions and get there in 30+ years. Much of the manufacturing sector can do the same, but probably not completely, so they may rely on some form of offset for many years to come. It is hard to imagine any lawmaker implementing an immediate $2 gasoline tax (which is quite possibly why some are advocating they do) and even that may only drive the US auto sector to look like more like its EU counterpart – where an even higher gasoline tax has been in operation for decades. A different approach is needed here, one that agressively targets vehicle efficiency, incentivises lower carbon fuels and implements road use policies such as the Congestion Charge in London. Finally, the built environment needs urgent attention as well, but revised building codes and efficiency retrofits (e.g. insulation) are probably the answer.

Yesterday I gave a short presentation to various London media folk on emissions trading:


But I found a better presentation on the basics here: