Published on February 19th, 2013 |
by Katharina Obermeier
Image © Mohri UN-CECAR / Flickr/ Greenhouse Gasses
The EU’s Emissions Trading System: A Problem of Markets or Politics?
Of the major states which signed up for binding reductions in their greenhouse gas emissions, the European Union is one of the only ones which is on track to meet its targets (though it’s worth noting that some individual member states have fallen severely behind). One of the measures the EU has developed in its quest to aggressively cut emissions (up to 18% below 1990 levels so far) is its Emissions Trading System (ETS). This is an example of a cap-and-trade system, one of the basic methods for governments to create incentives for reduced pollution.
While the reality of the ETS is quite complex, the idea behind it is very simple: the government – or in this case, the European Commission – determines a level of emissions which it considers acceptable. In order to force industries to stick to this level, it creates a number of permits which is equivalent to the level of emissions for which it is aiming. These are then either auctioned off to industry participants or allocated among them depending on perceived need. So a company can only produce a certain level of emissions, which will be higher if it holds more permits and lower if it holds fewer. Companies can freely sell permits to one another on the market, meaning that if one company adjusts its technology or policy in order to emit fewer greenhouse gases, it can sell superfluous permits to another company which may find it harder to adapt to a lower emissions level.
From an economic point of view, cap-and-trade systems are superior to alternatives such as the carbon tax introduced in Australia last year. This is because they allow a free market of emission permits to develop, which will automatically transfer permits to those industries which find it harder to adapt to the new limits, thus making pollution more cost-efficient while also providing an incentive for all market players to find new ways to emit lower levels of greenhouse gases. In addition to this, with a cap-and-trade system governments can directly determine the level of pollution they allow, whereas with a carbon tax this is by no means certain – if the tax is not high enough, for example, businesses may still find that it is more profitable to continue emitting higher levels of greenhouse gases than to adapt their technology or policies.
In theory, all is well. In reality, however, the market for permits in the ETS has hit rock bottom in the last few months, creating little incentive for industries to lower their level of emissions. The downward trajectory began with the economic crisis of 2008, which lowered demand and industry output in Europe, meaning industries automatically were polluting less than EU officials could have anticipated when it determined the number of permits in the market. This created a surplus of permits, driving the price into the ground. The problem escalated further when the European Commission’s proposal to postpone a planned auction of fresh permits in order to stabilise prices was rejected by the European Parliament’s Industry, Research and Energy Committee, sending a clear signal to the market that European politicians were not prepared to intervene in the carbon market. While the more important vote on this issue in the plenary of the European Parliament is yet to take place, the recent collapse of the permit market demonstrates the huge impact that a single vote in a sub-group of the Parliament can have on European industry. And the influence goes far beyond just Europe. Some analysts are suggesting that the EU’s problems with its ETS might prompt the US to turn towards a carbon tax instead of a cap-and-trade system, with potentially significant consequences for the US economy and industry. Not only that, but Australia and China are also set to follow the EU’s example and introduce their own emissions trading schemes in the coming years. The current failure of the ETS in the EU may impede these developments. The Commission has published a report on proposed solutions to the current surplus, such as permanently retiring permits from the system or using price management mechanisms, but it is ultimately up to the Parliament and Council to save the system. The world does not currently have enough success stories on combating climate change to allow European politicians to allow the ETS to fail.