Will The Eu Save The Planet?

It was supposed to be the great hope for emissions reduction in Europe and ultimately the world. When carbon trading got under way in 2005 in the form of the EU Emissions Trading Scheme (EU ETS), covering 11,400 power stations and heavy industrial sites responsible for about 40% of Europe’s CO₂ emissions, governments were confident this market-based approach would help deliver low-cost investment in a low-carbon future. Three years on and there is a feeling that in terms of driving investment in low-carbon technology and emissions reductions at least, Phase I of the scheme (2005-2007) has been a failure.

The concept of carbon trading, the so-called cap-and-trade approach, grew out of the Kyoto Protocol signed in 1997 that bound European countries to an 8% reduction in greenhouse gas emissions below 1990 levels by 2012. Under the terms of the EU ETS, installations are set CO₂ emission levels that they must try not to exceed within a certain compliance period. If they fail, they have the option of buying emissions credits from companies that have emitted less than their allowance and thus have credits to sell.

Under lobbying from industry and relying on its, in retrospect, inflated emissions projection figures data, member states’ governments set Phase I allowances that weren’t challenging enough. Some companies found themselves with carbon credits to sell without having to cut emissions and helped themselves to large windfall profits before the price of carbon collapsed by 60% as a result of the 173-megatonne oversupply of credits sloshing around the market. Power-generating companies did especially well out of this situation as not only did they get given their allowances for free, they were also able to pass the “cost” of these allowances on to consumers as if they had bought them. It has been estimated that the four biggest European power producers – E.ON, RWE, Vattenfall and EnBW – made between €6bn and €8bn in profit from the first round of the EU ETS.

Lionel Fretz, CEO of Carbon Capital Markets, says: “Now that there is proper data available, you can see all the arguments put forward by industry were patently misleading. Phase I hasn’t worked in terms of reducing emissions because governments were hoodwinked by industry regarding how many allowances companies needed.”

Because the Phase I price of carbon fell so dramatically, there has been very little incentive for companies to invest in low-carbon technology – it’s cheaper to buy allowances. In some cases the reverse is true, with industry continuing with business as usual knowing it will receive more free allowances for Phase II (2008-2012). The Germans are still building coal-fired lignite power stations, for example.

For all its faults and its failure to drive investment in low-carbon technology so far, however, EU ETS supporters point out that within just three years a fully functioning carbon market has been created. “In 2005, from nowhere, Europe suddenly had a calculated, monitored, verified and reported CO₂ emissions market covering over 11,000 installations across 27 member states,” says Garth Edward, trading manager at Shell Trading. “We never knew before how much CO₂ these installations were emitting; now we do, and we also have a registry system linking all those companies that is the basis of compliance.”

To be fair to the European Commission, it has recognised some of the problems that existed in Phase I and acted accordingly. “The credibility of emissions trading in Europe, but also worldwide, hinges on our capacity to rectify this situation for the second trading period,” said European Environment Commissioner Stavros Dimas recently.

The allocations in Phase II are much tighter as they are based on verified, not estimated, emissions – according to analysts UBS, there will be an undersupply of 199 megatonnes of carbon credits or 9% of the total annual average of allowances predicted to be required. The current Phase II carbon price of €19.30 per tonne seems to be reflecting that newfound confidence in the cap.

Professor Michael Grubb, chief economist at the Carbon Trust and executive director of Climate Strategies, thinks this time the Commission has got the balance right. “Phase II allocations and the restrictions that the European Commission introduced were pretty much spot-on,” he says. “Phase II should create the conditions for quite a meaningful carbon market, which won’t collapse in the way that Phase I did. In that sense, it has done enough.”