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Monday, October 30, 2006

Stern words: review admits problems with EU Emissions Trading Scheme

The Stern Review is out. Just digging through it now. For the first time the Government are acknowledging the problems with the EU's Emissions Trading Scheme.

The Commission has already fessed up that the EU is off course to meet its carbon reduction targets. The front page of Saturday’s Guardian reported that according to figures released by the European Commission, the EU “is falling woefully short of its targets for cutting greenhouse gas emissions.”

It said that, based on current measures and policies, the emissions of the EU's original 15 members will be just 0.6% below 1990 levels by 2010, and predicted that emissions in 2010 will actually be 0.3% higher than they were in 2004. The Commission said that, on unchanged policies, seven countries - Austria, Belgium, Denmark, Ireland, Italy, Portugal and Spain - would exceed their individual emission limits, which are binding under EU law. Even with extra measures, Spain is projected to exceed its 1990 emissions by 51.3% in 2010, compared with an allowed increase under Kyoto of 15%.

This won't surprise anyone who read our paper on the emissions trading scheme (ETS), which is currently costing the UK billions but failing to reducing emissions. Undaunted by this, instead of fixing the existing system, the Commission is proposing that civil aviation be brought within the EU's Emissions Trading Scheme and is considering legislation for car manufacturers.

Will Hutton, writing in the Observer, said that the EU’s Emmissions Trading Scheme “has had a wobbly first 12 months”. But this is totally missing the point - the problems with the scheme are now locked in until 2012.

Last week the Commission admitted that the ETS is currently "pointless", because even in the second phase (2008-2012) EU members are planning to print 15% more permits than there is pollution. Commissioner Dimas said that if these targets were accepted then the ETS would "become pointless and it would be difficult to meet our Kyoto targets."

However, the Stern Review is the first time we have had an admission from (effectively) the UK Government, that the system isn't working:

They note that: "Overall allocation in the EU ETS market is not set centrally. Rather, it is the sum of 25 individual member state decisions, subject to approval by the Commission. As such, total EU allocation is an outcome of many decisions at various levels, with a risk of gaming on allocation levels between member states if they make their decisions expecting allocation levels will be higher elsewhere in Europe. It has therefore been difficult to ensure scarcity in the EU ETS market. As a result, the total EU wide allocation in Phase One is estimated to be only 1% below projected “business as usual” emissions15,16. This underlines the need for stringent criteria on allocation levels for member states, and robust decisions by the European Commission on NAPs to ensure scarcity in the scheme."

The review goes on to say that : "At the start of trading in January 2005, traders had limited information on supply and demand for emission allowances. In particular, the NAPs did not contain clear data on the assumptions lying behind the projections of emissions used as the basis for allocations. The release of the first data on actual emissions from the scheme’s participants in April 2006 led to a dramatic downward correction in prices (see figure above), as the data showed that the initial NAP allocations exceeded emissions in most sectors of the scheme14. The volatility that this caused demonstrates the importance of transparency in initial allocation plans." (p.329)

They produce the graph of the collapse of the system in April 06 - when the markets finally realised that too many permits had been printed:

Stern notes that the EU went down this ineffective route having failed to agree on a common carbon tax:

"The international harmonisation of carbon taxes can be extremely difficult in practice. At
a European level countries have previously failed to agree on a common carbon tax. Even the
relatively homogenous group of four Scandinavian countries that sought to implement a uniform tax from the early 1990s ended up with a complex patchwork of partial application and
exemptions between and within the countries" (p.474).

However, it says the ultimate goal should remain the creation of a "global price for carbon" through a network of overlapping international agreements. This is a very thorough bit of work. But the ideas in it are not really new. Even within our own niche on the EU ETS it doesn't seem to have really taken the problems head on.

Its proposed solutions for the ETS are:

1. more auctioning (good, but how will you achieve it and when?)
2. a "tougher" review by the Commission of member states self-set emissions targets (won't make any difference - members aren't scared of being whinged at by the Commission) and
3. further expansion of the scheme.

The last bit is the most problematic. Inclusion in the scheme is currently restricted to certain sectors and installations with a potential thermal output above 20MW. Bring in more small operators and the high admin costs of trading start to outweigh the benefits.

The bigger problem with the ETS (apart from the fact that it doesn't work, and won't work, and costs the UK a fortune) is that it doesn't reward (or punish) member states for doing the big stuff that might actually make a dent in global warming. Example: Britain's carbon emissions are about 40% higher than in France - a result of France's heavy use of nuclear.

The report has already done what it is supposed to - pave the way for a whole raft of fiddling tax rises from the Treasury. (It was interesting to hear Stern himself on Today this morning - resisting the Government's spin on his work from almost the first word.)

But it doesn't really take us much further forward. What we need is an environmental equivalent of the Economist's "Stockholm Consensus" project - which effectively sought to answer the question - "what is the most effective use of given international aid budget?". We could do with a serious piece of economic work on the lowest cost way to reduce emissions. Maybe the opposition could take a lead.