The EU ETS – a Failure or a Significant Step Towards Sustainable Energy?

Port Talbot Steelworks steel production plant in the UK

The European Union Emissions Trading Scheme (EU ETS), introduced in 2005, was the first large scale emissions trading system for greenhouse gases [1]. It obliges companies in energy-intensive industries, such as power and heat generation, oil refining, and steel, iron and aluminium production, to purchase allowances for releasing carbon dioxide into the atmosphere; generally, one allowance per tonne of CO2 [2]. Its main goals are to reduce the emissions of greenhouse gases and to act as a cost incentive towards low-carbon technology [3].

In the European Union, CO2 emissions decreased by 11.3% from the start of the trading system in 2005 through to 2011 [4]. The introduction of the EU ETS has definitely had a positive impact on lowering emissions, primarily through implementing new standards of energy efficiency and through promoting the use of renewable resources [3]. However, this decrease may be attributable to other contributing factors, such as the economic recession, and the success of the scheme could be debated due to the oversupply of allowances [5]. Companies buying or receiving allowances have “banking” opportunities; this means that if the planned amount of CO2 is not emitted into the atmosphere, they can keep previously obtained extra permits for future use or resale [3]. The EU ratified the amount of allowances for years 2008 – 2012, before the start of economic crisis, therefore larger emissions were expected and an unnecessarily high number of permits were allocated to the market [6], and improved manufacturing efficiency, 555 million international emission reduction credits and general uncertainty in demand have increased the surplus even further [5].

The oversupply of allowances reached almost two billion by the start of 2013 [7]. The continuous excess of allowances has caused the price of CO2 to decrease from €30 per tonne in 2008 to below €10 per tonne in 2012 [5]. In contrast to phase I (2005- 2007) and phase II (2008 – 2012), in which high level of permits were given out freely, phase III (2013- 2020) is intended to have considerably fewer free allocations [5]. In theory, this should raise the price of CO2, but in reality the influence will be minimal due to the vast number of unused allowances from the previous phases of EU ETS. The constant low price of CO2 is not an incentive for companies to invest in alternative, environmentally-friendly technologies because using current CO2-dependent techniques is more profitable in the short-term [5].

There are several ways to increase the price of CO2 in the trading scheme. The most popular measure seems to be the withdrawal of some of the allowances for an indefinite amount of time, known as “back-loading [3].” The reduction of CO2 allowances will increase the demand, which in turn raises the price per tonne of CO2. The proposal to withhold 900 million allowances that were supposed to enter the market between 2013 and 2015 passed in European Parliament in July [8]. However, there is still a surplus of around one billion permits, so the withdrawal probably isn’t going to affect the CO2 price enough to raise it to double-digit numbers, let alone to the price levels of 2008 [8]. Thus, further cuts in allowances or other improvements to the system are needed. The European Parliament also has to ratify the conditions under which another back-loading might occur, state clear opportunities for the withheld allowances to re-enter the market, and define an understandable basis for the set-aside of allowances to reduce the uncertainty introduced by governmental interference with the market [3].

Another option considered to raise the cost of CO2 is price control, which involves creating a minimum price at which new allowances can be sold [3]. This will result in an immediate price increase due to the understanding that new permits would enter the market only if they reach a certain value [3]. Since it would not be economically useful for companies to sell allowances below the minimum price, the cost of already circulating permits will rise, creating a price floor [3]. The average price of CO2 would stay at the minimum price level due to the oversupply of allowances. There is a significant opposition to this method because of hostility to governmental interference with the market, and a clash of interests with some members of the European Union [3]. Poland, which uses coal to generate 93% of its electricity, opposes interference with the carbon market and fears that higher emission costs might hinder their global competitiveness [5]. However, national price floors in the carbon market have already been designated in some member countries; the United Kingdom, for example, has appointed a price floor rising from £16 in 2013, to £30 in 2020 [3].

The third option discussed has likely the fastest route to reduction of CO2 emissions [3]. At the moment, the ETS Directive states that the emissions of greenhouse gases in energy-intensive industries should be lowered by 1.74% a year. However, this requirement is too small for the European Union to fulfil its long-term target of lowering its greenhouse gas emissions 80-95% by 2050, compared with the levels of 1990. One of the discussed measures to address this has been a proposal to raise the annual rate of reduction by about 0.5% or more to reach the EU’s mid-century goal [6]. In the long term, it would increase the price of CO2, but due to tedious bureaucracy and the aforementioned competing interests inside the EU, raising of the annual reduction rate in the near future is unlikely [7].

The differences inside the EU have so far been one of the main reasons why the scheme hasn’t been thoroughly improved. Managing a uniform emissions policy between 28 EU members, Iceland, Liechtenstein and Norway is not an easy task, and changes cannot be applied quickly [2]. The first proposal for carbon back-loading was rejected by the European Parliament in April 2013 [8]. In addition to differing interests of European countries, there is a significant number of companies which oppose governmental interference in the market due to a potential loss in competitiveness; an increased carbon price may cause firms to move their manufacturing to countries with less restrictive emission policies, a process called carbon leakage [5]. On the other hand, some large companies, such as Shell, support back-loading and are mainly interested in clarity of the future EU ETS policy and emission targets [5].

Despite some flaws, EU ETS has been a step towards more sustainable energy production, and other countries and territories have started to construct similar programs. Both Australia and California have already introduced their own emissions trading scheme, and China and South Korea are planning to implement systems similar to the EU ETS [6]. The EU scheme has fulfilled its goal of reducing emissions, however more allowances need to be set aside, and price control methods must be applied to the system to create a favourable basis for low carbon investment and to continue decreasing greenhouse gases emitted [3]. It is important to complete further improvements to the ETS and keep uncertainties of the market and policy as low as possible to give the companies time to adapt with future changes. Fossil fuel sources are decreasing rapidly, and heavy emissions are influencing the climate. Therefore, carbon pricing is a much-needed step towards more environmentally-friendly sustainable future.

References:
1. EIlerman, A. Denny and Barbara K. Buchner, eds. 2007. The European Union Emissions Trading Scheme: Origins, Allocation and Early Results. http://reep.oxfordjournals.org/content/1/1/66.abstract
2. European Commission 2013. The EU Emissions Trading System. Policy. http://ec.europa.eu/clima/policies/ets/
3. Grubb, Michael 2012. Strengthening the EU ETS. http://www.climatestrategies.org/research/our-reports/category/60/343.html
4. European Environment Agency (EEA) 2013. EEA Greenhouse Gas – Data Viewer. http://www.eea.europa.eu/data-and-maps/data/data-viewers/greenhouse-gases-viewer
5. Library of the European Parliament 2012. Prospects for the EU Emissions Trading System. http://www.europarl.europa.eu/RegData/bibliotheque/briefing/2012/120323/LDM_BRI(2012)120323_REV1_EN.pdf
6. Sandbag 2012. Losing the Lead? Europe’s Flagging Carbon Market. http://www.sandbag.org.uk/site_media/pdfs/reports/losing_the_lead.pdf
7. European Commission 2013. EU ETS continuing decline in emissions but growing surplus of allowances in 2012. http://ec.europa.eu/clima/news/articles/news_2013051601_en.htm
8. Bayar, Tildy 2013. Europe Votes to Rescue Emissions Trading Scheme. http://www.renewableenergyworld.com/rea/news/article/2013/07/europe-votes-to-rescue-emissions-trading-scheme
Image credit: Wikipedia. Port Talbot Steelworks, http://en.wikipedia.org/wiki/File:Port_Talbot_Steelworks_-_geograph.org.uk_-_41552.jpg

Ralf Ahi is a 2nd-year student at the University of Edinburgh studying Chemical Engineering with Management MEng. Follow The Triple Helix Online on Twitter and join us on Facebook.

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