March 28, 2007

12 reasons why the EU Emissions Trading Scheme is an environmental and economic failure

In 2005 the EU created an ambitious EU-wide Emissions Trading Scheme (ETS) to tackle the alleged growing threat from global warming.

The idea of a market-based solution to pollution control is appealing. Permit-trading schemes have worked successfully in the past, with the US sulfur dioxide trading system since 1990 perhaps being the best-known example.

However, the EU’s ETS has raised serious questions about its organization and effectiveness:

(1) While some EU member states have chosen very tough targets using past emission levels as a baseline, other EU member states, (including some of the richest members) have given firms far more generous allowances based on future expectations. This means that companies from countries with more restrictive emission policies have had to buy permits from rival firms in other member states.

These transfer costs outweigh the theoretical advantages of replacing the EU’s existing trading scheme with a pan-EU scheme.

(2) If one EU member state sets itself an ambitious target in a common system, when other member states have printed permits "on demand," the only result will be that companies from the more regulated country will purchase credits from companies in other, less regulated member states which can then make windfall profits while doing little to curtail their emissions. Hence, ETS provides no incentives to invest.

(3) According to figures released in June 2006, member states handed out permits for 1,829 million tons of CO2 in 2005, while emissions were only 1,785 million tons. Emissions would have to be 44 million tons higher for the system to actually work effectively – in other words, at present the system is simply not limiting emissions. Only four out of the twenty five member states had targets which were lower than their actual emissions.

(4) Some EU-member states seem even to be not interested in practical measures at all: carbon emissions in some countries are rising as if ETS and/or EU agreements on carbon emission reductions did not exist. This comes along with worries that binding targets could stop their industrial development.

(5) Instead of auctioning off permits and allowing the market to operate, EU-governments have handed permits out to firms according to pre1989-style National Allocation Plans (NAPs). This attempt at central planning has had all kinds of negative consequences. Among others, hospitals, universities, and public transport companies have been forced to spend millions to buy certificates. On the other hand, large oil and energy companies have made substantial profits from the scheme. Thus, the ETS applies a central planning rather than market-based approach.

(6) When it was realized in April 2005 that many member states had set ultra-loose targets, the secondary "market" for emissions permits crashed. This volatility increases risk for participants, which itself has a cost. It creates a lot of speculation, but reduces a firm’s incentive to reduce emissions. Only a stable future cost of carbon dioxide would allow companies to plan to reduce emissions.

(7) Currently, the price is already below one Euro for one ton of carbon. Thus there is little incentive for firms to cut emissions as it is cheaper to purchase credits to offset them.

(8) Russia and other CEE countries, which are (statistically) below their Kyoto targets, are preparing to generate billions of credits (assigned amount units) to be sold to those countries unable to meet their Kyoto commitments, with dramatic consequences for Western European economies.

(9) ETS is an administrative nightmare: Compared to an energy tax or focused emissions tax on power stations, the scheme is complicated and has imposed very high administrative burdens. Many SMEs are covered by the scheme, and have to employ staff and external consultants to conduct monitoring, and compliance activities, and pay for official verification, despite their little contribution in reducing total emissions.

(10) Inconsistencies of EU climate and energy policies: while some governments are pressing for favorable treatment of nuclear power, others are pressing for favorable treatment of brown coal (lignite) under the ETS.

(11) The main effect of the ETS has been to substantially increase electricity prices, which is weakening the EU’s position in a globalized economy.

12) Technical problems in the national registries for the Czech Republic, France and Slovakia have resulted in data for these countries being invalid. Errors in these countries led to some allowances being canceled rather than surrendered at the end of the operational year. No information has been received from Poland, Cyprus, Luxembourg and Malta because their emission allowance registries are not yet operational. This means that accurate data is only available for 18 of 27 countries. In addition, the data for Italy is of extremely questionable quality.

Conclusion: The EU’s ETS is far from being the most cost effective way to reduce net carbon emissions. Adding up simply the transfer and administrative costs suggests high costs, while there is no evidence that the scheme is actually limiting emissions across the EU.

Note: This paper was compiled by the CF?CT Europe Research Unit and distributed at the Amigo Society's conference "ETS: A Good Example to Follow?" on 29 March 2007 in Brussels