The EU Emission Trading System needs an Overhaul

Posted by Eberhard Rhein on 25/02/13

The EU emission trading system, created 10 years ago, was meant to facilitate EU countries achieve their target of reducing green house gas emissions by 20 per cent until 2020, at the lowest cost. To that end, the 11 000 biggest emitter companies accounting for about 45 per cent of total EU green house gas emissions had to cut their emissions by 1.7 per cent annually to achieve a cumulative reduction of emissions of 21 per cent over 2005.

The EU Commission, in charge of managing the system, allocates annual emission allowances to all participating companies: a straightforward method for achieving a long-term policy objective.

No policy maker could have foreseen the stagnation/decline of C02 and other green house emissions after the 2007 financial crisis, due to lower production of energy, steel, heavy chemicals and increasing energy efficiency.

Consequently, the emitter companies easily reached and even exceeded their annual 1.7 per cent reduction targets.

The case of Arcelor, Europe’s biggest steel producer, is striking: due to a 30 per cent fall of EU steel output since 2007 it made windfall profits of some € 200 millions in 2012 from surplusallowances.

The idea of an EU-wide market for green house gas emissions that could be freely traded appeared very attractive, when the system was devised in 2002. It was hoped that the C02 price would become a benchmark for assessing energy investments:The higher the C02 price the bigger the incentive to reduce emissions and avoid buying emission certificates.

Experts and officials had hoped that the C02 price would settle between € 15-30 ton. But these expectation failed to materialise. The price reached a peak of € 8 in 2008 before declining to € 2.80/ton in January 2013, reflecting a glut of allowances, as companies easily managed to cut their emissions by 1.7 per cent annually because of stagnating or even declining energy demand.

To cope with the very low C02 prices, the Commission has proposed a temporary withdrawal, until 2019-20, of 900 million allowances ( of 900 million tons of C02) from the market, hoping for a better economic situation and a boost of C02 prices towards the end of the decade. After green light from the EP Environment Committee the proposal is likely to be adopted by EP and Council n the coming weeks. This would offer some relief, but not remedy the intrinsic cause of the low C02 price.

In retrospect,the EU may have been too cautious when fixing an annual reduction of only 1.7 per cent back in 2003.

From 2015 onwards, it should envisage an annual reduction of emissions of 2.5 per cent. This would be in line with the modest economic growth perspectives until the end of the decade and allow the absorption of the substantial allowance overhang in the system.

If the EU is still serious about its 2050 target of reducing green house gas emissions by at least 80 per cent over 1990, it needs to target a 40 per cent reduction by 2030, followed by 60 per cent in 2040. That will require a comprehensive approach going beyond the ETS.

The next EU Commission should therefore come forward with appropriate policy proposals for 2030, including a revised Emission Trading System.

Brussels 25.02.2013 Eberhard Rhein

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