EMISSIONS TRADING, A FLAWED BUT FIXABLE CAP&TRADE SOLUTION

Carbon emissions trading system 'seriously flawed'; Report by campaign group Sandbag critical of scheme/Hot air carbon credits preventing actual emissions cuts
Damian Carrington, 20 July 2009 (UK Guardian)
and
EU soft on polluters, greens say
Laurence Peter, 22 July 2009 (BBC News)

SUMMARY
The European Union (EU) Emissions Trading Scheme (ETS), the world’s biggest and most established greenhouse gas emissions (GhGs) trading system, is once again being attacked.

The criticisms and responses are especially important right now as the U.S., Australia, Japan and China are all in various stages of designing their own trading systems and the international community will meet at the end of this year to finalize plans for a (hopefully) worldwide effort to fight climate change and the GhGs that are driving it.

ETS S.O.S.:Why the flagship ‘EU Emissions Trading Policy’ needs rescuing, from UK climate change and emissions trading specialist group Sandbag, reports that Europe’s biggest emitters are taking advantage of the continent’s cap&trade marketplace and making a killing at the expense of EU utility ratepayers and the world’s climate.

More significantly, flaws in the ETS design threaten to allow the EU’s worst spewers to go unrestrained for the coming 7 years.

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Opponents of cap&trade jumped at the opportunity to use the Sandbag findings to their advantage but the report is not intended as a condemnation of the ETS.

The report, authored by Anna Pearson and Bryony Worthington, is an attack on how the ETS is currently being implemented but is offered in support of reaching an agreement at the December international summit on climate change in Copenhagen to make the cap&trade system work better, not to imply the system should be abandoned.

The report describes the ETS as “a central plank” the EU’s effort to deal with climate change where 2 billion permits are traded yearly. Though the ETS could potentially be a sharp tool at cutting GhGs, it is currently blunted by 2 major flaws: (1) Too many permits are available. (2) The market has no provision to manage falling demand for permits.

The ETS, according to Sandbag’s report, did not set strident enough emissions cutting goals and then issued too many permits to big emitters in the early stages of the system. The result was that permits were too abundant and therefore too cheap. It was too easy and too cheap to pay to spew.

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The assumption was that over time caps could be ratcheted down and excess permits would be used up. That was about to happen in 2008. The permit value had begun to stabilize. Then the worldwide economic downturn occurred. Emitters’ productivity fell off. They were generating fewer emissions and needed fewer permits.

The ETS presently may have as many as 700 million surplus permits available for use through 2020.

To make matters worse, the market was designed with the assumption there would be no need for a mechanism to cope with falling demand. Energy demand was expected to grow while caps were tightened.

There was a mechanism designed into the system to protect the big emitters from demand that became too great and threatened to drive the price of generating emissions too high too fast. It was the availability of Certified Emissions Reductions (CERs) through the United Nations (UN) Framework Convention on Climate Change (FCCC) Clean Development Mechanism (CDM).

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Should ETS permits become scarce and drive the price up high enough to inhibit industrial activity in the EU, the designers reasoned, emitters could offset their spew by buying CERs for emissions reducing projects in emerging economies and undeveloped nations. Competition between the CER and ETS permits markets would keep both manageable.

When the recession set in, there were not only excess ETS permits but there were 265 million approved CERs, of which only 82 million were purchased. This grossly further diminished the value of the excess ETS permits.

There could be as many as 900 million CERs available through 2020.

That’s a total of 1.6 billion permissions to emit going forward over the coming decade.

There is now no need for the big emitters to obtain new permits and the permits they now own make it possible for them to continue doing business without any cuts in GhGs through 2020. What’s more, the rules allow them to hold up to 40% of current permits for use through 2020, so they may be able to continue spewing without penalty, according to Sandbag, for approximately the next 7 years, especially if market demand remains constrained and productivity remains reduced.

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The worst short-term consequence is that the EU’s ability to provoke action by the international community at Copenhagen is now profoundly compromised. Its “central plank” in the climate change fight shows little effect and shows little promise of having an effect.

The even worse long-term consequence is that, with too many permits sellers and too few buyers, the price of emissions is very low and is likely to remain so. The cap&trade system therefore is generating and will go on generating few revenues to invest in New Energy infrastructure. And it will not price emissions at a cost that will give big emitters any reason to invest. Without present investment in New Energy, there will be little New Energy in the future and GhGs will be the same devastating reality at the end of the 2nd decade of the 21st century that they are at the end of its 1st decade.

The price of permits is currently ~14 euros per tonne of GhGs. The generally accepted rule is that the cost of emissions must be ~25 euros per tonne to drive a large-scale transition to New Energy. (Interestingly, it is estimated that industry is unlikely to invest in carbon capture and sequestration technology until the price on emissions reaches 40-to-50 euros per tonne.)

Sandbag says the only solution is a sharp increase in required emissions reductions, from the present 20% goal to 30% below 2005 levels by 2020. It also suggests that a revised plan must be much more stringent with the big emitters. It wants the excess permits in the system cancelled.

Should the international community reach a deal at Copenhagen to cap world emissions, Sandbag wants the EU to boost its GhG cuts goal for 2020 to 40% below 2005 levels.

The good news: As a result of the economic downturn and reduced productivity, EU emissions are down despite the limited effectiveness of the ETS.

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COMMENTARY
Funny story: Sandbag reports that 10 European plants account for ~60% of all ETS industrial surplus permits and 3 of the 10 plants, accounting for 15% of the surplus permits, are operated by Arcelormittal, a steel maker. A spokesman for Arcelormittal said that, well, yeah, the company did make some money from the 1st phase but, heck, they didn’t design the system…

The 2nd phase of the EU ETS began in 2008 and runs through 2012. Its 1st phase, from 2005 to 2008, was marred by the tribulations of a just-initiated system in which provisions for big emitters were generous, to allow them to transition to new business circumstances in which emissions had a cost. The ETS had been widely perceived to be stabilizing in early 2008. Then the economic downturn presented unforeseen circumstances.

The 2nd phase of the ETS extended caps to more of the EU’s worst emitters, including power plants and energy-intensive industries (cement, steel and glass manufacturers), and covered around 50% of all EU GhGs.

Although the big emitters took advantage of the benefits they were given in the 1st phase, the financial profit-taking was seen as compensation against the costs of transition.

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When the big emitters realized they would not need a large part of the permit supply they held for the 2nd phase because of decreased productivity and associated reduced spew resulting from the economic downturn, they dumped the permits on the ETS for capital.

That would not be so problematic if there were not still such an excess of permits. If the companies had sold permits that they would soon once again need, the market would act to rationally discourage spew through a climbing price for permits. As long as the need for permits remains restrained, though, the price will not climb. Diminshed demand for permits will remain the case as long as the big emitters’ productivity is low. Unfortunately, Sandbag and many other forecasters see the conjunction of excess permissions to emit, in the form of both ETS permits and CDM CERs, and low productivity to characterize the coming years.

Some ETS observers are not yet convinced the situation is quite so dire. When the permits were dumped, at the end of 2008 and in the early part of 2009, ETS prices dropped below 10 euros/tonne. In recent months, as the world economy has stabilized, the price has climbed back to thye 14 euros per tonne level and held steady. It could be an indication of the potential of the market to respond.

One BBC report says power companies do not have excess permits but are running short and buying from cement and steel manufacturers.

This is good news and bad news. It means energy is being consumed and that could translate into economic activity. It also means EU utility ratepayers are subsidizing the losses of manufacturers in the bad economy.

The best outcome would be that companies take some short-term profits during the worst of the downturn but hold a significant enough portion of their excess to protect themselves against returning demand and productivity. In a very good sign, that is reportedly exactly what Arcelormittal, which did so well in the 1st phase, is doing.

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That is also the pattern observed by watchers of the ETS central emissions bank.

Emissions trading worldwide in 2008 reached a 92 billion euro (£79 billion, $130 billion) value on a volume of 5 billion tonnes of GhGs.

QUOTES
- Tim Yeo, chair, UK parliament environment audit committee: "These findings confirm what many have begun to suspect. Although emissions trading remains conceptually valid, in practice the EU ETS has not succeeded in driving investment in low-carbon technology [and]… Concern remains about the extent to which British companies can purchase credits overseas instead of cutting emissions at home "
- Barbara Helfferich, environment spokesperson, European Commission: "Let's not panic about it yet…[The EUA price has remained] relatively stable over the past few months [at 14 euros/tonne]… The best measure is the market - if there were an over-allocation of permits you would see the price radically drop…"
- Jean Lasar, spokesman, Arcelormittal: "We haven't sold any permits in this trading period... we are keeping them, we might need them at a later stage…We can't be expected to shape our carbon strategy on what is happening now in the market. The long-term strategy is to significantly reduce emissions…"

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- Bryony Worthington, founder/report co-author, Sandbag: "With too many rights to pollute in circulation, the scheme is in danger of being rendered irrelevant…At a time when other countries are looking to set up their own trading schemes and the world is set to debate a global deal on how to tackle climate change, [this] flagship policy urgently needs rescuing – starting with much tougher caps."
- From the Sandbag report: “Despite its difficulties, the EU Emissions Trading Scheme still has enormous potential to cut carbon emissions by enabling the market to do what it does best, uncover the most cost efficient abatement opportunities. It is vital that debate starts now on how to improve the Emissions Trading Scheme.”
- Guy Turner, director of analysts, New Carbon Finance, predicting market forces would eliminate the surplus permits, bring the emissions price back up and drive emissions cuts: "The 21% target will look tight by 2020."
- Rajendra Pachauri, head, Intergovernmental Panel on Climate Change (IPCC): "[An international agreement at Copenhagen] may change the whole dynamic. That is my feeling, though I may be wrong."