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The EU’s Emissions Trading System: Trouble in Paradise

Thursday, April 19, 2012

The bloom is fading from the rose.

The European Union Emissions Trading System (EU ETS), launched with much fanfare in 2005, is the world’s first and only major mandatory global emissions trading scheme. Designed to combat climate change, it currently regulates more than 10,000 installations in the EU’s energy and industrial sectors, which together are responsible for close to half of its carbon dioxide emissions and some 40 percent of the continent’s total greenhouse gas emissions.

Under the system, each regulated utility or industrial installation is allocated emission allowances from national allowance plans; if one falls below the emission allowance, it may profitably sell its emission trading permits in the commodities exchange to other companies that have exceeded allowances. The goal of the EU ETS is to encourage capital investment in low-carbon energy technologies and fuels.

Presently, the EU ETS is completing its Second Trading Period, which started in 2008 and lasts until December 2012; emission credits are given out for a sequence of several years at once. But the bloom is fading from the rose. In 2009, the European Commission called on the Obama administration to join with Europe in establishing a joint mandatory transatlantic carbon trading scheme based on the EU ETS system. But the proposal went nowhere, as the Obama administration’s cap-and-trade emissions legislation was stymied in the U.S. Congress. There is no support for this type of environmental and energy legislation in the U.S. Congress among most Republicans, and little among Democrats. Similarly, recent international discussions between the major economic powers have resulted in little tangible progress on climate change policy.

This is the sixth time in the last seven years there has been an oversupply of carbon offset allowances.

Furthermore, as of January 1, 2012, many foreign airlines are enraged at being forced to pay a new carbon-offsetting tax when entering EU airspace. The Chinese and Indian governments are both refusing to let their national airlines pay this tax to the EU, and other nations are set to join this boycott.

The plan to move the EU ETS system to other large, developing countries, and then to a global carbon trading market system by 2020, is only marginally closer to fruition than when the EU ETS was first established in 2005.

In March 2012, consulting firm Ecosystem Marketplace released a report on the evolution of the voluntary carbon offset market since 1997. The report, “Bringing It Home: Taking Stock of Government Engagement with the Voluntary Carbon Market,” was sponsored by the International Emissions Trading Association, International Carbon Reduction and Offset Alliance, and the Carbon Markets and Investors Association. It found that more than 20 national and sub-national governments had mandatory or voluntary domestic carbon market exchanges. However, in 2011, only 11 percent of credits granted were then voluntarily traded worldwide—leaving most of the credits untraded, the report found.

There is no support for this type of environmental and energy legislation in the U.S. Congress among most Republicans, and little among Democrats.

Of greater concern to the system’s advocates is that prices of tradable emissions permits in the EU ETS have declined to record lows in the commodities marketplace. While the European Union just released preliminary (and incomplete) data showing that its carbon emissions have fallen at a greater-than-expected volume in 2011 (by 2.45 percent), this positive news has also had a negative effect on the marketplace for carbon emissions. A total of 1.88 billion tons of carbon were emitted in 2011, down from 1.94 billion tons in 2010. The 2011 emissions level was 144 million tons below the EU ETS cap. This is the sixth time in the last seven years there has been an oversupply of carbon offset allowances.

Europe’s economy has contracted and, after a mild winter, continent-wide demand for energy has declined. Thus, power utilities have been operating at lower capacity levels, resulting in less carbon dioxide and other airborne pollutants being released into European airspace. Recent economic data shows the European economy worsening this spring, which could mean even lower demand from utilities and industry for tradable emission permits, leaving the long-term viability of the EU ETS in doubt.

Thomas A. Hemphill is associate professor of strategy, innovation, and public policy at the University of Michigan-Flint’s School of Management.

FURTHER READING: Hemphill also writes “Just How Dangerous Is Talking and Driving?” Claude Barfield discusses “The First Carbon Trade War?” Kenneth P. Green contributes “Not Free to Choose: The Reality behind Clean Energy Standards” and “Voters Beware Carbon Tax Seductions.” Representative Fred Upton authors “Rethinking America’s Energy Policy.” Jonah Goldberg describes “Cooling on Global Warming.”

Image by Darren Wamboldt / Bergman Group

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