The EU’s Emissions Trading Scheme Has Been Voted Down

Summary.  The European Union instituted its Emissions Trading Scheme, using a cap and trade mechanism, in 2005.  Since that time, the Scheme has gone through periods in which the number of allowances was too high, resulting in excessively low values for their price. 

In a vote on April 16, 2013 the European Parliament defeated a proposed measure continuing to allot allowances to the emissions sources among the EU’s member nations, largely for economic reasons.  If allotments are not revived, the ETS will cease operations.  This would terminate one of the first multinational efforts to mitigate greenhouse gas emissions.
 

The ETS exemplifies the administrative and political difficulties facing cap and trade regimes.  Valuing carbon emissions is better achieved with a carbon fee.

 

Introduction.  The original members of the European Union (EU) in 1997 acceded to the Kyoto Protocol, an international treaty to limit emissions of carbon dioxide (CO₂) and other greenhouse gases (GHGs).  The Protocol entered into force in 2005.  Even before this date the now expanded membership of the EU undertook to establish an Emissions Trading Scheme (ETS) to limit GHG emissions through 2020, using a cap and trade market mechanism.  In such regimes allowances, once granted, can be traded or auctioned in an open market; this fixes a monetary value for them.

In the initiation phase of the ETS the EU allowed each member nation independently to establish the number of allowances (each permits release of one metric ton of CO₂).  As a result, too many allowances were granted, and the ETS market wound up valuing the allowances at a very low price, even approaching EUR 0 in one year.  In the second phase (2008-2012) the number of allowances granted was reduced, and the ETS market valued allowances at reasonable levels.  In the third phase, beginning in 2013, the EU began centrally to determine the distribution of allowances.

Unfortunately, the EU cancelled its most recent auction   in March 2013 because bids received were “significantly” below the actual market rate.  In 2013, the start of Phase 3, about 40% of newly issued carbon emission allowances were being sold at auction for the first time.  The rest are still distributed at no charge.  The price had fallen to EUR3.73 (US$4.86) a metric ton early in the year.  The price had been about EUR 25 in 2008.

Longer term the ETS price for emission allowances has fallen drastically, by 90%, in the last five years.  This is due largely to a drop in demand for energy among EU countries because of recessionary conditions.  This has led to an oversupply of allowances.  The ETS began to reevaluate its allocation of allowances, in an attempt to rebalance the trading system and maintain a price on emissions.

Unfortunately the EU has now voted against its cap and trade regime.  The New York Times reported on April 17, 2013 that the European Parliament had voted not to lower the number of carbon dioxide emission allowances to be granted going forward.  The Times called the result “a potential death blow” to the cap and trade emissions regime.  Even so, emissions from the EU had fallen by 10% between 2007 and 2012, at least partly because of weak economic conditions.  The Parliament gave greater weight to the desire to keep energy costs down in view of the economy than to the overarching need for the world to limit its emissions of GHGs.  After the vote, the value of an allowance fell 40% to about EUR 3 per metric ton.  It is estimated that in order to have an effect on curtailing emissions, the price would have to be about EUR 30 per metric ton or higher. 

Analysis

This blog has long advocated in favor of a direct fee on carbon fuel consumption, rather than implementation of a cap and trade regime, to put a price on emissions of GHGs and thereby lower the annual rate of GHG emissions.  This latest development in the EU, the failure of its policymakers to continue the ETS, shows that a cap and trade regime may continually be subject to political interference.

As written in a recent post a cap and trade regime has many disadvantages in comparison to a carbon fee.  Some of these are apparent when considering the EU.  The factors include a) a need to account accurately for baseline emissions from each identified source prior to placing the regime in operation; b) a continued need for monitoring emissions from each source as the regime operates; c) a need for a  mechanism to allot allowances both at the outset and in subsequent periods of operation; d) a mechanism or rule for distributing allowances, including determining whether to grant or sell them; and e) setting up the administrative offices needed to operate the regime.  It is seen from this incomplete list that a cap and trade regime presents many challenges, requires an extensive bureaucratic structure, and includes many opportunities for mistakes to be made, or for influence, that defeat the objective of constraining emissions.

In contrast, a carbon fee is extraordinarily simple in its operating features and is easy to implement.  For example, a low rate could be established at the outset, which would increase annually to a level at which it would have a meaningful effect in reducing energy demand.  Experience has shown (not discussed here) that a carbon fee is easy to apply, has a broad if not universal reach, and achieves its objective according to its magnitude.  It is clear that the simplicity and effectiveness of a carbon fee offers major advantages over use of a cap and trade regime.

Many commentators have urged use of a carbon fee to mitigate emissions. 

 

In summary, the simplest, most direct, and most effective mechanism for reducing dependence on fossil fuels and mitigate emissions of GHGs is to apply a carbon fee.  The time to begin abating humanity’s emissions of CO₂, a major greenhouse gas, is now.  The longer we wait, the more firmly we cement our dependence on fossil fuels, and the more difficult it will be to achieve meaningful mitigation of global warming.

 © 2013 Henry Auer