Climate Change and the EU Emissions Trading System

by Robert Edge-Partington

 

Abstract

The EU’s climate change policy is in danger of failing to meet its 2030 targets. The Emissions Trading Scheme aims to encourage countries to reduce their carbon emissions and is the centerpiece of climate change policy. Furthering this, the EU Emissions Trading Scheme is the largest in the world of its kind. The European Union has a responsibility to be a global leader in demonstrating that carbon trading can be the economic means to obtain a sustainable future for the world, and ultimately reduce carbon emissions. However, the urgency to reform the ETS is growing, especially given the changing face of the European Union in a post-Brexit world. This paper will examine the ways in which EU could reform the ETS moving forward, in order to fulfill the exciting potential of carbon trading. 
 

The Issue

Former US president Barack Obama described climate change as the “one issue that will define the contours of this century more dramatically than any other.”1 Issues such as air pollution and vector-borne diseases are on the rise as a cause of climate change, inciting concern in the European region. The life expectancy of over 80% of Europeans is reduced by an average of nine months as a result of high particulate matter concentrations exceeding World Health Organization Air Quality Guidelines.2 It is also projected that climate change will cause a 50% rise in Salmonella infections between 2071-2100 in Europe since these pathogens thrive at higher temperatures.3 The evidence of severe climate change is damning for the European community, and it is clear that serious action must be taken to prevent the worst impacts of climate change. As stated by Centre for European Policy Studies Task Force Chairman Yngve Stade: “climate change is a global issue that ultimately requires global solutions … it is crucial for the EU to continue its efforts to reach a global agreement.”4 The importance of the European Union in the context of global climate change cannot be understated; it is our responsibility to lead the charge towards a sustainable future, especially given that many of the world’s leading economies and top emitters are European countries.5 In this paper, I will assume understanding of basic economic processes. 
 

Defining European Climate Policy and Emissions Trading

The first major action against climate change on the European scale came in 1991 with the introduction of the Community Strategy to Limit CO2 emissions.6 The 1990s became a landmark decade for the progression of climate change policy across the world, with the Kyoto Protocol recognized as the most significant piece of legislation to date. This protocol laid the foundations for the global drive towards a sustainable future. 

Emissions Trading, an economic concept which aims to create a global market worth tens, potentially hundreds of billions of dollars annually based on reducing CO2 emissions, is of the most important components of the Kyoto Protocol. Put simply, emissions trading means that governments are granted the authority to allocate or sell ‘permits’ to emit certain quantities of a pollutant for a predetermined time period. If a firm wishes to increase its carbon emissions, it must purchase permits. In this way, firms are incentivised to lower their emissions, since higher emissions cost them increasing capital. This is known in most environmental circles as carbon pricing, which serves to reflect the social cost of emissions. Businesses incentivising action against climate change may prove to be one of the largest driving forces in working towards a sustainable future on a global scale. The creation of this market has been “an achievement of global significance”, especially given that the EU Emissions Transfer System is the biggest established emission trading system to date.,7,8

In the last 18 months in particular, there has been extensive discussion and intense debate regarding the European Union’s Safety Reserve. The EU Safety Reserve is a method of transferring permits from more wealthy countries to less wealthy countries; those below the EU mean GDP per capita ($41,000 USD in 2017).9 Given that several EU countries are already on track to meet their 2030 targets, they have permits which are not being bought, and thus are available for transfer. This increase will be applicable to allowances freely allocated to power installations from 40% of the auction share to 60%, a seismic increase. Furthermore, recent discussions on this article have been concerning, giving rise to questioning of whether the new ETS amendments allow coal investment.10 Further coal investment would be a large setback for emissions trading as a global model. The EU ETS ultimately seeks to phase coal out of power production, not to create loopholes that allow EU countries to maintain, or even increase their use of coal power. If the EU ETS discussions do not become more proactive, the entire system risks falling behind and failing to meet its goals. This is especially notable, given that China’s national ETS was announced in mid-December 2017.11 While this Chinese market has not yet begun operations, it serves as a poignant reminder to EU policy makers that this is no time to regress. 

Fundamentally, the European Union has a commitment to achieve three targets by the year 2030: at least a 40% reduction in greenhouse gas emissions from their 1990 levels, at least 27% renewable energy share, and at least 27% improvement in energy efficiency. 12 Considering the amount of time granted to the EU to meet these targets, the lack of concrete framework for compliance is startling. For example, in the ETS sectors, a cut of 43% must be made from 2005 levels in order to meet the 40% target, suggesting that there is still a great deal of work to be done, and that the situation may even have worsened.13 The European Union must act on these three targets, and proactively fulfill its responsibility as a world leader in the fight against climate change. Likewise, given the large proportion of global carbon emissions coming from the European Union, its involvement is paramount to ensure that progress is made. 
 

Systemic Fixes

A key concern of the EU ETS market is to preserve competition, so that the market may grow, and become a more established part of the European Economic Community. Michael Faure pinpoints the need for a multidisciplinary approach to the ideal emissions trading scheme, which seeks to balance a “legal and economic perspective.”14 The legal framework surrounding the ETS is simple; in order to emit, firms must purchase permits to do so from governments, incentivising them to pursue other means of power production. Yet, the price of permits is likely not high enough to push firms towards pursuing carbon-free methods of producing power. 

In order to effectively incentivize emissions reductions, the cost of emitting must be higher than the cost of instituting company policies that will reduce those emissions. As of market close on January 28th, 2018, carbon cost €9.06 per ton.15 However, if the price of reducing emissions is even just €9.07 per ton, companies have no incentive to reduce emissions. Some policy makers, including French President Emmanuel Macron, have stated that any price under €25, or even as high as €30, is insufficient to produce meaningful investment in emissions reduction.16,17, With the price at less than half of this valuation, there is little reason to expect progress will be made. 
 

The Power of Linking the ETS and the Importance of Brexit

According to Article 25 of the ETS, it is possible for the EU ETS to link with other emissions trading schemes. The ETS itself can be seen as an amalgamation of 25 national schemes which are regulated through legislative checks and balances.18 Linking the ETS to other local emissions trading schemes has high potential for the EU, especially in the context of the changing face of the European Union in the post-Brexit world. The issue of Brexit is especially pertinent to the future of the ETS, since the UK was one of the nations which spearheaded the European integration of Emissions Trading. Furthermore, according to the UK government, the ECJ will not be able to regulate UK schemes.19 Promoting a linkage system with the EU ETS and non-EU nations may be the quickest and most-effective fix to this issue. Despite Brexit upsetting the balance of the EU ETS, it may actually be beneficial to the future of European emissions trading since Brexit discussions will call for serious discussion and reconsideration of the legislation behind the EU ETS. 

In the book How to Stop Brexit (And Make Britain Great Again), Former UK Deputy Prime Minister and Liberal Democrat leader Nick Clegg presents one such reconsideration through the “EU of concentric circles” model.20 With the United Kingdom positioned in one of the outer rings of the EU concentric circles, there is potential for the ETS to continue to exist in a revised format, with the UK still integrated into EU climate policy. This may seem opportunistic or idealistic, but in recent years climate change has often taken a back seat in discussions, and Brexit negotiations will necessitate a reconsideration of the EU ETS. Furthermore, climate change and the ETS should be a central part of Brexit negotiations.  Although Brexit seems inevitable at the time of writing, climate change will remain relevant to both parties, affecting the EU and the UK in equal measure. 

The linked schemes would have to cover one or more of the six gases mentioned in Annex II of the Kyoto Protocol (CO2, methane, NO2, hydrofluorocarbons, perfluorocarbons, sulphur hexafluoride). Given that of the 25 Annex II countries 19 (including the European Economic Community) are in the European region, using Annex II of Kyoto appears to be a perfect basis for climate cooperation on a scale beyond the EU, or a basis for incorporation into an “EU concentric rings” scheme.21 Effective combination of the Annex II goal, provision of “financial resources to enable developing countries to undertake emissions reduction activities,” with the EU ETS could lead to a much simpler future for emissions trading policy.22 Indeed, this could even be extended to the new Chinese market for emissions trading, which dwarfs its European counterpart. The Chinese market emits 3 billion metric tons of carbon per year from power generation enterprises, as compared the EU power sector’s 1 billion metric tons.23 Despite this exciting potential for expansion into a linked global carbon market, the most important focus of the EU must be the  2030 goals. 

As the reworking of the European Union takes place, the concentric circles model (shown above right) can be seen as the perfect expression of the future of the EU. With the concentric circles model, reworked ETS could easily include non-EU countries such Switzerland, Norway, and the UK, thus expanding its effectiveness.24 The ETS could, like the European Economic Area, be a relative to the European Union without formally being a part of integrated policy. Given that climate change transcends all international borders and requires global cooperation and proactivity, a reworking of the ETS to supersede EU membership, and instead defining it on the basis of geography could prove to be an effective solution to the problems of the ETS’ current format. 

 

Closing Thoughts

If the EU 2030 goals are to be met by the European Union, the ETS requires major reform by policymakers and negotiators, instigated by Brexit as a reform catalyst.. The recent discussions of permit reallocation to countries below the EU GDP per capita average show an economy-centric mind-set in the European Union and a complacency that prioritises economic growth over environmental protection. This calls into question the progress and acceptance of the very real threat of climate change within the EU. The key to changing this attitude is to completely reform the EU ETS, if there is to be any hope of meeting 2030 goals. There must be dialogue and communication between non-EU European nations and their EU neighbours. 

I view the future of a successful, functional ETS as a new circle in the European concentric circles model, with no shortcuts for countries below the average GDP per capita, and non-negotiable, pre-determined permit allocations. When permit allocations are adaptable for some, a negative precedent of irresolute policy is set. If this method is followed, the ETS has the potential to flourish and become not only one of the world’s largest financial markets, but also a revolutionary foundation for global cooperation on carbon reduction. 
 

Endnotes

  1. "Remarks by the President at U.N. Climate Change Summit." National Archives and Records Administration. September 23, 2014. Accessed February 05, 2018.https://obamawhitehouse.archives.gov/the-press-office/2014/09/23/remarks-president-un-climate-change-summit.
  2. "Data and statistics." WHO/Europe. 2012. Accessed February 05, 2018. http://www.euro.who.int/en/health-topics/environment-and-health/Climate-change/data-and-statistics.
  3. Ibid.
  4. Egenhofer, Christian, et al. Business consequences of the EU emissions trading scheme, Centre for European Policy Studies, 2005, Preface. Accessed February 05, 2018.
  5. "CO2 time series 1990-2013 per capita for world countries." Emissions Database for Global Atmospheric Research. October 30, 2017. Accessed February 05, 2018. http://edgar.jrc.ec.europa.eu/overview.php?v=CO2ts_pc1990-2013.
  6. "Action pour le climat - European Commission." European Climate Change Program. February 16, 2017. Accessed February 05, 2018. https://ec.europa.eu/clima/policies/eccp_fr.
  7. Grubb, Michael, Emissions Trading & Competitiveness: Allocations, Incentives and Industrial Competitiveness Under the EU Emissions Trading Scheme, Earthscan, 2006. Accessed February 05, 2018. 
  8. Faure, Michael G., Peeters, Marjan, Climate Change and European Emissions Trading: Lessons for Theory and Practice, Edward Elgar, 2008. Accessed February 05, 2018. 
  9. "GDP per capita, consumption per capita and price level indices." Statistics Explained. December 14, 2017. Accessed February 05, 2018. http://ec.europa.eu/eurostat/statistics-explained/index.php/GDP_per_capita,_consumption_per_capita_and_price_level_indices.
  10. Jones, Dave. "Is the ETS becoming a tool for coal investment?" Sandbag. October 23, 2017. Accessed February 05, 2018. https://sandbag.org.uk/2017/10/19/ets-becoming-tool-coal-investment/.
  11. Williams, Rachel Solomon. "China's national ETS launches today: Is it an early Christmas present for the climate?" Sandbag. December 20, 2017. Accessed February 05, 2018. https://sandbag.org.uk/2017/12/19/chinas-national-ets-launches-today/.
  12. "2030 climate & energy framework." Climate Action - European Commission. February 16, 2017. Accessed February 05, 2018. https://ec.europa.eu/clima/policies/strategies/2030_en.
  13. Ibid.
  14. Ibid. Faure and Peeters. 
  15. "CO2 European Emission Allowances." Business Insider. Accessed February 05, 2018. http://markets.businessinsider.com/commodities/co2-emissionsrechte.
  16. Ibid.
  17. Felix, Bate. "French President Macron says Europe needs significantly higher carbon." Reuters. September 26, 2017. Accessed February 05, 2018. 
  18. https://www.reuters.com/article/us-france-eu-carbon/french-president-macron-says-europe-needs-significantly-higher-carbon-price-idUSKCN1C12H7.
  19. Robinson, J., Climate Change Law: Emissions Trading in the EU and the UK, Cameron May, 2007. 
  20. Freeman, Steve. "European Union Emissions Trading System post-Brexit." Confederation of Paper Industries. October 2017. Accessed February 5, 2018.
  21. Clegg, Nick, How to Stop Brexit (And Make Britain Great Again), Penguin, 2017.  
  22. "Annex Two Countries." United Nations Framework Convention on Climate Change. July 18, 2000. Accessed February 05, 2018. http://unfccc.int/cop3/fccc/climate/annex2.htm.
  23. "Parties & Observers." United Nations Framework Convention on Climate Change. March 20, 2017. Accessed February 05, 2018. http://unfccc.int/parties_and_observers/items/2704.php. 
  24. Ibid. Williams. 
  25. "Britain should not ape Norway - but new EU membership terms are fully possible." Open Europe. July 11, 2012. Accessed February 05, 2018. http://openeuropeblog.blogspot.co.uk/2012/07/britain-should-not-ape-norway-but-new.html.

 

Glossary of terms

CO2 – Carbon Dioxide.

ECJ – European Court of Justice – the court which is the superior authority on European Union law. 

ETS – Emissions Trading Scheme – refers to the European Union’s system of greenhouse gas emissions trading. 

EU – European Union

EU ETS Article 25 – A EU ETS article which links the ETS to other emissions trading schemes outside the EU. 

Greenhouse Gas – those covered by the Kyoto Protocol; carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulphur hexafluoride, nitrogen trifluoride. 

Kyoto Protocol – an international treaty signed in 1997 and effective as of 2005, making it international law to reduce greenhouse gas emissions.