EU Emissions Trading System

10 December 2008

The House of Lords EU Committee have today called for ambitious reforms to the EU’s Emissions Trading System pointing out that as the EU’s main tool in reducing carbon emissions it is vital that the system is a success.

The report, published as the UN climate negotiations take place in Poznan in Poland, makes clear that the EU ETS has become the cornerstone of UK and EU climate change policy but at the end of its first stage its record – in delivering reductions in greenhouse gas emissions – is as yet unproven. Plans for the third phase of the scheme (2013-2020) are expected to be agreed in outline when EU leaders meet in Brussels on 11-12 December. The Committee consider these plans and stress that the System should be reformed to ensure it meets its goals despite reservations from some member states.

The Committee received evidence that Member States such as Poland, with a high reliance on coal burning to generate power, were opposed to moves to ensure all carbon permits in the power industry were auctioned rather than given away as was the case in phase 1 of the ETS. The Committee argue that the EU should aim for 100 per cent auctioning of allowances by 2013, and where exceptions are made for certain Member States it should be on the understanding that the time limited transition period is used to develop and trial clean coal technologies

The Committee also recognise the risk of 'carbon leakage' – the prospect that emissions-intensive production may relocate to countries where regulation is less stringent – but notes that vulnerable firms appear to be concentrated in a handful of sectors. The Committee proposes that industries susceptible to carbon leakage should be identified by 2009, but decisions on whether to allocate free emissions permits to those sectors should be postponed until after the UN Climate Change Conference in Copenhagen in December 2009, when the position of their competitors becomes clear.

The Committee recognises that some EU countries are calling for the most ambitious changes to the ETS to be postponed until industry is in a better position to absorb the costs they might entail. But it argues that these calls should be resisted, pointing out that the planned changes would only take effect in 2013 by which time an economic recovery is expected to be underway, and emphasising the importance of putting in place a stable regulatory environment that allows the private sector to plan ahead.

The report highlights two major risks to the effectiveness of the ETS. It warns that the scheme’s effectiveness hinges on compliance, without which the ETS would not only fail to deliver the desired emissions reductions but also distort competition among participating companies. This risk is magnified at the international level, should a global treaty to replace the Kyoto Protocol be signed. Experience thus far – in terms of compliance with the Kyoto Protocol and the EU’s internal burden-sharing agreement for meeting collective targets under the Protocol – is far from reassuring. The Committee consequently calls on the Government and the European Commission to place a high priority on robust auditing and enforcement mechanisms in the course of negotiations on the ETS and on a successor to Kyoto.

The Committee also points out that if the ETS is to live up to its full potential, it must be linked up to emissions trading schemes in other parts of the world. It warns that on current projections, the establishment of such links could prove arduous due to differences in the price of carbon emissions across different trading schemes. It anticipates that the EU may eventually face stark trade-offs between maintaining the environmental integrity of the EU ETS and extending its reach.

The report asserts that national governments should retain the right to decide how auction revenues (which could potentially be worth billions of euros) are spent, rather than having this prescribed at EU level. But it warns that a considerable proportion of those revenues should be channelled into measures linked to climate change if the credibility of the scheme is to be preserved in the eyes of those paying for emissions permits. The Committee also cautions against using auction revenues to fully compensate industry or households (except those most vulnerable) for price increases resulting from the ETS (e.g. in the cost of electricity), as this would undermine the very purpose of the scheme, which is to create a price signal that prompts changes in behaviour.

Commenting Lord Sewel, Chairman of the House of Lords EU Sub-Committee on Environment and Agriculture, said:

"The gravity of the threat posed by climate change merits a bold response. Ambitious revisions to the EU ETS are necessary if the system is to meet its goals. An auction based approach together with robust enforcement are essential.

"We accept that some Member States have legitimate concerns about the effect of strengthened ETS on their economies but it is vital the EU work to address those concerns without undermining the potential environmental benefit of the ETS. The EU must back any agreement that is reached with a strong and durable enforcement regime to ensure that agreed targets are achieved.

"Linking the EU ETS to other emissions trading schemes will be essential in order to maximise its environmental performance and minimise its economic costs. Worryingly, the prospects for such links appear to be poor.

"Both the UK and the EU’s climate change policy is riding on the success of the ETS, which as yet is far from guaranteed. A timid deal at the summit of EU leaders could produce the worst of all worlds."

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