Columnists: Andrew Warren, British Energy Efficiency Federation

Published on: 6 Jul 2015

The EU ETS must be reformed or (reluctantly) scrapped

Andrew Warren argues the Europe's emissions trading scheme has been a bold experiment, but it now risks overshadowing more effective emissions reduction measures.

The European Union emissions trading scheme - the EU ETS - is a wonderfully bold experiment. A tremendous example of 10 years of cross-border co-operation between 28 sovereign states, attempting to combat one of the greatest threats to mankind.

Even so, it needs urgently to be altered dramatically. And if it really cannot be changed, so it can for the first time deliver real carbon savings, then it must be sidelined in importance - even (reluctantly) scrapped.

Were this to happen, given the hostility to carbon trading schemes expressed in his recent encyclical on climate change, that would be the first very concrete victory for Pope Francis' advocacy.

It is now exactly 10 years since this trading scheme began operating. That it ever managed to do so was a great tribute to the dogged determination of those at the European Commission who - together with executives from a couple of the big power utilities - had championed it despite a background of incredulous scoffing at their apparent over-ambition by the Bush Administration in the US and business-as-usual mouthpieces across Europe.

The Father of the EU ETS is usually held to be a Belgian Commission official called Jos Delbeke. He was one of the earliest to appreciate just how enormous an issue combatting the threat of climate change was. A decade earlier he had been the champion of a new pan-European tax, on fuel usage. This would have added $10 tax upon each barrel of oil burnt in Europe. The objective was two fold: it would deliberately increase the cost of energy, thereby encouraging more frugal usage. As a tax, it would provide resources for public authorities to fund judicious stimuli programmes to further this ambition.

Despite strong support from within the Commission, the proposal died a political death, ridiculed as a crude tax-and-spend measure both by business-as-usual champions, and climate deniers. So Delbeke tried again. He promoted a business-to-business trading scheme, initially modeled on a US scheme created by chemical companies to address the phasing out of CFCs , gases held responsible for the "ozone hole", and indeed substantial contributors to the "greenhouse effect". Indeed there is a case that even today this 1990s trading scheme has done more to combat climate change across the world than any other trading initiative.

A strong lobby for a European cap-and-trade system was created. Critically, a financial lobby sprung up, which saw profits emerging from taking a percentage on all permits traded: this the one sector that has unequivocally benefitted from the scheme.

The ambition of the EU ETS was always remarkable. By including both all electricity generation and most intensive energy using sectors operating across 12,000 sites, it was able theoretically to claim it was incorporating half of European emissions, and (then) around 10 per cent of the world's greenhouse gases.

Economists have long calculated that, in order to achieve the original objective of profoundly altering the generators' merit order towards non fossil fuels, let alone stimulating serious further industrial energy efficiency investments, the EU ETS trading price needs to be well over €40 per tonne. The trading price has never yet reached that amount, and has been as low as one-hundredth of that amount, 40 eurocents.

Why has the EU ETS failed to live up to its promise, having negligible impact itself? I think the answer can be boiled down to two basic mistakes. This is a cap-and-trade scheme. Throughout, there has been too much concentration upon the trading aspects, and too little upon the overall size of the cap. It was wrong to permit each national government to make their own permit allocations: from 2005 to 2012, most national governments provided their own industry with generous allocations, in some cases even larger than the amounts requested.

For eight years, each of these permits was handed out for free. That had been due largely to stop in 2013, when the Commission (with Jos Delbeke now head of a new climate change directorate) arranging regular auctions. Strong lobbying by vested interests has stopped that happening. Even today many industry sectors, even some generators, continue to receive their allowances gratis.

The second big problem has been the collapse in the ETS price. This happened well before Europe went into recession. But that augmented the problem. Companies found that decreased demand for products meant they had a surplus of allowances. As no allowance has an official expiry date, electricity generators bought up huge swathes of permits at knockdown prices. And hoarded them away. Attempts to place a full expiry date on any allowance have always faltered.

The founding fathers of the EU ETS were confident that, within the decade, this pioneering scheme would have spread across the developed world. Agreed there are some separate, vaguely similar, schemes operating in parts of the US and China. But these work in a vacuum. The only real attempts to integrate with an overseas scheme (Australia) ended in political rejection.

Zealots for the EU ETS theory remain. Over the past 10 years, probably their greatest effect has been to deter policy-makers - whether European or national - from implementing stronger energy saving programmes. Some in key positions have even argued that reducing demand for energy would be a bad thing, because it could depress further the EU:ETS trading price - a classic example of losing sight of the wood for the trees.

The ostensible market-based approach of a trading scheme should, according to theory, have delivered the answer to combating climate change, guided by that mysterious "hidden hand of the market".

Such purblind thinking still operates. Even last November the 28 heads of EU governments were still resolving the ETS must remain "the main European instrument" to reach the 40 per cent greenhouse gas reduction target due between 2005 and 2030.

They still require that any and all energy efficiency initiatives and schemes "will fully respect the effectiveness of the ETS scheme'. Bearing in mind how singularly ineffective the ETS has been over its initial decade, this bodes very ill indeed for the Pope.

Andrew Warren is chairman of the British Energy Efficiency Federation

The views expressed in this column are those of the columnist and do not necessarily reflect the views of eceee or any of its members.

Other columns by Andrew Warren