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EU Emissions Trading Scheme underperforming?

01 April 2010 #Environment


The EU Emissions Trading Scheme (ETS), established in 2005 to accelerate climate change abatement by facilitating investment in environmental technologies, has underperformed in delivering its objectives due to instability of, and relatively low, carbon prices.  This has resulted in inadequate investment being channelled into environmental technologies and services, an originally intended by-product of the scheme.

Though the recent economic downturn, which reduced overall economic activity and hence the activity of major polluters such as steel mills, had unintended impacts on the benefits expected from the EU ETS.  The recession has led to polluters producing less, thereby requiring less power, and hence polluting less.  The EU ETS began with grandfathering permits to major polluters, providing them with free permits to pollute based on pre-recession activity.  Due to the decline in their activity, polluters in many cases have been able to easily cover their carbon emissions with the amount of allocated permits.  The resulting lack of demand for emission permits has resulted in a relatively low price of carbon.  In fact, many of these same polluters have excess leftover permits equivalent to the tune of 400m tonnes of carbon dioxide, which sold off for profits of up to €6bn depending on market prices.  In theory, these could be pure profits as the polluters have yet to be incentivised to invest in low carbon technologies. 

Though polluters have access to these potentially massive profits, they are now hoarding their excess permits in anticipation of restriction of free allowance handouts and the reduction in overall emissions cap as the next phase of the EU ETS comes into play.  Additionally, polluters are buying allowances generated from offset schemes in developing countries, which are cheaper and less valuable than the grandfathered permits as they may not be eligible in the future.  ‘Banking` the allotted allowances, as it has come to be known, will allow polluters to use them in the future to meet their emission requirements.  The resulting effect of this is identical to that of grandfathered emission permits, which have allowed polluters to meet their emissions requirements without actually having to reduce their emissions, resulting in no investment being leveraged into low carbon technologies.  Simultaneously, the continued lack of demand for carbon permits is maintaining a low price of carbon.  In addition to a low carbon price, uncertainty of a future rise of the prices is hindering investment in low carbon technologies.  In its current state, the EU ETS is therefore unlikely to immediately reduce emissions significantly despite the overall cap on emissions being reduced. 
 
Alternatives to an ETS have also been suggested.  The carbon tax, for example, has been shown to be a practical method by which to reduce carbon emissions significantly over a relatively short period of time in several countries globally.  A carbon tax provides a clear price signal to those affected, as well as the rest of the private sector, resulting in the leveraging of private sector investment.  The House of Commons Environmental Audit Committee recently suggested a carbon tax as a potentially viable mechanism by which a minimum price of carbon could be guaranteed, suggesting that a hybrid model of a tax and ETS could be beneficial. 

Though there is acknowledgement that a sufficient carbon price is needed to move forward, the advantages and disadvantages of all methods continue to be hotly contested and the debate seems to continue with inaction being perpetuated by the confusion left by Copenhagen.

Taken from The EIC Environmental Investment Network.

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