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The EU's Faltering Cap-and-Trade System
January 29, 2007

http://roguepundit.typepad.com/roguepundit/2007/01/the_eus_collaps.html

The EU is really struggling to get its nations to make significant reductions in their GHG emissions. The Emissions-Trading Scheme (ETS), the EU's cap-and-trade system for GHG emissions from heavy industry (about half of all emissions), is faltering badly. The price of a credit continues to collapse, from its peak of €30.50/metric ton last April to its closing price Friday of €3.05/mt. There are several reasons for this, including...

- In the first phase of the ETS, most nations issued too many credits to many of their polluters. This guts the financial incentive to reduce emissions. Some corporations took advantage by quickly selling their excess credits while pricing was strong...several power companies made hundreds of millions that way. This is the basis for some environmental groups speculating that if airlines were included in the ETS, they could make similar windfall profits.

- No EU nations have offered to make significant cuts in their allowances during the second phase of the ETS (2008-2012). In fact, several requested increases.

- When the EU set the second phase caps for some of its nations (others are pending), it only proposed a 7 percent decrease in total emissions as compared to 2005 data. Despite this, the EU is running into staunch resistance in getting several of its members to accept the new caps.

In most EU nations, there's considerable trepidation that achieving the caps will be so expensive that it will hurt their economies. For instance, Germany is fighting a modest proposed 4.4 percent cut in its cap--in stark contrast to its recent verbal support of a 30 percent worldwide cut in GHG emissions. Talk is cheap. Meanwhile, Eastern Europe's GHG emissions have declined 36.4 percent since 1990 (previous blog here) because of deindustrialization since the break-up of the Soviet Union. So, several of these nations are battling for more cap growth to allow for modernization.

A case in point is Slovakia, whose GHG emissions are 40 percent lower per capita than Germany's. Its phase 1 cap was set far too high, 21 percent above what the actual emissions have been. However to satisfy a condition of joining the EU, Slovakia recently shut down two units of an aging nuclear power plant, making the nation more dependent upon electricity generated from fossil fuels. To accommodate the increased emissions and some economic growth, Slovakia proposed a 12 percent cap increase for phase 2 of the ETS. The EU offered just a 1.3 percent cap increase. So...

Slovakia will file a lawsuit against the European Commission (EC) over its demand the EU member cut its annual carbon dioxide emissions from 2008-2012, Slovak government officials said on Wednesday.

Environment Minister Jaroslav Izak told reporters the carbon dioxide (CO2) cap for 2008-2012, which the European Commission had ruled in November, was insufficient and the process of setting the quota was inappropriate.

"The government decided at today's meeting to file a lawsuit against the decision by the European Commission on CO2 allocations for Slovakia for the years 2008-2012," he said.

...

"The reason for the lawsuit is mainly an economic one," Fico told journalists after a government meeting at which ministers agreed to file the motion.

"Such a significant reduction (in emissions) would cause serious troubles for the economy," he said.

The claim of a cut in the cap is political posturing...but Slovakia certainly isn't alone in that rhetorical dishonesty. For instance, France trumpeted a proposed 4.2 percent decrease in its phase 2 cap, ignoring the fact that this would provide for an increase over its actual emissions during phase 1.

Since November several states have tried to persuade the Commission to soften its stance. Other countries have also threatened legal action.

The issue has split Germany's government, with the Economy Ministry saying on Tuesday it was considering a complaint against the Commission while the Environment Ministry rejected the idea.

By creating an economic incentive to get polluters to invest in cleaner operations--or at least buy credits from others that do, cap-and-trade systems increase costs for some businesses. They're paying for the right to pollute beyond a certain amount. Most businesses and government agencies have no choice but to bear such costs and try to pass them along to consumers, taxpayers, etc.

However, the resulting higher costs can hurt businesses that compete in the global marketplace. A few employers will find it easier to cut costs by relocating elsewhere...like to developing nations with fewer environmental regulations and no obligations under the Kyoto Protocol.

In other words, a downside of cap-and-trade systems is that they can help drive outsourcing, offshoring, and the like. When that happens, at least the same amount of carbon still goes into the atmosphere while the jobs and revenues go elsewhere. This is why so many EU nations are fighting for more cap room. And, a similar concern is part of the reason why the U.S. hasn't signed the Kyoto Protocol.

California has been dealing with the don't-cut-and-run business strategy as well. I've blogged previously about California's increasing dependence upon electricity from coal-fired power plants built outside of the state and thus beyond the reach of its tougher environmental regulations. The state has just closed part of that loophole by banning its three major investor-owned utilities "from entering into long-term contracts with sources that emit more carbon dioxide than a modern natural gas plant." Municipal utilities are next.

It will be interesting to see how Governor Kulongoski fleshes out his recent proposal for Oregon to have a cap-and-trade system and possibly participate in a regional system. Can he come up with something which will truly reduce carbon emissions without significantly raising the costs of living and doing business here? Let's at least hope he can learn from others' successes and failures.