Phase three of Europe’s emissions trading scheme promises to be the toughest yet for companies

The European Commission on 23 January claimed it was reinforcing its global leadership in the fight against climate change by announcing a series of measures to cut emissions and steer energy policy towards a low-carbon future. Central to the commission’s vision is the European Union’s Emissions Trading Scheme (ETS), which will be dramatically revised from 2013 under the commission’s plans.

The EU ETS is the world’s largest carbon market, and has spawned imitators, in some US states and in Australia, where a scheme is under development. EU officials have regularly described emissions trading as central to the global effort to reduce greenhouse gas output and thus prevent dangerous levels of global warming.

EU environment commissioner Stavros Dimas reinforced this message in January. The biggest aim of the EU’s climate and energy package, he said, was to “strengthen the EU’s position in international negotiations” on a successor to the Kyoto Protocol, which will lapse in 2012. Negotiations started under United Nations auspices in Bali, Indonesia, in December last year, and the EU hopes that an agreement can be finalised at the 2009 UN climate change conference in Copenhagen, Denmark.

Dimas added that the revised EU scheme has been planned to be easily linkable with other trading systems across the world, potentially creating a global market for trading carbon credits.

Planned changes

From 2013, the commission will scrap EU member state national allocation plans, which have been the basis until now of emissions allowances given to companies covered by the ETS. Rather than continuing to distribute free allowances, the commission wants to make auctioning the rule, with a plan to auction about 60 per cent of allowances in 2013.

Free allowances have enabled some companies, especially power firms in the UK and Spain, to make windfall profits by passing the nominal cost of allowances on to customers. These allowances may have cost these companies nothing, but they nevertheless have the value of being tradable on the carbon markets.

Auctioning means that companies will have to pay upfront for allowances, cutting their ability to make windfall profits (although they can still pass on costs to customers). In theory, governments can use money raised at auctions to fund greenhouse gas reduction projects.

In addition, emissions trading will be extended to some new industries, such as aluminium and ammonia producers, and to new gases, such as nitrous oxide and perfluorocarbons.

The number of allowances issued per year will reduce between 2013 and 2020. In 2020, there will be 1.72 billion allowances, each representing one metric tonne of carbon dioxide. This is a 21 per cent reduction compared with 2005.

This is a “much stricter” target than has been seen so far, says Henrik Hasselknippe, Point Carbon’s director of emissions trading analysis. He says that from 2013, the ETS “system will be tighter, and we expect [carbon] prices over time to increase”. But it is hard to forecast prices so far ahead because of other variables such as changes in energy demand, he adds.

“All in all it is a very comprehensive package [that will] drive investment to cleaner technologies,” Hasselknippe says.

Business is also broadly comfortable with the overall target. Philippe de Buck, secretary-general of BusinessEurope, formerly Unice, says his organisation supports the policy of an emissions cut largely to be delivered by emissions trading. He adds that the proposals are “quite revolutionary” and have the potential to fundamentally alter business behaviour.

However, he adds: “The more we read the documents, the more we have concerns. It’s nice to look at the broad view but we have to look at the technicalities.”

Auctioning is the top business concern. The European Commission has been vague on the details, saying that precise mechanisms by which allowances will be given out – either free or via auction – “will be developed later under a committee procedure”.

This, BusinessEurope says, is “not satisfactory”. In addition, not all sectors will be treated equally. Electricity generators and other power companies will be subject to full auctioning from 2013 because, the commission says, of “their ability to pass on the increased cost of emission allowances” – in other words, through electricity price rises. BusinessEurope says these could be “significant” and will impact on both industry and consumers. In industries, such as steel, that are more open to international competition, companies will not be able to pass on to customers the costs of allowances bought at auction.

However, Laura Schmidt of the Association of Electricity Producers (AEP), which represents firms such as British Energy, Centrica, EDF Energy and RWE Npower, says the consensus among energy firms was that they are “not opposed” to full auctioning. This is because, Schmidt says, costs can be passed on, “as any business would”.

Not all power generators will feel the same impact. Those with coal-fired power stations prominent in their portfolios will be required to buy through auction more emissions allowances than those producing energy from natural gas or renewables.

If auctioning is to be the rule for the power sector, it should be so across all EU countries, Schmidt says, adding that the AEP was waiting to see the details of how the auctioning proposals would be implemented.

Road to Copenhagen

Commission officials say decisions about the balance of free and auctioned allowances depend on the final international climate change deal in Copenhagen in 2009.

A post-2012 international agreement is likely to rely on emissions trading as the main method of cutting carbon dioxide pollution. If this happens, industry outside the EU will be subject to ETS-like constraints and Europe’s relative competitive position will not be harmed. But if an international agreement fails, EU industry will find itself burdened with the extra cost of cutting emissions, while competitors elsewhere continue to pollute with impunity.

For this eventuality, the commission outlined three options. First, it could require importers bringing carbon-intensive goods such as steel or paper products into the EU to participate in the ETS. Second it could seek international sectoral agreements on emissions, which should lead to “substantial reductions” and include effective “compliance mechanisms” according to Dimas. Third, it could return to a system of free allowances, thus only imposing additional expense on EU firms that must buy additional allowances because of excess emissions.

But this is a backstop. One commission official says: “If there is no international agreement, we are going to be really disappointed.” The official adds that in the event of international negotiations failing, reintroducing free allocations would be the quickest and easiest of the three options, because it could be done without seeking a joint decision from the European Parliament and member states in the EU Council.

The changes to the ETS proposed by the commission must themselves be agreed by parliament and council, meaning much hard bargaining in the months ahead. But the ETS is meant to make a major contribution to a target the EU has already agreed: that greenhouse gas emissions should be cut by 20 per cent by 2020 compared with 1990 levels. In case of an international agreement, this target increases to 30 per cent.

The commission also announced in January national emission reduction targets for sectors not covered by the ETS, chiefly agriculture, construction and transport. The targets range from 20 per cent cuts for Denmark, Ireland and Luxembourg, to a permitted increase for the EU’s poorer countries, such as Bulgaria and Romania, which are to be given scope to catch up economically with their western neighbours.

Commission president José Manuel Barroso has an upbeat message. “These proposals will create jobs in Europe and not destroy jobs,” he says. “It is a package for protection of our planet and environment but also for promoting energy security.”

This story first appeared on, the website for business climate news.

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