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September 28, 2010
To Meet Targets, EU Greenhouse Gas Emission Trading System Needs Improvement
    by Robert Kropp

A report by oekom research recommends that emissions reduction permits be auctioned, and that the system be expanded to include more industry sectors and types of emissions.

The European Union Greenhouse Gas Emission Trading System (EU ETS) was launched in 2005, in response to agreement among the signatories to the Kyoto Protocol to reduce greenhouse gas (GHG) emissions. The European Union agreed to reduce its emissions by eight per cent from 1990 levels by 2012.

The EU ETS is a cap-and-trade system, in which one emission allowance gives a company the right to emit one ton of CO2. Companies that keep their emissions below the level of their allowances can sell their excess allowances, while companies exceeding their limit can either reduce their emissions or buy extra allowances. Currently, the EU ETS is the largest GHG emissions trading system in the world.

Now, five years after the launch of the EU ETS,
oekom research has produced a Position Paper, which, oekom reports, "Views the system positively," but also finds that the system "is still performing well below its full potential."

While emissions trading retains the potential to significantly reduce GHG emissions, "There is some serious criticism of the form emissions trading has taken in practice," according to oekom. Kristina Rüter, Research Director at oekom, stated, "The large numbers of emissions permits issued have led to extremely low CO2 prices and thus also given out misleading signals to the market."

In addition to the large number of permits issued, the manner in which they have been allocated thus far has contributed to the problems encountered by the EU ETS. The program is designed to be implemented in three stages; the current stage, the second, is scheduled to continue until 2012. Until now, according to oekom, emission permits have been allocated free of charge, for the most part. Because of this, European energy suppliers have received "unexpected additional revenues, by valuing the free emission permits at the current market price, apportioning them as a cost and adding them to energy prices."

"The lower-than-expected price" of permits, according to a 2009
report by Climate Strategies, "Reduces incentives for low-carbon innovation and investments." And in a 2007 submission that addressed the EU ETS after 2012, when it is scheduled to enter its third phase, Climate Strategies called for "the use of a reserve price on EU ETS auctions to protect investors against extremely low price scenarios."

As the
Institutional Investors Group on Climate Change (IIGCC) stated in a report published earlier this year, "Investors are less likely to take account of climate change issues when policy does not make the issue material, when there are uncertainties surrounding climate change policy and when the long-term nature of many physical climate change impacts means that they are outside current investment horizons."

A third problem identified by oekom is the selection of industries to be included in the system thus far. At present, an estimated 11,500 installations in Europe are subject to the cap-and-trade system of the EU ETS. However, as Rüter stated, "There are a large number of industries and greenhouse gases that are not covered by the EU ETS."

"As yet," oekom reported, "It does not cover other large GHG emitters such as aviation, shipping and the aluminium industry." The number of industries covered by the system is scheduled to increase in 2012, at which time, for instance, "Aircraft wanting to take off or land in the EU will then have to acquire emissions certificates in order to do so."

Plans are also underway to expand the emissions included in the system.

One of the key initiatives of the Kyoto Protocol has been the
Clean Development Mechanism (CDM), which allows companies to implement emissions reduction projects in developing countries, where, at present, cap-and-trade schemes are rare. According to oekom, "The CDM mechanism in particular has—after initial teething problems—been very well received internationally," and at present more than 2,000 projects have been registered.

However, critics have argued that too many CDM projects have not met the standard of additionality, by which is meant that the project would have been set up even without financing through certified emission reduction (CER) credits. "If the principle of additionality is not safeguarded," oekom observed, "A rise in emissions worldwide will result."

oekom concluded the paper with recommendations that would "provide effective support for the goal of limiting global warming to two degrees Celsius which was adopted at the climate conference in Copenhagen in 2009." The recommendations include tightening reduction targets to be met by 2020, including all relevant industry sectors and emissions in the system, and developing an international trading system.

"A major step forward here would be the establishment of a transatlantic system incorporating the EU ETS and a North American trading system," oekom stated. In the US, a cap-and-trade scheme was included in the Waxman-Markey bill that passed in the House of Representatives. However, the Senate has failed thus far to even bring up comprehensive climate change legislation for a vote.

However, as Climate Strategies stated in its submission to the EU, "Efficient investment requires that the EU ETS must continue after 2012, despite the inevitability of a world of unequal implementation and prolonged international differences in carbon prices."

Citing a number of analyses, including its own Industry Climate Risk Index, oekom highlighted the financial risks "to companies which do not pay sufficient attention to climate change and climate protection and the impacts of these on their activities."

"At the same time," oekom continued, "Companies have a social responsibility to make a contribution to protecting the climate."


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