Polluting away (Source: Alex E. Proimos)

Polluting away (Source: Alex E. Proimos)

A recent report by Sandbag, a leading emissions trading think tank, has revealed that under the EU ETS leading industrial firms have amassed a surplus of 240m emissions allowances (EUAs) between them during the 2008-2010 period. The surplus is estimated to be worth €4.1bn in the market, and is due to the combined effects of over-allocation and the economic downturn.

The crux of the EU ETS is the tradability of EUAs; firms can supplement or divest of their initial allocation in the market. The risk is that they can profit from over-allocation without making any real efforts to cut emissions. If the EU wants to act fast to reduce the surplus, it may have to cancel already allocated EUAs, something which is not addressed by the EU ETS legal framework.

The goal of the EU ETS

The purpose of the EU ETS is to allow firms whose levels of emissions fall below the number of allocated EUAs to sell spare ones in the market. However, the EU ETS envisages that this reduction in emissions levels would occur as installations develop greener, more innovative technologies of production which would pave the way towards low carbon economies in the Member States.

It is questionable whether selling surplus EUAs on a large scale complies with the environmental goals and spirit of the EU ETS. The long-term goal of emissions trading is not limited to trying to achieve reductions wherever possible without a concerted strategy and in reliance upon incidental decreases in industrial production. A recent report by the UK Committee on Climate Change highlighted the risk that reduced production caused by the economic recession would reduce the price of EUAs. This may disincentivise investment in green technologies by making it more attractive to continue purchasing EUAs without any effort to improve the environmental credentials of production.

Effects of the surplus on the emissions market

The EU emissions market has grown from $7.9bn in 2005 to $119.8bn in 2010 and now makes up over 80% of the worldwide carbon market value. Selling the considerable EUA surplus on the open market would increase the supply of EUAs and potentially drive down the market price without corresponding improvements in technology. Without a viable market, the very premise of the EU ETS, the entire regime would collapse.

What can the EU do?

The EU is faced with increased pressure to reform the EU ETS and remove at least some of the excess EUAs from the market. However, the EU Parliament has recently voted against an increased level of reductions from 20% to 30% from 1990 levels by 2020.

The EU ETS Directive is silent on whether EUAs, once allocated, can be cancelled despite their validity. It may well be that the EU wishes to retain the discretion to cancel EUAs if environmental policy so dictates. This is concerning for those firms that have been stockpiling EUAs which they are not using to cover their emissions. Cancelling valid EUAs at will could effectively amount to setting more stringent emissions targets through the back door. The effects of this uncertainty on the workability of the emissions market remain yet to be seen.

Does it matter how emissions reductions are attained, so long as they are attained? Arguably, yes. The danger posed by the EU ETS as it currently stands is that it may be disincentivising polluters from self-scrutiny and technological innovation in favour of taking the easy way out. Absent genuine emissions reductions through the development of green technologies, the effectiveness of the EU’s environmental policy in the fight against climate change could be seriously called into doubt.

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