NEWS

The cost of carbon rises in Europe—along with complaints

06/02/2008

COPENHAGEN, Denmark—As the U.S. debate over climate change regulation begins in the Senate, both U.S. lawmakers and Europeans are mulling over the painful lessons learned in the European Union’s pioneering experience with such market-based controls.

Europe accounts for three-fourths of the global carbon emission trade, but its toothless carbon trading scheme based on free allowances has so far only succeeded in increasing power prices without making a dent in greenhouse gas emissions. So the European Commission, the European Union’s executive body, has cut free permit quotas this year and plans to switch to an auction system for 2013.

The controversial plan is meant to drive up the cost of carbon and force companies to curb emissions and is being met with loud complaints from heavy industry.

"The system during the first three years was fundamentally flawed," said Henrik Hasselknippe, the director of E.U. emissions trading analysis for Norwegian consultancy Point Carbon. "It succeeded in everything but cutting emissions. In the first phase, there were too many allowances in the system, so there was no need to cut emissions."

The European Union’s Emission Trading Scheme, or ETS, covers more than 10,000 electricity generators and refineries that emit about half of the European Union’s carbon dioxide. The ETS accounts for about three-fourths of the €40 billion global carbon market.

Carbon trading works by forcing participating countries or companies to trade a limited number of emission permits. A tightening supply of permits should increase the price of carbon and encourage companies to become more energy efficient or decrease their emissions by switching to renewable energy or adopting new technologies such as carbon capture and storage (CCS).

The European Commission earlier this year announced that it was aiming for E.U. countries to slash greenhouse gas emissions by 20 percent from 1990 levels and generate 20 percent of European power from renewable sources by 2020. At the heart of the plan lies the carbon trading scheme, which is supposed to deliver about 60 percent of the emission cuts.

Emission credits, a case of too many and too cheap

But the first phase of the scheme, which ran from 2005 until 2007, failed. Lacking accurate CO2 measurements and under pressure from lobbyists, the European Union allocated too many free carbon credits. As a result, even as emissions of carbon dioxide remained below the quota of permits allocated for free, they actually rose slightly last year among businesses participating in the trading scheme.

To address the problem, the commission cut the allocation of carbon emissions permits by about 9 percent for 2008-2012 and has proposed forcing energy companies to buy them from 2013 on, instead of receiving them for free. At least a fifth of the money raised through the auction is supposed to be used for other projects to reduce greenhouse gas emissions, such as CCS technology and stopping deforestation, as well as research and development for new sources of renewable energy.

The commission also wants to allocate the permits centrally instead of leaving that up to individual nations as before and to extend the scheme to other heavy industries like cement, steel and paper. An analysis by Swiss bank UBS shows that the second and third phases (the latter lasting between 2013 and 2020) will be about 10 percent and 20 percent short of permits, respectively.

"Many of these elements would be appropriate also for a federal carbon cap-and-trade system in the United States," Hasselknippe said. "There can be differences on how much you give for free and how much you auction, but the principle will be the same. It is inevitable that we will see the emergence of a federal system in the United States, and we won’t have to wait too long."

Some industries threaten to move out of Europe

The specter of permit auctions caused a swift outcry from European industries likely to be affected. Power companies said they would curb investments, while other industries threatened to move operations outside the European Union.

"The auction is a big change. The majority of E.U. companies covered have or are planning to reduce their investments," Hasselknippe said. "The main protests we heard are from industry sectors like metal and cement, which face international competition. They can move their production outside of Europe. The power sector is opposing the technical details of the auction plan, but power companies will recoup their costs from consumers."

Still, German energy giant E.ON AG announced it would cancel four planned coal power plants in response to the new auction plans. Other players in heavy industrial sectors in Germany, such as the car, steel, cement and glass industries, argued that forcing them to buy emission permits at an auction would put them at a disadvantage compared to U.S. and Asian competitors that do not participate in carbon trading.

Berlin, backed by France, the Czech Republic and Austria, wants such sectors to be excluded from the carbon permit auctions unless the rest of the world signs up to similar penalties for polluters. The heavy industry found an unlikely ally in German Chancellor Angela Merkel, who had been instrumental in hashing out the original plan to cut E.U. emissions, but now has come out in favor of concessions for certain industries.

This does not sit well with European Commission President José Manuel Barroso, who argues that Europe must become the first low-carbon economy. He and British Prime Minister Gordon Brown would like to delay specifying the exemptions to certain industries until the United States, China and India have been persuaded to sign on to similar measures.

Barroso says the commission’s plans would cost Europeans €3 a week per person and would eventually save €50 billion as they reduce oil and gas imports into the European Union.

German energy users, unions and car lobbies worry about competitiveness

But German energy users’ lobby VIK complained earlier this month that forcing German industry and energy companies to buy permits for their greenhouse gas emissions from 2013 at auction will drive up energy prices, putting the possible cost for the German industry at well over €100 billion between 2012 and 2020. "There will not be one more [metric ton] of CO2 emissions saved through such an auction," VIK said in a statement. "But power prices would be rising further for consumers."

Citing a study by Dutch consultancy Ecofys, VIK said that it would cost German power companies €1.6 billion over those eight years to meet tighter CO2 caps. On top of that, competition for permits could drive auction prices to a total of €85.4 billion for power companies and to €25.5 billion for other industries during that period, VIK said.

The Germans share Americans’ love of big cars, so, unsurprisingly, Germany’s powerful car lobby has also attacked the European Union’s plans to cut greenhouse gas emissions. VDA, the German Association of the Automotive Industry, led by former Christian Democratic Minister Matthias Wissmann, opposes any general E.U. limit on emissions.

Europe’s steel industry and a workers’ union last month also warned that the European Union’s efforts to curb climate change could put tens of thousands of steel industry jobs at risk. In a joint statement, the European Metalworkers’ Federation and the European Confederation of Iron and Steel Industries (EUROFER) asked the European Union to strike a fair balance between fighting climate change and guarding the industry’s competitiveness. Gordon Moffat, EUROFER director general, said the European Commission proposals would cut growth in the steel industry and could increase the price of steel by 10 to 20 percent per metric ton.

Low carbon price fails to spur CO2 capture and storage

But supporters of the trading scheme say it is precisely these higher costs that are needed to spur the technological innovations needed to cut carbon emissions. Europe’s carbon trading scheme has so far produced a carbon price too low to make it economic to bury coal plant carbon emissions underground.

At its lowest point, the price of carbon emissions sank below €1 per metric ton in the scheme’s first trading phase. That is a far cry from the CO2 price between €50 and €100 per metric ton that Jeremy Bentham, Royal Dutch Shell PLC’s chief economist, predicted in February as the price that would be needed to drive investment in CCS technology. Rajendra Pachauri, chair of the Intergovernmental Panel on Climate Change, the U.N. climate panel that last year won the Nobel Peace Prize for its work on climate change, has said that a price of up to $100 per metric ton by 2030 should be the goal.

For now, experts are not sure that even the auction system will push the European price there.

"For Phase 2 until 2012, we will see a carbon price average of €30 per ton, increasing toward the end of the period," said Hasselknippe. "In Phase 3, we expect that to be easily above €50. That is not going to necessarily be enough to ensure massive penetration of carbon capture and storage, but will enable renewables."