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Is the EU Emission Trading Scheme working?

The EU Emission Trading Scheme (EU ETS) is the centrepiece of Europe's policy response to climate change. It covers over 10,000 factories, power stations and industrial plants, which collectively account for around half of Europe's carbon dioxide emissions.

Unsurprisingly, such a large scheme has received some criticism. The scheme is not perfect, and four of the most common criticisms are outlined briefly below.

1. Are there too many allowances?

What is the criticism?

According to Sandbag, an environmental campaigning organisation, certain sectors of the EU Emission Trading Scheme have been given more allowances than they need. This means that they do not have to reduce their emissions and are able to sell the allowances for a windfall profit.

How justified is it?

While some industries do have more credits than they need, the scheme as a whole requires emission cuts. Sandbag's analysis shows that in 2008, industrial and power companies had to reduce their emissions by 190 million tonnes.

Each member state decides how allowances will be distributed among economic sectors, and they usually try to protect certain industries from becoming uncompetitive by giving them free allowances. This leads to unequal situations between sectors.

If the participants in the scheme believed that there are too many allowances, the price would fall to zero. However, EU Emission Allowances have a strong price.

What is the impact on Carbon Retirement?

If there were more allowances in the EU Emission Trading Scheme than the participants needed, retiring them would not necessarily reduce emissions. However, the scheme will require emission cuts, which means that all allowances will be used. Each allowance that is retired therefore reduces emissions by one tonne.

2. Is the price likely to collapse, as it did previously?

What is the criticism?

In spring 2006, the price of EU Emission Allowances collapsed, almost to zero. This was during phase one of the scheme, which ran from 2005 to 2007. It could demonstrate the inherent unpredictability of the system and show that a similar collapse could happen again.

How justified is it?

The price collapsed when the European Commission released the first batch of verified emissions data. Before this, the level of carbon dioxide emissions had been based on estimates. The data showed that too many allowances had been distributed, because the regulators had thought that levels of emissions were higher than they actually were.

The European Commission now releases verified emissions data annually and the market has a clear understanding of emissions volumes in Europe. This means that an event like the price collapse in 2006 is unlikely to reoccur.

The price of EU Emission Allowances changes, mainly due to changes in the price of energy and industrial output. The economic recession that started in late 2007 caused the price of allowances to fall, because polluting companies were producing less carbon dioxide. These changes do not cause systemic shocks like the 2006 collapse.

What is the impact on Carbon Retirement?

As demand for EU Emission Allowances changes, the price you pay for retiring allowances changes. In summer 2007, for example, when the price of oil was very high, EU Emission Allowances were relatively expensive. In spring 2009, when industrial output was low, allowances were relatively cheap.

A reduction in the price all the way to zero would indicate a surplus of credits, and retiring allowances would not reduce emissions. However, this is considered highly unlikely.

3. Does the scheme cause energy intensive industries to move outside Europe?

What is the criticism?

Europe– particularly through the EU ETS – has stronger climate change legislation than most other parts of the world. This can be a burden for carbon intensive and trade-exposed industries such as aluminium and steel, which may choose to move outside of the Europe to avoid carbon costs imposed by the EU ETS. This is often called ‘leakage'.

How justified is it?

A small amount of leakage is thought to have occurred as a result of the EU ETS. Point Carbon's annual survey into carbon marketsshows that approximately one in twenty companies trading in the EU ETS have already moved some part of their operations as a result of the carbon price; three in twenty are considering moving some part of their operations and sixteen in twenty are not.

EC and member states are moving to protect industries that may move outside the EU, by allocating them free credits rather than requiring them to buy credits through auctions.

What is the impact on Carbon Retirement?

If Carbon Retirement increases the price of EU Emission Allowances, it may increase the amount of leakage and therefore reduce emission reductions within Europe. This is not likely to be a significant issue because the impact of Carbon Retirement on carbon prices is likely to be very small, while exposed industries will receive free allowances.

4. Is the cap tight enough?

What is the criticism?

Some environmentalists feel that the EU ETS should have fewer credits and create larger emission reductions.

How justified is it?

Annual allocations of EU Emission Allowances across Europe during phase II (2008 – 2012) are approximately 7% lower than emission levels in 2007. During phase III (2013 – 2020), the allocation will reduce by approximately 1.7% per year. If a global agreement is reached in Copenhagen in December 2009, the EU will commit to a further 10% reduction in emissions by 2020.

What is the impact on Carbon Retirement?

The value of Carbon Retirement as an emission reduction mechanism does not depend on the sufficiency of the cap. While we would like to see a smaller overall allocation, so long as the number of allowances requires a reduction from business-as-usual emissions, retiring allowances creates an emission reduction.

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