Sunday, July 02, 2006

Kyoto faces crucial test as new round of emissions trading begins

As climate change attains unprecedented prominence as a global public issue, we face a further test of humankind’s ability and willingness to do something about it.

The countries participating in the European Union’s Emission Trading Scheme (ETS) are set to hand in their new National Allocation Plans (NAPs) for Phase 2 of the scheme, which will cover the period 2008–2012.

Recall the recent volatility in the carbon-permit market (see my May 19 post) due to over-generous allocations in Phase 1 of the ETS. As the Phase 1 trading period neared its end, some large emitters found to their pleasant surprise that they had many more permits than expected. As those with surpluses scrambled to sell—and profit from—permits they had received for free, the market price of permits dropped from €30 to €8. Suddenly, it became cheaper for those who had run out of permits to continue high-emitting business-as-usual than to reduce emissions.

This was exactly the opposite of what the ETS’s designers had intended. None of this would have happened if the European Commission, which administers the system, had been less lenient about approving certain countries’ obviously inflated emission estimates. I predicted that the EC would learn from this embarrassment and apply greater critical scrutiny to countries’ NAPs in Phase 2, or develop instrumental safeguards against over-estimation.

Well, we’re about to find out if it has.

No doubt the member countries are mindful of the likelihood of increased critical scrutiny on the part of the EC. This might explain why almost all of them have missed the June 30 deadline for submitting their estimates of the amount of greenhouse gases (GHGs) their respective industries will emit. So far, only Germany and Estonia have submitted their plans. The UK says it is close to submitting its own, with tougher emission caps this time (its estimate for 2005 was 36 million tonnes higher than actual emissions) and a requirement that emitters buy 7 percent of the total permits at auction. In Phase 1, all permits were free.

The ETS’s proponents are careful to point out that Phase 1 was a trial, and that they expected some kinks and hiccups. These would of course be eliminated in subsequent phases. As Canada struggles to develop its own response to the Kyoto imperative, we would do well to pay close attention to the next steps in the ETS drama.

I know I will. A carbon market is in the cards; it’s just a matter of time. Stay tuned.

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