Sunday, November 12, 2006

Greenhouse gas reductions in the EU: talk meets reality
You will recall my May 19 post, in which I described the teething problems in the European Union’s Emission Trading Scheme (ETS). After the ETS’s first year of official operation, the price of carbon crashed to around €8 per tonne, making it cheaper for Europe’s biggest emitters to continue business as usual than to cut emissions.

To make things worse the price then spiked, which, according to some observers, enabled some of Europe’s largest emitters to actually make an additional profit from the sale of their excess permits.

This is exactly the situation the ETS’s designers set out to avoid. The ETS was supposed to make business-as-usual expensive enough to compel heavy emitters—including and especially coal-based electricity generators—to find ways to cut emissions without sacrificing economic output. To discourage business-as-usual, the ETS was designed to make carbon permits scarce and therefore expensive.

So how did carbon become so cheap? Because rather than ensuring permit scarcity, the system allowed permit abundance. It is difficult to say precisely how this happened, since certain aspects of the permit allocation process are confidential. But one thing is clear: the European Commission issued more carbon permits than emitters could use. This means that somewhere along the line, somebody over-estimated the amount of carbon Europe’s heavy emitters would emit. And permits were allocated based on this over-estimation.

Regardless of the methodologies by which carbon emissions were estimated, I suspect the central reason for this over-allocation was the realization that the ETS would surely cause electricity prices to rise—and rise significantly—though the European Commission tries to make it look like the scheme is only one factor among many affecting the price of electricity (see the EC’s emissions trading website).

All this raises a fascinating question: how much is Europe really willing to pay to implement Kyoto? A possible answer: not as much as the ETS would cost, if the scheme were administered with brass-balled discipline. And what would it cost? It could well be that certain EU members, whose electricity systems are 50 percent coal-powered, are not much interested in finding out.


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