19 June 2019

Editorial Viewpoint: EU-ETS: SOS

by Michael Edmund, Editor

"Failure is the foundation of success, and the means by which it is achieved" - Lao Tzu

Its raison d’être is ambitious: controlling greenhouse emissions, no less. But it has recently been criticised as irrelevant; and its prognosis so poor as to need "life support"; while Climate Commissioner Hedegaard, apparently attempting its resurrection, has spoken in terms of a "final wake-up call." Notwithstanding the progress on emissions that has been made in the fifteen years since Kyoto, these recent comments might suggest that the European Emissions Trading System (ETS) has collapsed; they may even support a charge that it has failed completely. Whether or not this final accusation is justified, there can be little doubt that the ETS is in crisis. But it was not always like this. Conceived as the cornerstone of the European response to the 1997 Kyoto protocol, the ETS was the first - and is still the largest - international system for trading greenhouse gas emission allowances.

Does the ETS matter? Has the market failed? Is an interventionist stance now more appropriate?

In short, the answers are: Yes, No and Maybe.

A cornerstone is relied upon for the integrity of the edifice it supports and, like all good ideas, the ETS is simple. In essence, a carbon permit allows the holder to emit one ton of carbon dioxide, and is issued to countries or groups that have reduced emissions below their Kyoto quota. If an environmentalist organisation plants enough trees to absorb one ton of CO2, it might sell the resulting permit to a steel producer that expects to exceed its emissions quota. An industrialised nation, for which reducing emissions might be relatively difficult, may buy permits from a less industrialised one. Carbon (or the right to emit it) therefore acquires an economic value; and a market is created for the buying and selling of the rights to emit it. This market becomes possible because the goal of the Kyoto Protocol is to reduce emissions on a global basis.

Back in April 2006, the price of carbon permits hit a peak of €32 per ton, but has since almost completely collapsed. It dropped by more than one-third during 2012 alone and recently traded below €3, less than 10% of its peak value. This is somewhat lower than the €20 to €30 price point suggested by analysts as necessary to support investment in clean technology. Therein lies a clue to the split personality of the ETS: it is an economic device but it has been set environmental objectives. Unsurprising, then, that Germany's 'Der Spiegel' has asked pointedly if it can ever be relevant again.

However, the environmental side of the debate was made crystal clear earlier this month, when the American National Snow and Ice Data Center [NSIDC] launched a website offering "the latest satellite data and periodic scientific analysis on surface melting of the Greenland Ice Sheet." According to the NSDIC, 2012 was the first year on record when the entire ice sheet experienced melting at some point in the season [my italics - Editor]; moreover, the overall extent of the melt was the largest in over thirty years, and it lasted almost two months longer than average.

Greenland, it seems, is melting.

The extent of mankind's role in climate change has been a subject of what might be termed heated debate; and it is beyond the scope of this article to discuss it further than simply repeating one of the findings of the 2007 Fourth Intergovernmental Panel on Climate Change [IPCC] Assessment Report. It found that "Anthropogenic change has been detected in surface temperature with very high significance levels (less than 1% error probability)."

Mankind, it seems, is melting it.

Elsewhere, recent figures compiled by the The European Environment Agency indicate that greenhouse gas emissions for the European Union increased by 2.4% in 2010, despite the economic recession and the policies intended to tackle climate change. The Agency attributes the rise to signs of economic recovery in some areas, and to a colder winter, adding that emissions might have been higher still if it were not for a strong increase in the production of energy from renewable sources. The rise followed a sharp decline in emissions between 2008 and 2009, itself largely attributed to the financial crisis and recession.

Emissions are no longer falling, but rising once again.

Therefore, and for these reasons at least, the success of the ETS matters a great deal.

The recent economic recession has acted like lead weight, dragging down national economies as well as the price of emission. That much is pure economics; and this is no forum for economic theory. But it is hardly a revelation that a market is nothing more than than a vehicle for transactions, where price is set by buyers and sellers and influenced by factors such as the levels of competition and of supply and demand. As such, a market can neither succeed nor fail: it is what it is.

One significant factor in the spectacular collapse of the price of carbon permits is reduced demand because of the recession: emitters need fewer permits because they are emitting less. And when recession finally gives way to economic growth, the usual wisdom is that increasing demand will force the price back upwards. The problem will therefore take care of itself naturally, there is no need to intervene and we have at a single stroke answered two of the questions posed above. Inevitably, the situation that faces the ETS is much more complicated and there is certainly no room for this degree of complacency. Many other factors are in play, one of which is the relationship between availability of shale gas in America and coal exports to the EU. In short, supply of carbon has dramatically increased at the same time as demand for permits has shrivelled away. These circumstances have conspired to create the ridiculous situation (in environmental terms anyway, if not in economic ones) that it is profitable in Europe to burn "new" coal for electricity, and loss-making to burn "old" gas, bought at prices negotiated some time ago.

In essence, therefore, carbon permits constitute the point where environmental concerns collide head-on with economic realities. And so the real problem is that, economically speaking, emission needs to be cheap (particularly in a time of recession) because of the need for a low price for energy and manufactured goods. Environmentally speaking, however, emission must be made expensive - because ultimately the price is paid by the planet. A final thought is that as emission becomes more expensive, green alternatives become more economically appealing, raising the attractive prospect of a market-oriented positive feedback mechanism requiring no intervention.

In purely economic terms, market interventions represent an artificial distortion of the price. No clearer example can be given than that of the recent decision on backloading: the vote in the European Parliament to restrict temporarily the supply of emission permits has raised hopes that the carbon price will rise by €2-3. The environmental aspect is the hoped-for prevention of the release of 900 million tonnes of carbon dioxide into the atmosphere. The original design of the ETS incorporated a steady reduction in the supply of permits over time, and so this latest intervention does not represent a major shift in policy. More generally however, once a market price is judged according to external criteria, then it ceases to be purely a market. The twist is that intervention will increase the price of emissions - that is the intent, after all - and ultimately it will be the hard pressed consumer who will pay - one way or another. In other words, intervention equals political unpopularity, perhaps particularly acutely in a time of recession. But this is by itself no reason not to intervene: perhaps the market needs a different measurement of the price of a carbon permit, one that takes more account of the environment. And it definitely needs a great deal more public concern over climate change.

The ETS was conceived long before the current economic crisis; and the price of a carbon permit is variable, simply a reflection of prevailing market conditions at the time it is determined. These market conditions have clearly changed dramatically in the last fifteen years - even if the environmental issues have not. "Business as usual", on a new surge of cheap carbon, is no way to protect the planet. The money needed for investment in renewable technology must be found from somewhere, at a time when there is not much money to be found anywhere: one might say that the economic climate is not conducive. Philosophically, this represents the difference between genuinely investing in the future (as distinct from the weasel words used to disguise mere current spending); and repaying the (environmental) debt accrued from past carbon use. Either way, if the market is to be judged by some other yardstick, such as its ability to raise this money, then it should be also judged by the standards that apply to other revenue-raising measures - such as a carbon tax, for example.

The ETS may be in crisis, but it has not failed. And Lao Tzu's encouragement was never more appropriate. He also suggested that a journey of a thousand miles begins with a single step. We have made the first steps with the ETS; now it is clear that we must make more. This journey is far from over. Or, as Vance Havner once put it, albeit in a different context, "It is not enough to stare up the steps - we must step up the stairs."

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