By most measures, Europe's carbon emissions trading scheme has had a successful start. In its first year -- 2005 -- the scheme transacted a total of 230 million metric tons of CO2, worth about €4 billion. And since January this year, volumes and prices, which reached about €27 a metric ton in March, have been rising steadily. A whole new industry -- of exchanges, brokers, research firms, consultants and publishers -- has been created, seduced by the promise of what is expected to be a multi-billion-euro industry.
Under the scheme, the European Union's 25 national governments agree CO2 emissions targets with the European Commission, before apportioning carbon credits to installations in their countries.
In the first phase, to the end of 2007, the trading scheme covers about 5,000 EU companies, or 12,000 plants, representing about half of all current CO2 emissions in Europe.
Over time, governments are expected to reduce the number of free carbon credits available, thus forcing companies to pay for extra allowances in a marketplace, or to invest in new technologies to reduce their footprints (and costs).
Increasing Importance
Sebastian Foot, of ICF Consulting, expects carbon prices to remain sufficiently meaningful to compel companies into thinking about adapting and replacing plants during the second phase, which starts in 2008. The carbon issue is "beginning to reach the boardroom", he says.
For now, however, high gas prices have dented the trading scheme's effectiveness, with many power plants switching away from gas to coal -- a cheaper, more polluting fuel. Belgian bank Fortis recently said carbon prices would need to double -- or gas price would need to fall by 30% -- to make gas viable again.
Meanwhile, uncertainties surrounding the future of the scheme are causing some companies to wait before making hard decisions. Critics of the scheme say its timeframe -- which extends only to 2012 -- does not provide sufficient clarity for companies to make long-term commitments.
The emissions trading scheme is, by its nature, a creature of governments. Bureaucracy has already hampered its start, and there are worries that officialdom will get in the way of its future success.
National Allocation Fights
Some countries, including the UK, were late in agreeing their national allocation plans, and delayed introducing necessary laws before the scheme came into force. A number of national carbon credit registries did not come into existence until the middle of last year. Italy, for example, has been more than a year late in entering the scheme.
In a report in December, the European Commission conceded that problems with national allocation plans had hampered the first phase. The report said: "The late notification, approval, and finalization at national level of some plans introduced uncertainties not only for respective national authorities and business, but also for actors in the allowance market across Europe."
For its part, the UK has entered into persistent wrangles with the commission over its emissions targets. Having agreed most of its 2005-07 national allocation plan, it went back to Brussels in late 2004 to ask for an extra 19.8 million metric tons.
After the commission rejected that proposal, the UK last November went to the Court of First Instance, Europe’s second-highest court, winning the right to less strict limits. Recently, however, the commission said it would continue to reject the UK’s proposal on the grounds that it missed a deadline last year for re-submitting its plan.
The UK also looks set to miss the deadline for submitting its plan for the second phase, which the commission wants in Brussels by June. The commission is concerned that the UK will open the way for other governments to make similar delays.
At the same time, the UK’s Guardian newspaper reported that different government departments were arguing over whether the UK could hit its 2012 target of reducing CO2 emissions by 20% below 1990 levels.
Another problem with the scheme has been uneven implementation of national allocation plans across the EU. Dieter Ameling, head of the German steel industry association, recently told Financial Times Deutschland that German producers were suffering from stricter allocation plans than their counterparts in Britain and France. Ameling said the system should be put on hold until the problem, as he saw it, was solved.
Consistency Required
A report from the Center for European Policy Studies, which looked at the first year performance of the scheme, recommended that the commission seek more uniformity in how national allocation plans are implemented. Some observers argue the system would be better administered centrally from Brussels -- though that is likely to be resisted by national governments.
Aviation is due to join the scheme in the second phase, in 2008. But there are significant obstacles to overcome before that can happen.
Among the challenges are finding agreements between countries on targets for the sector, and creating a system that treats all airlines -- including EU and non-EU groups, and "incumbent" and “low-cost” carriers -- equally. Some airlines have argued that bringing into the scheme non-EU airlines that use EU airspace would lead to legal headaches, with the US likely to oppose such a move.
The commission has yet to decide on such crucial issues as how emissions of airlines will be calculated, how credits will be apportioned, and whether it will give away credits, or ask airlines to pay straight away. Whatever the scenario, it is clear that -- unlike other sectors -- airlines are unlikely to cut emissions by very much, even if there is an incentive to do so.
Aircraft manufacturers say they have done much of what is possible to increase fuel efficiency and cut emissions.
European airlines are currently consulting with the commission over the scope and shape of the emissions trading scheme for their industry, with low-cost and bigger airlines battling over the rules. In one corner, the bigger airlines such as British Airways and SAS are in favour, but want to see the scheme’s remit limited to intra-EU flights.
Jan Skeels, secretary general of European Low Fares Airlines Association, stresses the difficulties of implementing the scheme in the sector, and argues any system should take into account the fact that low-fare carriers tend to fly newer, more efficient planes.
The low-fare carriers argue that the scheme, depending on the options adopted by the commission, could be disastrous for no-frills carriers, and could frighten off customers by raising ticket prices substantially.
Adaptation Possible
Research by Dutch group CE Delft finds that in most scenarios ticket price rises would be minimal, running to a few euros for most types of flights. And the report finds that the trading scheme could be adapted for aviation, despite the difficulties.
“Beforehand, many parties thought it would be very difficult because there were many difficulties. Our study showed that these difficulties can be overcome and that emissions trading is a viable option,” says Bart Boon, author of the research, which was commissioned by the European Commission.
Given the wrangling, the involvement of airlines is likely to be limited at the beginning of the second phase. Jonathan Shopley, chief executive of Carbon Neutral, which works with companies and others to offset carbon emissions, says he does not expect aviation to play its full part five to ten years.
The European Commission is due to report on progress in June, and to make recommendations for the second phase.
Under the Kyoto Protocol, the maritime industry is also due to join the emissions trading system during the second stage. But, compared with aviation, there has not been much pressure on that industry to get involved with the scheme, and Foot says its involvement in 2008 is unlikely.
Likewise, consultant McKinsey says other areas of the transport sector -- such as cars and buses -- would be unsuitable for emissions trading and governments should consider other remedies to reduce emissions.
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This column has been reprinted courtesy of Ethical Corporation. It was first published on April 4, 2006.