Memorandum submitted by Charles Donovan
1. THE AUTHOR
Charles Donovan is the Commercial Manager of
the Climate Change Policy Group of Enviros Consulting Ltd., one
of the UK's largest environmental consulting firms. Enviros Consulting
is a leading advisor to industry and Government on issues related
to climate change and the application of market-based mechanisms
to environmental protection. The company's experience in environmental
markets includes consulting work on the UK Emissions Trading Scheme,
the Climate Change Levy Agreements, the Landfill Allowance Trading
Scheme, the EU Emissions Trading Scheme, the Clean Development
Mechanism, Joint Implementation, and the Renewables Obligation.
Mr Donovan is also Chairman of the Executive
Committee of the London Climate Change Services Providers Group
(LCCSPG), a new business association of UK companies with expertise
in greenhouse gas emissions reductions. The LCCSPG has been formed
to capitalise upon the "first mover" advantage of British
companies in delivering climate change solutions to a global market.
The LCCSPG expects to be formally incorporated in the spring of
2005, drawing upon the support of over 70 UK organisations in
the fields of engineering, consulting, law, accountancy, verification,
information technology, education, and financial services.
Mr Donovan's written and oral testimony is provided
in a private capacity. His comments may not be construed as being
the policies of either Enviros Consulting Ltd. or the London Climate
Change Service Providers Group.
2. INTRODUCTION
Emissions trading has been embraced by international
governments as a tool for reducing greenhouse gas emissions for
good reason. Experience from other emissions trading schemes indicates
that the flexibility afforded by trading may allow environmental
objectives to be achieved at reduced cost. Due to the scale of
investment required to accomplish a low-carbon global economy,
the issue of costs and cost minimisation must be of paramount
importance to UK and international policymakers. To pretend that
we can stabilise greenhouse gas emissions irrespective of cost
would not just ignore the realities of our modern global economy,
but more importantly, would reduce our chances for success.
As demonstrated by previous testimony given
to this Committee, there are widely divergent views about the
capacity of emissions trading systems to deliver greenhouse gas
reductions on the timescale required to avert severe climate change.
While some of this criticism is indeed well founded, all stakeholders
in this debate should keep in mind that emissions trading is a
tool for accomplishing objectives, not an objective in itself.
The element currently lacking that would make emissions trading
a truly potent tool for combating climate change is the political
leadership to implement it effectively. If such political will
surfaces, emissions trading will be a powerful tactic we can employ
to cost-effectively reduce GHG emissions at a domestic, European,
and international level.
3. EMISSIONS
TRADING IS
A CRITICAL
ELEMENT OF
A GLOBAL
SOLUTION TO
CLIMATE CHANGE
European and international emissions trading
systems are both feasible and desirable methods of reducing greenhouse
gas emission. Before exploring the details of why I believe this
to be true, it is useful to quickly review the basics of how the
EU Emissions Trading Scheme (EU ETS) will work.
Obligated installations across Europe will soon
be allocated a specified quantity of allowances to emit carbon
dioxide (CO2). Firms must manage these allowances in a way that
ensures that by the end of the trading period, the number of allowances
held is commensurate with the amount of CO2 emitted. For the scheme
to work there must be a scarcity of allowances; that is, there
must be, on aggregate, fewer allowances available to firms than
they need.
By appealing to the profit motives of a firm,
emissions trading encourages installations not to meet their individual
caps, but rather to optimise their output given a new marginal
cost, the cost of emitting carbon dioxide. Installations with
low-cost opportunities to reduce CO2 are expected to continue
to make emission reductions so long as the cost incurred to do
so is less than the revenue gained from selling carbon allowances.
At the right price, all firms are capable of making carbon reductions.
With demand created by the installation-level
carbon caps and supply available by firms with low-cost carbon
abatement opportunities, a market is created and CO2 reductions
can be achieved. The concept of emissions trading is in fact quite
simple. However, the implementation of such a scheme has proven
to be highly complex, raising concerns from Government and industry
about both its viability and its desirability.
In considering which approach and specific objectives
the UK Government should adopt during its presidency of the G8
and the EU in 2005, a number of potential benefits and potential
failures of greenhouse gas emissions trading must be kept in mind.
I wish to emphasise three issues in particular. These are:
— the economic benefits to the UK economy
from emissions trading;
— concerns about the fairness of emissions
trading; and
— the need for a durable long-term
strategy.
3(a) The economic benefits to the UK economy
from international emissions trading
The UK is the most significant social laboratory
in the world with regards to the application of market-based mechanisms
to environmental protection. The tradable permit schemes currently
operating or in development include those to increase packaging
waste recovery, reduce waste to landfill, increase the generation
of renewable energy, and reduce greenhouse gases.
With regards to the UK's experience with greenhouse
gas trading, there are numerous points of legitimate criticism
about the environmental effectiveness of the schemes and their
value for money. Nonetheless, a number of important benefits must
be recognised. Because of the UK ETS, we have a much improved
understanding of the quantity low-cost GHG reduction opportunities
that remain in the UK economy. Because of the EU ETS, some of
the UK's largest tanks and financial intermediaries are now active
contributors to the policy debate about CO2 reductions. Because
of the Clean Development Mechanism and Joint Implementation, UK
renewable energy companies are actively seeking business opportunities
in Africa, Asia, and Latin America. In short, we have learned
enormously, engaged important stakeholders, and stimulated industry
in a manner that could not have been accomplished by the alternatives
to emissions trading schemes.
The UK's forays into emissions trading have
also developed a new domestic industry comprised of climate change
service providers. Similar to the success of Denmark's energy
policies in developing industry-leading wind energy companies,
applications of emissions trading are making UK companies global
leaders in delivering climate change solutions. As a result of
their unique experience, UK companies are creating jobs and value
added for the UK economy from their knowledge and technical skill
on climate change issues.
UK climate change service providers are key
enablers for governments and industry to deliver the environmental
objectives of climate change policies at minimal cost. The economic
benefits of the UK's leadership on GHG emissions trading lend
legitimate support to its desirability.
3(b) The perceived fairness of the EU ETS
While the EU ETS has so far been championed
by the UK, attention must be given to short-term implementation
issues to ensure that the European experiment with market-based
greenhouse gas regulations achieves its objectives and, in turn,
lays the foundation for coordinated global action to reduce greenhouse
gas emissions. One of the most pressing issues for consideration
in the short-term is distribution of the costs and benefits of
CO2 reductions across industry.
The EU ETS has the potential to increase costs
for industry in two ways. Installations that expect to exceed
their CO2 caps will need to make emission reductions or purchase
allowances from other market participants. These may be referred
to as the direct costs of carbon trading. Companies also must
adapt to changes in energy prices that result from the EU ETS.
These are often termed the indirect costs; they do not arise from
installation-level caps but rather, the way in which the market
responds to CO2 caps.
While much attention has been paid to the direct
costs of carbon trading, the indirect costs pose the greatest
financial risk to industry. For UK industry in particular, financial
risk will become manifest most immediately through an increase
in electric power prices. Despite the complaints from some economic
sectors about these prices rises, this is how carbon trading is
intended to work. The EU ETS was designed to send a price signal
to electricity users indicating the environmental cost of consumption.
While this is likely to work in the UK, the
price signal will not be seen in all EU Member States. In countries
where tariffs remain highly regulated, electricity prices will
not accurately reflect the cost of carbon. A legitimate argument
can be made that in this respect, the EU ETS will create an unfair
playing field. However with low carbon prices, the distortion
is likely to be quite small.
Perhaps a more compelling issue with regards
to the perceived fairness of the EU ETS is the potential for a
transfer of wealth from power consumers to power generators. Power
generators, particularly those in the UK's liberalised electricity
market, will seek to increase the price at which they sell electricity
by the marginal cost of emitting CO2. This is how a competitive
market is intended to work. The problem is that the total revenues
that will be gained by power generators by passing carbon costs
to consumers will far exceed the total costs from carbon trading.
This is a direct result of the decision taken at a European level
that most carbon allowances should be given away for free.
It is surprising—as well as potentially
damaging to the viability of the EU ETS—that this issue
has not received wider consideration. Perhaps less surprising
is that power generators have not yet explained to consumers and
the Government the magnitude and eventual use of the revenues
they will gain.
Concerns regarding wealth transfer have also
been raised with regards to allocation by some EU countries of
more CO2 allowances than are needed by their industries. A surplus
of allowances attributable to unrestrictive carbon caps is expected
in several EU Member States. Over-allocation is not just counterproductive
with respect to the underlying objective of reducing greenhouse
gases, but also raises troubling questions about the underlying
logic of the scheme itself.
If the benefits of emissions trading are to
be fully realised, the supply of allowances into any emissions
trading scheme must be the result of investment in emission reductions.
This holds true for trading on any political level, whether it
be domestic, European or international. If such a guideline is
widely observed, there will be no doubt about the desirability
of emissions trading systems as a tool for reducing greenhouse
gases.
3(c) The need to place emphasis on long-term
goals as much as short-term objectives
Depending upon the actual rate of economic growth
within Europe over the next three years, the allowance deficit
created by the National Allocation Plans of EU Member States will
create demand for CO2 allowances of between 5-50 million tonnes
per year during Phase 1. With respect to the long-term objective
to stabilise atmospheric GHG emissions, it is almost trivial.
Nonetheless, if the EU ETS is supported by a durable greenhouse
gas policy framework, the reduction will be part of a greater
achievement.
While we must have some focus on short-term
objectives of climate change mitigation policies, we can not afford
to be myopic. Climate change mitigation is not primarily an environmental
problem, but rather an economic one. For this reason, effective
climate change policy development in the UK will require more
significant participation from the Department of Trade and Industry,
the Treasury, and other Government ministries charged with management
of economic affairs. The task facing us is to fundamentally change
the carbon-intensity of the domestic and global economy. Considering
the pervasiveness of carbon energy sources in our economy and
the level of investment that has been made in its infrastructure,
it is clear that we face an unprecedented task. To reduce carbon
intensity while at the same time improving quality of life, the
only course of action available is not to contract, but to grow.
This growth must, however, be based on new models of infrastructure
investment.
Due to the long-term nature of capital investment
in the energy, transport and industrial sectors, we must focus
on creating market conditions that will facilitate substantial
GHG reductions into the future. Establishing a cost of carbon
through market-mechanisms is a first step. This must be quickly
followed by the establishment of a long-term signal to energy
consumers about what future carbon costs are likely to be. With
respect to the decision-making process of businesses, there is
a growing body of evidence that without a reasonable level of
certainty about the scope of future climate change regulations,
firms will delay or cancel plans for investment.
Without a durable climate change policy framework,
the EU ETS will not reach its potential. For this reason, achievement
of the UK's publicly stated target to reduce emissions to 20%
below 1990 levels by 2010 can help shape the present-day choices
being made by industry. Perhaps even more important is the goal
of a 60% reduction by 2050 outlined in the Government's 2003 Energy
White Paper. More concrete proposals are needed about how and
at what rate the UK will achieve this goal in order to increase
confidence on the part of business that low-carbon investment
is the most prudent alternative.
It is essential that politicians, people in
business, and the general public develop a deeper shared understanding
of the impetus for climate change mitigation. Significant levels
of education and outreach will be required to convince all levels
of society of the need to act. In particular, more dialogue outside
of the United Nations Framework Convention process should be initiated
to gain widespread consent for this urgent global project.
4. SUMMARY
Over 40 years ago, Americans were urged by their
political leaders to support a massive financial undertaking in
order to land a man on the moon. That first lunar voyage mobilised
the resources of an entire nation on an urgent time scale to achieve
a breathtaking goal. With a sustained and disciplined effort,
the race to stabilise GHG emissions can capture the imagination
of British citizens in just that same way.
The UK has vast technological, financial and
creative capabilities that can be organised for the purpose of
climate stabilisation. The G8 and EU Presidencies provide a unique
opportunity to inspire widespread mobilisation. As the UK already
possesses all of the resources and talents needed, Government
must now show its leadership by developing a major national commitment
to technological and social research on climate change mitigation
and by effectively implementing policies that will contribute
to a low-carbon economy.
While building its vision for the future, the
Government should not lose sight of the remarkable aspects of
the achievements to date. The EU Emissions Trading Scheme is the
first cap and trade emissions trading system in the world to be
implemented for the reduction of greenhouse gases and it is the
first time that any government has so comprehensively regulated
carbon dioxide emissions. But for the EU ETS to be truly successful,
it must not be just an achievement of innovative environmental
regulation, but also deliver real reductions in emissions that
will lend support to our 21st century race to the moon.
10 January 2005
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