The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents

Memorandum submitted by Cap & Share UK



    — Recent scientific findings about tipping points in the climate system point increasingly to the existence of a global climate emergency.— Addressing this emergency requires (among other things) swift and sweeping reductions in greenhouse gas emissions, realistically achievable only by "capping carbon".— An effective capping system would guarantee that a cap was met, would do so in a manner attracting public support, and ideally would do so efficiently.

    — In stark contrast, the EU ETS has so far been ineffective, opaque (to the public and even to regulators), iniquitous (rewarding existing polluters at the expense of the general population) and inefficient (delivering the wrong economic incentives).

    — This design of the EU ETS appears to demonstrate regulatory capture by the carbon-intensive industries, akin to that demonstrated recently by the financial services industry.

    — The EU ETS can be reformed by embedding it within an upstream system, which would be not only effective, but also transparent, fair, and even inspiring.

    — An EU system could be linked with other carbon markets elsewhere, but a global system would be simpler, more transparent, more effective and may be the only option open if we are to address the crisis effectively in the very short time remaining to us.


  1. Dramatic developments in climate science are suggesting the need for much lower targets (than those given in the 2007 IPCC report) for greenhouse gas concentrations—in the range 300-350 ppm CO2e or even lower. Such targets take the policy discussion out of the range that the Stern Review even considered politically achievable, but failure to stabilise at these lower levels is likely to lead to a runaway process resulting in increases of 6 degrees C or more. In the history of the planet, changes of this magnitude were associated with the extinction of 95% of all species. This is now a global emergency. If dangerous climate change is to be avoided or at least contained, it is crucial that very rigorous measures are taken now—and the goals set by the UK and EU are nowhere near ambitious enough.

2. Rapidly fluctuating energy prices are focussing minds on energy security. Meanwhile, the banking and financial collapse and severe deterioration in the global economic situation are mirrored by a growing collapse in public confidence in sophisticated financial instruments, and a heightened awareness and cynicism about financial scams, tax avoidance and the like. This does not bode well for the future of the EU ETS if and when it is perceived, correctly, to reward the worst climate polluters with windfall profits at the expense of the public and those in fuel poverty.

  3. A central question of this Inquiry is whether the EU ETS can be extended into a global carbon market system which could transform the global energy economy to the degree sufficient to address the climate crisis. As the EU ETS now stands, our answer to this question is "no". The EU ETS is a flawed system, and its design demonstrates that the European (and national) political systems appear to be powerless to mobilise against, and impose an adequate countervailing power over, vested interests whose economic power is based on the use of carbon energy. These interests must be reined in if climate change mitigation is to be effective on anything like the necessary scale.


  4. To avert runaway climate change, it is imperative that we rapidly set an absolute global cap on CO2 emissions (decreasing year by year), which is low enough to bring the concentration of CO2 in the atmosphere down to the required level. An EU cap can be seen as a step towards this goal, so we start by considering an EU-wide scheme.

5. In discussing the EU ETS we will use for comparison the Cap & Share scheme, running at the EU level. Under this Cap & Share scheme, there is a single overall cap for EU emissions. This cap is applied "upstream" by regulating the amount of fossil fuels—coal, oil and gas—introduced into the EU economy (being imported or extracted from the ground). The cap is enforced by requiring fossil fuel suppliers to acquire permits for the greenhouse gas content of the fossil fuels they want to bring into the economy. The number of permits in circulation is determined by the size of the cap. The revenue raised (in selling these permits) goes equally to all adult members of the population, to compensate for higher energy prices. (Cap & Share is related to Cap & Dividend, which is getting wide exposure in the USA; see for more details).

  6. The advantages of Cap & Share are many. Since there are only a very small number of fossil fuel suppliers, it's easy to cap fossil fuels entering the economy. Since all emissions are controlled upstream, there is no need for any downstream rationing system: the price of capping carbon is built in to fuel, and simply flows through the economy, as with a carbon tax. (Indeed a carbon tax with the tax revenues returned to the population is very similar to Cap & Share; with the critical difference that with Cap & Share a cap is in place—the problem with carbon taxes is that they cannot guarantee any given reduction in emissions). An upstream cap is transparent and highly visible; thus the cap is hard to evade. Finally, the system is transparently fair; popular support comes both from this and from the fact that the benefits accrue to the households and citizens of Europe, rather than its polluting businesses or its governments. Overall, this system could provide a model for the rest of the world and make a major contribution towards meeting the very low greenhouse gas targets in the short time that the emergency demands.


  7. By contrast, consider the EU ETS. A number of shortcomings of the EU ETS are apparent, which include:

    7.1 Lax, ineffective caps

      No EU-wide cap was set. Instead, in Phase I national governments and power generators gamed the system for their own interests, overestimating the number of permits that they would need, which led to oversupply and a collapse in the carbon price, so no real reductions in carbon emissions can be said to have been achieved. Current plans for a revised directive regulating the post-2012 EU ETS state that an EU-wide cap on emissions will be set for Phase III. However, even this is not an absolute cap but one linked to permits allocated during the second trading period.

      7.2 Windfall allocation of permits

    As the vast majority of permits were given away free of charge, but the companies then charged the customers the market value of the permits as a cost of production, these companies made windfall profits whilst consumers experienced rising fuel and food prices. With this "grandfathering" the EU succeeded in turning the "Polluter Pays" principle on its head, instead establishing a system based on "Pay the Polluter". Despite calls for auctioning of permits, in the second trading period less than 4% of the permits are expected to be auctioned, and even according to most recent plans, only 70% of all permits will be auctioned by 2020 "with a view to reaching 100% by 2027". Power companies in EU countries stand to earn windfalls totaling several tens of billions of euros during the second phase, and further action to protect Europe's worst polluters was confirmed at the Brussels meeting in December 2008.

    7.3 Perverse economic incentives

    Grandfathering means that carbon polluters reap the benefit of the carbon revenues, while the renewables sector gets no such benefits. (Currently, the industry is lobbying to reserve a large proportion of ETS certificates as a revenue source for the development and start-up costs of CCS, despite its shortcomings). The design faults in the current EU ETS have also led to a carbon price far too low to set incentives for investment in low-carbon production mechanisms.

    7.4 Dubious CDM projects

    According to current plans, most countries will meet their targets only through recourse to Clean Development Mechanism (CDM) projects, rather than making more difficult emissions reductions at home. This is highly controversial as there are many doubts as to whether CDM projects achieve any additional CO2 reductions. Furthermore, CDM use is increasing. But developed countries have prime responsibility to set their own houses in order, as they are historically responsible for the increase of CO2 concentration in the atmosphere.

    7.5 Partial coverage

    The EU ETS does not cover carbon emissions for goods consumed in the EU but manufactured elsewhere. According to recent research, CO2 emissions for which the UK is responsible have actually risen by 0.3% between 1990 and 2004, despite appearing to have fallen by 5.6% (the 5.6% figure did not take embedded emissions in imported goods into account). Similarly, the EU ETS only covers large installations, leaving a myriad of small emitters, and the personal/household sector, outside the system. (A particular issue is transport, a sector where emissions are increasing. Coverage of aviation and shipping is planned in the EU ETS third phase; however, it would be much more effective if the whole transport sector were covered, for example by a Cap & Share scheme. Cap & Share can work for individual sectors of the economy—the Irish government is considering its adoption for its transport sector, and reports commissioned by Comhar from AEA and Cambridge Econometrics were very positive).

    7.6 Complexity

    Extension to smaller installations and the possible addition of personal carbon trading only add to the existing complexity of EU ETS arrangements. This complexity renders the EU ETS opaque to the public, and even to regulators. As the system has become ever more complex, to suit the needs of each vested interest, the ETS has been described as "even more complicated than the German tax system"—which is saying something. It is a difficult subject for public opinion to get a handle on: hardly a topic for sound-bites.

  8. With all these shortcomings, why has the EU ETS worked out this way? It appears to be a wonderfully clear example of the concept of "regulatory capture". A system ostensibly set up to act in the public interest, by imposing necessary restraints on business interests, has instead had its design and subsequent implementation taken over and managed to suit exactly those interests.

  9. This has been possible because corporate groups with high-stakes interest in the outcome of climate policy were far better resourced and thus influential than the NGOs and other groups who were trying to protect the climate. The energy companies are some of the most powerful economic interests in Europe (when Gordon Brown was asked, as Chancellor, who were the most powerful people in Britain, he cited Lord Browne, at that time CEO of BP, as more powerful than himself). It is hardly surprising that the chosen EU ETS design is complex, evadable, and malleable to lobbying by vested interests, resembling a tax system with a cosy network of tax haven arrangements. It all serves the "greenwash" function of making it appear that the EU and its member governments are doing something about climate, while in reality the situation continues to deteriorate.

  10. There is a parallel here with the banking crisis, where instruments of such complexity were invented that the resulting informational asymmetry rendered even the regulatory authorities and experts unable to understand and control what was happening. The same is true of the EU ETS and, rather like banking regulation, climate regulation using the EU ETS has become almost totally ineffective. But while life may go on as the financial system collapses in ruins, a collapse of the climate system threatens life on a truly fundamental level.


  11. Can the EU ETS be reformed, rather than completely torn up? Yes. The current (or an improved) EU ETS can work in conjunction with the EU Cap & Share system outlined above, with the latter covering all non-ETS emissions. In other words, Cap & Share can dovetail with an EU ETS. (This is explained further in the Memorandum submitted by Laurence Matthews of Cap & Share UK to the EAC's Inquiry into Personal Carbon Trading). The combined scheme simply requires the following changes:

    — the EU ETS permits form part of the overall cap (and as such are bought by the fossil fuel suppliers, not given away);

    — in the Cap & Share scheme, fossil fuel suppliers still need permits for (the greenhouse gas content of) all fossil fuels brought in, except that now fossil fuels supplied to EU ETS companies are exempt;

    — to regain credibility, CDM (orJI) schemes are suspended or drastically curtailed;

    — border tariffs cover embedded emissions in goods imported to the EU (this both maintains competitiveness of EU industry, and discourages flight of manufacturing and capital to "uncapped" parts of the world).

  12. The combined EU-wide scheme would be simple to implement, and would enforce a fixed cap. Its effectiveness, inherent fairness, and the revenue coming to each citizen would make for a popular scheme and (with the EU leading the world in effective measures rather than just in rhetoric) an inspiring one.


  13. As a first step in extending this EU system to the world, trade with other blocs is certainly possible. Provided that this is trade with other markets which have caps (as opposed to CDM-like arrangements), the overall combined cap would remain intact.

14. Such inter-bloc trading would always leave out some countries, so there would still be border tariffs. More desirable (and a necessary goal before long in any case) would be a global cap. The question then is how to allocate shares of this global cap to countries, and a variety of mechanisms have been proposed ("Contraction & Convergence" is the best known, and there are several more recent elaborations). Developing countries have indicated their unwillingness to accept any climate regime which does not deliver to them the financial and technological resources that would enable their development along a low-carbon path, and carbon trading (possibly under bilateral government control) between carbon markets would allow such transfers of resources.


  15. Here complexity is creeping back in again, though. We can cut through all this with Cap & Share, but now implemented on a global scale. A global Cap & Share system would equally deliver resources to the developing nations—at the simplest level it would be the equivalent of "Contraction & Convergence" with instant convergence. This may seem politically impossible to achieve, but the simplest and fairest systems stand the best chance. In any case the alternatives are far worse, and a dramatic worsening of the climate situation (and the economic situation) may focus minds.

16. A global Cap & Share system would put up the price of carbon-intensive goods, but since most people in the world have low-carbon lifestyles they would gain considerably. The world's poor would have an interest in a high carbon price, which would also incentivise the movement to low-carbon forms of economic development—designed around new infrastructures, renewables, energy saving, and the ecological design and redevelopment of residential settlements, reintegrated with localised food-growing.

  17. Such a global system would have considerable implications for the oil and gas exporting countries. The current tendency of oil and gas prices to lurch chaotically between high and low prices is not in the interest of the fossil energy suppliers and, in any case, climate change will have profoundly destructive consequences for countries like Russia and Saudi Arabia too. It is actually in their interests to accept a global deal in which the "scarcity rent" of fossil fuels, driven by a global carbon cap aimed at stabilising the climate, goes largely to the world's poor.


  18. To deliver any such scheme, we need a publicly-backed political force with sufficient power to resist the vested interests and to drive down the level of emissions. It is necessary directly to challenge the political and business power complex that underlies the EU ETS, both in Europe and in the member states. The central political task here is to draw in the public as participants and drivers in the carbon reduction process. This would require the following steps:

    — the politics of carbon control must be contextualised in the public mind by messages about just how serious the climate crisis is—an awareness of a runaway process that could lead to extinction;

    — the basis for the carbon permit revenue distribution must be demonstrably fair, nationally and internationally; the arrangements seen to be in the interests of all (with the public being the direct beneficiaries of the carbon permit revenues, and with renewables and their carbon competitors clearly seen to be put on an equal footing);

    — the carbon control must be seen to be non-evadable (through being imposed at the few points where large and visible quantities of fuel enter the economy);

    — the public must be helped to cope with the rising carbon price, not only through distribution of carbon permit revenues, but also through guidance on how to adapt to the falling availability of carbon fuels, and measures to remove disincentives to doing so (for example where neither tenants nor landlords have any incentive to invest in energy efficiency measures for rental property).

  19. With such a programme, and with avoidance of climate chaos an explicit and frequently repeated goal of policy, everyone would know (and fossil energy companies would be put on notice) that the humanity intends to withdraw from using climate-destroying "toxic" fuels as soon as possible. This is a tall order. But try surviving a mass extinction event ...

March 2009

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