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

Memorandum submitted by the Environment Agency


    — Trading schemes allow greenhouse gas emissions reductions to be made in a cost effective way. We believe a broader and deeper carbon market is at the core of a global solution to climate change. — The changes proposed in the draft revised EU Emissions Trading Scheme (ETS) Directive, which will apply from phase III, will result in a stronger scheme with a more robust carbon price. — The proposed 2020 target of a 20% or a 30% (if a post Kyoto international agreement is reached) reduction in emissions from 2005 levels set out in the draft revision of the EU ETS Directive will ensure that the EU ETS sectors play their part in meeting the UK carbon budgets.

    — We welcome the future linking of the European Union Emissions Trading Scheme (EU ETS) to other trading schemes.

    — We support the need for more analysis on the expansion of the scheme to further sectors such as shipping, surface transport and over the longer term the farming and land use sector.

    — We have serious concerns over the impact of aviation expansion on climate change. Whilst we welcome its inclusion in the EU ETS we do not think this is a sufficient response to the problem of growing emissions from the aviation sector. Emissions other than carbon dioxide (CO2) from aviation that have a climate change impact are not covered and the ETS cap for aviation implies only a modest curb on CO2 emissions at EU level.

    — The Carbon Reduction Commitment (CRC) is a pioneering emission trading scheme aimed at organisations in the services, public administration and non-energy intensive industry sectors. Future caps for the CRC scheme should reflect the level of cost effective abatement available for those sectors covered.


  1.1 The Environment Agency welcomes the opportunity to submit evidence to the Environment Audit Committee's inquiry into the role of carbon markets in preventing dangerous climate change.

1.2 We are the Competent Authority for the EU ETS in England and Wales. We manage the Emissions Trading Registry and the new entrant reserve (NER) on behalf of the other UK regulators.

  1.3 Along with the Scottish Environmental Protection Agency (SEPA) and the Northern Ireland Environment Agency (NIEA) we will administer the CRC which is aimed at organisations in the services, public administration and non-energy intensive industry sectors. We will also participate in the scheme.


The role of international emissions trading in delivering a global greenhouse gas stabilisation target

  2.1 Avoiding dangerous climate change means making deep cuts in greenhouse gas emissions. Trading allows these cuts to be made in a cost effective way and ensures that the burden does not fall disproportionately on individual countries or sectors. We believe a carbon market that incorporates more sectors and more countries is at the core of a global solution to climate change.

2.2 We welcome the future linking of the EU ETS to other developing schemes. Equivalent standards of monitoring, reporting and verification, with associated enforcement must be maintained so that the carbon market stays credible and is an effective policy instrument in addressing climate change.

2.3 In addition to linking the EU ETS to other trading schemes we support the need for more analysis on the expansion of the scheme to further sectors such as shipping, surface transport and over the longer term the farming and land use sector. Any analysis should weigh the administrative cost (both absolute and per tonne of CO2) of including these sectors in EU ETS against the benefits. The inclusion of new sectors in emissions trading could be complementary to other measures, for example the EU agreement to reduce average CO2 emissions per km from new cars.

  2.4 The Carbon Reduction Commitment (CRC) will come into force in April 2010 with a three year introductory phase in which there will be no cap on emissions from the scheme. From April 2013, total emissions from the CRC will be limited through a cap on the number of allowances sold to participants.

  2.5 We are currently reviewing CRC coverage and abatement potential for this important sector. Future caps for the CRC scheme should reflect what is achievable in these sectors. We will publish the results of our study in full shortly.

Whether, and under what circumstances, emissions trading ought to be supplemented or replaced by tax or regulation

  2.6 We support the analysis in the Stern Review which concludes that an effective framework for reducing greenhouse gas (GHG) emissions includes both carbon pricing through tax, trading or regulation but also downstream policies to remove barriers to behavioural change and policies to encourage innovation. Trading is an important part of the solution but will work more effectively when combined with other instruments.

2.7 For example, there is an overlap between the EU ETS and the Carbon Reduction Commitment (CRC)/ Climate Change Agreements (CCAs). This occurs as all organisations will be exposed to an electricity price increase as a result of the EU ETS even if they do not directly have their emissions capped by the scheme. The service, public administration and non-energy intensive industry sectors above 6,000 MWh also fall within the CRC and many of the organisations in energy intensive sectors that are too small to fall within the EU ETS directly are subject to CCAs. We agree with the Government's analysis that this overlap is justified as these measures are designed to target other barriers to emissions reductions such as ensuring energy efficiency measures gain greater profile within an organisation.

  2.8 Methane emissions from active landfill sites could be suitable for inclusion in the EU ETS or another trading scheme such as the Carbon Reduction Commitment. Active sites are not numerous and are relatively large point sources of greenhouse gas. However, emissions from these sites need to be regulated closely to minimise any risks they pose and inclusion in a trading system should not be considered an alternative to regulation for safety and environmental hazard.

The record of Phase II of the EU ETS, and prospects for the success of Phase III

  2.9 The strengthening of the Phase II National Allocation Plans by the European Commission has already resulted in a stronger, more effective EU ETS. Phase II of the EU ETS is expected to produce an annual reduction of 29.3 MtCO2 against business as usual projections in the UK. A recent study by New Carbon Finance suggests that across the EU emissions fell by 3% in EU ETS sectors in 2008. This study estimates the carbon price was responsible for 40% of this decrease, with the recession accounting for a further 30%.

2.10 Currently, market commentary indicates that there will be a surplus of allowances in Phase II as a result of the downturn in the economy. It has also been suggested that the carbon price has fallen further still as struggling companies are selling their surplus allowances in order to generate an additional income (although this effect will be more temporary in nature). However, given that Phase II allowances can be carried across into Phase III we would expect the allowance price to rise again in time.

  2.11 We support many of the changes set out in the draft revised EU ETS Directive that will come into force in Phase III of the scheme. In particular, the introduction of a central cap with a long-term trajectory, greater levels of auctioning, a wider scope covering more emissions, and a more harmonised system will all improve the scheme. All of these changes taken together should deliver a much more credible carbon price and start stimulating greater levels of investment.

  2.12 The move to central EU cap setting from Phase III of the EU ETS will help to ensure a greater level of ambition for the scheme. The long-term 2020 targets of 20% or a 30% (if a post Kyoto international agreement is reached) reduction in emissions against 2005 levels set out in the draft revision of the EU ETS Directive will ensure that the EU ETS sectors play their part in meeting the UK carbon budgets. The EU ETS target post 2020 will need to be revised in the light of the necessary contribution from the EU and UK to meeting global greenhouse gas reductions.

Effects of the expansion of the EU ETS to encompass aviation

  2.13 By 2050, the Department for Transport (DfT) predicts that emissions of carbon dioxide (CO2) from the aviation sector will grow from 37.9 megatonnes (Mt) CO2 in 2006 to 59.9 MtCO2, within the range 53.0 MtCO2 to 65.0 MtCO2.This figure does not include the impact on the climate of non-CO2 aviation emissions at high altitude.

2.14 In percentage terms, aviation's share of the UK's GHG budget rises from just over 5% in 2006 to between 38 and 72% in 2050 depending on whether a radiative forcing factor of 1.9 is included (which attempts to account for the impact of emissions at high altitude). Increases at these levels would in effect require a reduction in GHG emissions by the rest of the economy of between 85 and 93% to meet the UK's overall targets of cutting GHG emissions by at least 80%.

  2.15 Our concern is that increases in emissions from the aviation sector will leave little or no headroom for GHG emissions from other sectors. This in turn suggests that either very costly abatement measures will be needed in these other sectors or that there is a risk that the overall target will not be met.

  2.16 All civil aviation, both international and domestic, will be included in the EU Emissions Trading Scheme (EU ETS) from 2012. While we welcome this development we do not feel that it is a sufficient response to the problem of growing emissions from the aviation sector for three reasons.

  2.17 First, the ETS does not cover the effects of non-CO2 emissions on the climate, such as water vapour and nitrogen oxides at high altitude. There is therefore a risk of increasing damage to the climate system from these emissions unless other policies are also pursued.

  2.18 Second, the ETS cap for aviation implies only a modest curb on CO2 emissions at EU level. Emissions are capped at 97% of the average annual emissions for the 2004-06 period between 2008 and 2012 and 95% between 2013 and 2020.

  2.19 Third, no cap has yet been determined for total emissions beyond 2020, so there is no carbon price signal for the longer term. However, decisions are being taken now to put in place infrastructure that will facilitate growth in GHG emissions from aviation over the 2020 to 2050 period.

Allocation or auctioning of EU ETS credits, and the use of auctioning revenues

  2.20 The revised Directive will result in much greater levels of auctioning of 60% for Phase III as opposed to 3% in Phase II. This will help to simplify the scheme and avoid windfall profits. We welcome this increase and would like to see full auctioning within the EU ETS as soon as possible. However, we accept that some sectors are subject to international competitiveness concerns which need to be addressed in any allocation methodology. We see this as a transitional measure until all of Europe's major competitors are part of a global carbon market, when there will be no need for free allocation.

Progress of cap and trade schemes in other countries (notably, the United States), and the prospects for, and practicalities of, linking between them

2.21 The scheme must link to other trading schemes in order to establish a global carbon market. We support the Commission's criteria for linking in the revised draft Directive.

2.22 State schemes in the USA and national schemes being developed in Australia, New Zealand and Japan all have the potential to link to the EU ETS and strengthen the scheme.

The robustness and effectiveness of "offset" schemes (ie those without a cap), such as the Clean Development Mechanism (CDM), and the issues around linking them to cap and trade schemes

  2.23 A carbon offset is a financial instrument representing a reduction in greenhouse gas emissions. There are two main markets for carbon offsets. The majority of carbon offsets are purchased by companies or governments in order to comply with caps on the total amount of carbon dioxide they are allowed to emit. The voluntary market is much smaller. Individuals, companies, or governments purchase carbon offsets to mitigate their own greenhouse gas emissions from transportation, electricity use, and other sources. Common offset projects include renewable energy and energy efficiency projects, methane flaring projects and afforestation projects.

2.24 We support the UK Government scheme for regulating carbon offset products with the aim of informing and safeguarding business and household consumers purchasing Carbon Offsets. The scheme sets standards for best practice in offsetting. Approved offsets have to demonstrate the following criteria:

    — Accurate calculation of emissions to be offset.

    — Use of good quality carbon credits ie initially those that are Kyoto compliant.

    — Cancellation of carbon credits within a year of the consumer's purchase of the offset.

    — Clear and transparent pricing of the offset.

    — Provision of information about the role of offsetting in tackling climate change and advice on how a consumer can reduce his or her carbon footprint.

  2.25 The Clean Development Mechanism (CDM) is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. A crucial feature of an approved CDM carbon project is that it has established that the planned reductions would not occur without the additional incentive provided by emission reduction credits. The project must be validated by a third party agency (a Designated Operational Entity) to ensure that it results in real, measurable and long-term emission reductions.

  2.26  There are restrictions on the type of CDM project credits that can be used by operators for compliance purposes under the EU ETS. Credits from Land Use, Land Use Change and Forestry (LULUCF) activities and nuclear projects cannot be used. In addition there are thresholds for CDM projects which therefore currently exclude small scale renewables.

The relationship between emissions credits and the UK carbon budgets set up under the Climate Change Act

  2.27 The number of Kyoto Certified Emissions Reductions (CERs) (generated through CDM or Joint Implementation projects (JI)) which can be surrendered by operators in the EU ETS is capped at half of emissions reductions required over the period 2008-20. If there is a move to a 30% overall EU emissions reduction target, additional CERs may be used for up to half of the additional reduction. So, if the target increases by 10%, CERs may be used for 5% of this reduction.

2.28 We support the provisions in the Climate Change Act to set a legally binding limit to the amount of overseas credits that can count towards the UK budget and the role of the Committee for Climate Change to advise on the legal contribution allowed. However, we are concerned that allowing 50% of the effort for the EU ETS sector to come from overseas could lock the UK into high-carbon infrastructure, such as unabated coal fired power stations, unless other measures are in place to avoid this.

Transparency of and justification for counting the purchase of emissions credits (especially from "offset" schemes) as decreasing emissions from the UK

  2.29 With regard to carbon units brought from, or sold to, other countries, only EU ETS recognised allowances and Kyoto Certified Emissions Reductions (CERs) should contribute to meeting the UK carbon account.

2.30 Carbon units generated from outside the UK and used to meet the UK carbon budgets should be cancelled or retired, and not sold or transferred. If these units are not retired or cancelled than they could potentially be used again, resulting in double counting of emissions reductions. We also consider that the use of free credits should be avoided to reflect the true carbon price in investment decisions.

10 March 2009

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