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

Memorandum submitted by the Summerleaze Ltd


    — European carbon markets are failing to deliver significant carbon-savings in Europe.— European carbon markets are failing to provide a high or reliable enough cost of carbon to justify substantial investment in carbon-reducing measures in Europe.— The period since the Kyoto agreement and the introduction of international carbon markets has coincided with an acceleration in the rate of increase of carbon emissions.

    — One factor in that acceleration is the offshoring of manufacture to less-efficient producers in developing nations.

    — European emissions increased in parallel with the process of offshoring, when they should have reduced.

    — Before Kyoto, emissions were reducing as GDP was increasing. Since Kyoto, emissions have increased at a fraction of the rate of increase of GDP. Carbon markets have had an insignificant impact on this relationship.

    — A rational and effective carbon-pricing mechanism would impose an equal cost of carbon on all sources and sinks. Cap-and-trade cannot do so because it does not scale down.

    — Correcting this deficiency by combining with other measures is economically-inefficient.

    — Low prices in the EU-ETS are the result of inevitable political gaming, not of delivery.

    — Low prices in the EU-ETS have a negative impact on sectors outside the EU-ETS.

    — Free allocation and auctioning of credits both have anti-competitive consequences.

    — Linking the EU-ETS with an American scheme would result in Europe paying the USA for soft savings, while American businesses continued to benefit from looser standards.

    — Many CDM and offset schemes provide illusory benefits.

    — Carbon budgets on a national level may be incompatible with trading mechanisms and utilities that are international.

    — Cap-and-trade is wrong in principle as well as practice, and cannot be made to work effectively.

    — Cap-and-trade and Kyoto should be replaced with carbon tax and an international risk-based market.


  Summerleaze Ltd is one of the most long-established renewable-energy businesses in the UK. We began investing in renewable energy in the early 80s, and commissioned our first renewable power station in 1987. We have generated around 2 TWh of renewable electricity to date. We are currently leading developments in three immature fields: anaerobic digestion, wood pellets, and renewable hydrogen.

Summerleaze is a founding member of the Renewable Energy Association (REA) and the Association of Electricity Producers (AEP). To our knowledge, the REA is not preparing a submission to this inquiry. The AEP has prepared a submission, but sadly it represents neither our views, nor a critical look at the subject. It is Panglossian in its determination only to see the good in carbon-trading. Whilst one may take the view that the benefits outweigh the disadvantages of carbon-trading (or vice versa), it takes the wisdom of three monkeys to believe that there are only benefits and no disadvantages, as the AEP seems to want the Committee to believe.


  The Kyoto Protocol was agreed in 1997 and came into force in 2005. Its objective is to reduce greenhouse gases in participating countries by 5.2% below 1990 levels by the end of 2012.

The Kyoto Protocol, if complied with, would be insufficient to achieve the UK's goal of limiting global warming to 2°C above the estimated historic average. It is estimated that full compliance would reduce temperatures in 2050 by 0.07°C. Consequently, the EU and its member nations have introduced more strenuous targets. The EU is committed to achieving a reduction of 20% by 2020, and 30% if other major nations will also commit to equivalent action. The UK government has recently increased its long-term reduction target from 60% to 80% by 2050.

  To date, the principal policy tool preferred to achieve these targets in Europe and the UK has been carbon-trading. The UK introduced a preliminary scheme, the UK Emissions Trading Scheme (UK-ETS) in 2002, which ran to 2006. The EU-wide European Union Emissions Trading Scheme (EU-ETS) began in 2005. The first phase ran from 2005-07, the second phase runs from 2008-12, and a third phase is currently under discussion.

  One of the main arguments used to justify a preference for cap-and-trade systems is that the cap ensures a specific level of reduction, whereas other approaches, such as carbon tax or regulation, do not offer such firm volume constraints. The existing cap-and-trade schemes put values primarily on emissions of carbon dioxide (CO2) and do not directly encompass emissions of other greenhouse gases. It is reasonable to use emissions of CO2 as a measure of the success of the cap-and-trade schemes.

  In the 1972-2002 period prior to the introduction of the UK-ETS, annual global CO2 emissions from fossil-fuel combustion increased from around 15,500 Mt (million tonnes) to 24,500 Mt. That is an average rate of increase of around 300 Mt or 1.5% per annum. By 2005, emissions had reached 27,900 Mt, increasing at 1,130 Mt or 4.4% per annum. And by 2007 (the most recent year for which we have figures) emissions were 29,600 Mt, increasing at 850 Mt or 3.0% per annum.[48] Similar trends can be seen if the other, smaller contributors (such as cement manufacture) are included.

  It might be argued that assessment relative to global emissions is unfair, but action is not justified unless it can have an impact on the global total. A significant criticism of regional action is that it may offshore the carbon (rather than reduce it) and thereby increase emissions by driving production to less technologically-advanced nations. When one reviews the regional changes in energy-consumption and emissions of carbon, it is clear that that is exactly what has happened. The effect is seen most starkly in the changes in the production and use of coal, the most carbon-intensive fuel.[49] Kyoto and cap-and-trade appear not to have had a beneficial effect.

  If we have exported our industry to China and other developing nations, European and UK emissions ought at least to be falling. Unfortunately not. UK emissions fell from 616 Mt in 1980 to 564 Mt in 2002. By 2006 (the end of the UK-ETS), our emissions had risen again to 586 Mt.[50] In Europe, emissions from those installations covered by the EU-ETS rose by 0.68% in 2007.[51] We seem to have achieved the indefensible: exporting our industries to where they would cause more damage, while making little progress on our own emissions.

  Stavros Dimas argues that the above figures for the EU-ETS show that "emissions-trading is yielding results" because emissions would have grown even more strongly without it, given a growth-rate for GDP of 2.8%. Between 1980 and the Kyoto agreement (1997), the GDP of the EC-12 nations increased by around 45% in real terms, while their CO2 emissions from fossil-fuels fell by 2%, unassisted by carbon-trading.[52] In the subsequent period before the start of the EU-ETS (2005), emissions increased by 7.1%, while GDP grew by 19%. The smaller increase in emissions than GDP in 2007 was simply maintaining a relationship that had been established since Kyoto was agreed and the previous inverse relationship of GDP- to emissions-growth was reversed.


Potential contribution of international emissions trading to delivering a global greenhouse gas stabilisation target, consistent with the UK's goal of limiting global warming to 2°C

  The science is not yet sufficiently certain to say what concentration of greenhouse gases in the atmosphere is consistent with a target of limiting global warming to a maximum of 2°C above the estimated historic average. A growing school of thought believes that, because of feedback loops, it is no longer possible to limit warming to this level. Another growing group is emphasising the role of other factors in the warming to date and questioning the IPCC process and their economic and scientific assumptions.

Given this uncertainty, it is doubtful whether the right approach is to target a particular level of a dynamic concentration of atmospheric greenhouse gases on the basis of an assumed relationship between that concentration and future temperatures and other climatic, environmental, social and economic conditions, with insufficient reference to risk, uncertainty, and the balance between mitigation and adaptation.

But if that were a rational approach, emissions trading would not be an effective way to achieve the goal. As demonstrated above, and substantiated in the paper attached at Annex A,it has not been effective to date, and is not likely to be effective in the future.[53]

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

  The approaches ought not to be combined. Whatever the social cost of carbon emissions, it is the same for all emissions at a given point in time. A single price should therefore be applied, and it is very much easier to do so through one mechanism than through multiple mechanisms. The complex interplay between multiple mechanisms results in inefficiencies, unintended and perverse consequences, rent-seeking opportunities, bureaucratic overheads and so on.

There are a number of tests of whether a carbon-pricing mechanism is a good one. One important test is whether the mechanism adjusts rapidly but smoothly as refinements in the science and data are announced. Another is whether it yields a rational and reasonably predictable price or whether the price is irrational and volatile. And another test is whether it can be applied equally to all emitters and absorbers of carbon.

  Emissions trading fails all of these tests, but the last is particularly important in the context of this question. Because of transaction costs, it is generally accepted that the approach cannot be scaled down below a certain level. Consequently, around half of all emissions are unlikely to be covered by this type of mechanism. Its adoption means that emissions from the uncovered half must be either ignored (as domestic heat is in the UK at the moment), or covered by other mechanisms (for example, a range of mechanisms in the transport field that apply very different social costs of carbon for different types of transport, and for transport as a whole compared with other sources of carbon). The upshot is a chaotic, inefficient and often irrational set of incentives.

  Emissions trading should be replaced by a carbon tax, applied at point of import or production of fossil-fuels, with some of the revenue used to compensate poorer households for the welfare impacts of increased energy costs, and balanced across nations (to avoid carbon-offshoring) by means of a mechanism to replace Kyoto after 2012 that treats the potential harm from carbon emissions as a risk whose cost of insurance should be borne by the emitter.[54]


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

  After prices in Phase I collapsed, apologists for the EU-ETS argued that it was only ever intended to demonstrate the mechanics of the concept and to provide information about the correct level at which to set the National Allocation Plans (NAPs). Phase II would benefit from this information and provide the correct incentive based on accurate allocations.

The Phase II NAPs, as finally set by the EU, required only a 2% reduction relative to verified emissions in 2005 (ie still above 1990 levels, despite Kyoto commitments). Like Phase I, they owed more to political gamesmanship than dry assessment of the data. The target was never challenging and was always likely to lead to a repeated collapse in prices, either through modest offshoring in continue benign economic conditions, or through reduced output in a downturn.

Phase I EUA prices ranged between €20 and €30 for the first 20 months, then collapsed to €15 when countries reported their emissions for the first year of the scheme, stabilised at that level for a few more months, and then began an inexorable decline to a few cents by early 2007. Phase II lasted only nine months or so in the €20-€30 range before it began the first stage of its inevitable collapse. It seems temporarily to have stabilised around the €10 level, but we have not yet had any verified data for emissions levels in 2008 to confirm the bad news and set the price on the second stage of its journey to zero.

  Low prices could be taken as a sign of success—that we are delivering carbon savings very cheaply. But it is apparent from the unambitious targets and the continuing high levels of CO2 emissions that this is not the reason. Prices are low because such minimal improvements are required that participants expect that, in an economic downturn, little investment will be required to exceed the required savings. Any such savings will be attributable to the closure of plant and the reduction of demand for energy, and not to the EU-ETS.

  It was never true that the problem with Phase I was lack of data and knowledge of the mechanism. The problem was always the gaming of the mechanism by governments hoping to profit from targets that they knew were unambitious. Once might have been considered misfortune, but twice looks like carelessness.

  If political leaders were inclined to game the system when economies seemed to be growing strongly, how much worse should we expect it to be in a downturn, when their economies are genuinely vulnerable to the imposition of even modest social costs? We have already seen the battle for looser targets continued in the Phase III negotiations. In the current circumstances, and given the track-record in more benign conditions, it is unfounded optimism to hope that Phase III would be anything other than another farce.

Extent to which the carbon price will be sufficient to drive low-carbon investment, in particular decarbonisation of energy

  Several major energy companies have terminated their involvement in large UK wind projects. Co-firing output is down. The large utilities are pressing for permission to build new coal- and gas-fired generating stations without carbon capture. From the existing plant, they are dispatching coal in preference to gas.[55] The current EUA price of €10/tCO2, (equivalent to around £7.50/MWh from coal and £3.50/MWh from gas) is insufficient (even with support from the Renewables Obligation) to encourage a substantial switch to low-carbon electricity-production either from the existing infrastructure or through new investment.

The carbon price has little impact on the two-thirds of our energy that is consumed in the heat and transport sectors, nor on energy-efficiency, other than marginal impacts through the electricity price. The greatest impact is negative, as the absence of a mechanism that places an equal value on carbon from these sectors has prevented significant investment.

  Investment decisions are based not only on current prices, but on expectations of future prices. Expectations are influenced by past performance and rational assessment. On both counts, an investor would not rely on a significant value from the EU-ETS in their financial modelling.

Impacts of economic recession on the workings of the EU ETS

  The 2% reduction required in Phase II will be achieved without the necessity of investment. Prices will collapse to nearly zero again, and those who are not recipients of government largesse from other sources will be unable to justify investing in more efficient infrastructure.

Impacts on and responses by UK firms covered by the EU ETS

Summerleaze is not directly covered by the EU-ETS. However, the Committee should bear in mind that many businesses not covered by the EU-ETS are indirectly affected by it.

All renewable generators are affected by EUA prices, because the vertically-integrated utilities (who are covered by the EU-ETS) can reduce their carbon emissions by buying power from renewable generators. This feeds through into the offered price (particularly as they have usually incorporated the opportunity cost of the value of their EUAs in their prices anyway). A low price for EUAs means a lower price for renewable generation.

  Thanks to the linking of the Carbon Reduction Commitment (CRC) with the EU-ETS, the mechanism will also affect renewable heat and energy-efficiency measures in the large, non-energy-intensive sector (eg councils and supermarkets). A low EUA price will undermine the value of one of the first mechanisms to try to encourage renewable heat.

Implications of the EU ETS for business competitiveness, and how to address them

  Electricity customers have no opportunity to import their supplies from outside the EU. The EU-ETS therefore has little impact on the competitiveness of the power sector as a whole, other than marginal impacts on demand, which will be insignificant at current EUA prices.

While free allocations remain, the EU-ETS has an impact on competitiveness within the power sector. Free allocations provide a significant advantage to incumbents, limiting the threat from market entrants, and reducing the competitive pressures on the established energy oligopoly (the "Big Six").

  In sectors exposed to competition from outside the EU, free allocations may be necessary while the EU-ETS is retained, in order to prevent offshoring of industry and carbon. However, free allocation distorts markets and inhibits competition within the EU, providing a benefit to existing dirty producers over clean producers and new entrants (see, for example, the cement sector). This Morton's Fork is another example of why the mechanism is bad, irremediable, and should be replaced.

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

  Free allocation of credits to incumbents is anti-competitive, but government monopoly-auctions of rights without which the bidders cannot stay in business drives participants to overbid and ultimately harms the industry and its customers. Auctioning is the lesser evil, but the least evil would be to scrap the mechanism altogether.


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

  American carbon emissions per capita are double those of Europe. Fuelled by cheap energy, the American economy has valued efficiency so little that there are many soft efficiencies to be achieved.

Even in times of prosperity, no American legislature would put a tight cap on national emissions. In the current circumstances, the US government will be even more careful not to impose heavy costs. If a carbon cap-and-trade scheme is introduced in the USA, it will be set with very achievable targets.

If we link the EU-ETS to cap-and-trade schemes with loose caps in countries where soft efficiencies can be made at little cost, we will end up (a) paying those countries for soft savings that they should have made at their own expense, and (b) yet again undermining carbon values in Europe.

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

  One cannot do justice in a few words to the many ways in which the supposed benefits of CDM and carbon-offset schemes are more illusory (or at least exaggerated) than real.


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

  Carbon budgets are another policy mistake, repeating the false assumption embedded in emissions-trading schemes that there is a rational basis for targeting a specific level or profile of emissions.

Nevertheless, we are to have them. Logically, the rights to the carbon-displacement belongs to the country that paid for them, not the country where they were "produced". This approach should be adopted, but care should be taken that both countries do not claim the "benefit".

"Non-emission" must not be confused with absorption. Renewables have a neutral, not a negative carbon impact. They do not increase a nation's carbon emissions, but they do not reduce them either. If demand increases in line with renewable output, there will be no reduction in a country's carbon emissions regardless of how much renewable energy is produced. Credits from foreign renewable-energy projects should not be counted as a deduction against national emissions.

  The multi-nationals will have choices about how much to invest in each country to reduce emissions. They will transfer at opportunity cost the credits from one country to another, as determined by their investment and operation choices. Those choices will influence the contribution of the power sector to the overall carbon budget. Auctioning would reduce the temptation to play games in this way, but would not eliminate the differences between national markets. There is a tension between the national nature of the carbon budgets, and the international nature of the EU-ETS, CDM and many of our utilities.

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

  The carbon benefits from many offset schemes are not correctly reflected in the calculation of attributable credits. Schemes involving production or destruction of methane unjustifiably assume unrealistically high rates of methane production, and lower rates of capture than could easily be achieved at low cost. Renewable-energy schemes are calculated to have displaced fossil-fired generation, when many of the projects simply increase the total amount of electricity consumed. Credits from tree-planting assume that all trees grow healthily for many decades, and count all the potential savings in the first year. No negative account is taken of tree plantations that die before they reach their assumed lifespan. Displacement of HFCs and other greenhouse gases is attributed to factories that never would have existed to use those HFCs if they hadn't been able to sell their "non-HFC-usage".

Whilst seeking the lowest-cost carbon savings regardless of location is sensible, the way in which this is done under the Kyoto protocol is so subject to fraud and miscalculation that it is questionable whether the system offers real environmental benefits. All parties involved (developers, auditors, purchasers of credits, governments) have strong incentives to over-estimate the benefits and under-estimate any flaws. It is unlikely that the situation will be improved by promises of tighter enforcement.

3 March 2009

48 To convert from C to CO2, multiply by 3.667 Back

49   Graph from International Energy Agency, Key World Energy Statistics 2008. Back

50   Energy Information Administration, International Energy Annual 2006, Table H.1co2. Back

51 Back

52   CO2 emissions from EIA op cit, GDP from Eurostat Long GDP series for historic EU totals spreadsheet. Spain, Greece and Portugal figures added to EC-12 totals for period prior to accession. Back

53   Bruno Prior, Cap-and-trade-why it is the wrong approach (2007), hard copy provided as Annex A with this submission, and available for download from Back

54   For a more detailed exposition of such a mechanism, see Bruno Prior, Carbon or harm? The price of the risk of anthropogenic global warming (2008), hard copy provided as Annex B with this submission, and available for download from Back

55   In the period December 2008 to February 2009, coal fuelled 44% of the UK's centralised power, while CCGTs provided only 35% and renewables only 3%. Back

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