Memoranda submitted by Sandbag
We have been tracking the development
of the EU ETS in detail and emissions trading policy more generally.
We have developed a set of recommendations for how schemes should
operate to ensure they are delivering for the environment and
for civil society:
Caps need to be ambitiousit has
proven far too easy for the exaggerated fears of incumbent industries
to water down the effectiveness of schemes, weakening prices and
In the absence of global agreements it
is sensible to begin with sectors not directly exposed to international
competition, rather than to water down the ambition of the scheme
to accommodate concerns over competitiveness.
Auctioning is the best method of allocation
and should be adopted from the beginning to avoid rent seeking
behaviour being rewarded with over allocations.
The use of "offsets" must be
handled carefully with quantitative and qualitative limits being
appliedcost minimisation for industry has to be balanced
against the risk of investment and jobs flowing overseas.
Provisions must be in place to "true-up"
or account for fundamental changes in starting assumptions ie
economic growth going into reverse or firm level output being
below the allocation estimate. This should include changes to
banking rules to prevent carryover of "hot air". Caps
were set politically taking into consideration impacts on industrynot
according to a scientific formula based on environmental carrying
capacity. As long as this is the case they can and should be adjusted
downwards if economic circumstances change.
Caps undermine civil society's ability
to generate additional reductions through their own actions. There
must therefore be provision for civil society to cause additional
effort to be undertaken ie caps should be reduced to reflect voluntary
actions by civil society that go beyond regulatory requirements.
This is an important issue which has received considerable attention
in the US and Australia but has thus far been largely ignored
In relation to the EU ETS specifically
we have undertaken analysis comparing 2007 emissions levels
with allocations in 2008-12 and uncovered that for the most
part industrial participants have been given generous growth targets
(on occasion greater than 100%) that provide no incentive for
the uncovering of emissions reductions. Power sector participants
have been substantially capped, however, leading to a transfer
of money from electricity consumers to heavy industry. We will
repeat this analysis in 2009 using 2008 emissions data
for the whole of the EU 27 which will give a very clear picture
of how the scheme is operating on the ground. We expect this analysis
to be complete in summer 2009.
In relation to the development of international
emissions trading schemes we believe the successor to the Kyoto
Protocol should facilitate the introduction of global sectoral
carbon budgetsbeginning with the power and aviation sectors.
The UN should provide the infrastructure necessary for countries
to meet targets under the global budget through participation
in a sectoral trading scheme.
In relation to the inter-operability
of regional trading schemes we have been tracking developments
in the US and Australia and anticipate significantly different
approaches will be adopted in these countries. The UN should introduce
guidelines to facilitate standardisation between schemes. The
EU should be open to making changes to its own scheme to increase
harmonisation and ease linking.
1. It is clear that placing regulated caps
on emissions and allowing trading as a means of compliance has
huge potential to drive action to combat climate change. Emissions
trading regulation creates a fixed volume allowance of emissions
over time and can be used to put the global emissions trajectory
on a steeply declining path while allowing the flexibility for
participants to comply with the caps at least cost to them and
society as a whole.
2. Two challenges need to be overcome if
it to deliver this outcome, however. Firstly the volume of emissions
under caps needs to be rapidly expanded: to give greater control
over emissions levels, level out competitiveness concerns (though
these are often inflated) and to ensure least cost abatement options
can be uncovered.
3. Secondly, increased political will to
impose challenging targets on participants in the scheme will
need to be found to ensure the trajectory created by emissions
caps is consistent with precautionary analysis of the latest science.
We believe this means global emissions peaking and declining well
within a decade and continuing on a trajectory towards no net
additional emissions to the atmosphere by mid-century. We believe
the EU ETS cap needs to set consistent with at least a 40% reduction
below 1990 levels by 2020.
4. Emissions trading is a form of regulation.
Caps are enforced and in the case of the EU ETS participants out
of compliance face stiff penalties. Governments should withstand
calls to abandon the policy and work instead to ensure it is implemented
5. Additional policies are being used to
supplement the effect of trading and caps were, in theory at least,
adjusted to take into account the effect of downstream polices
that would increase the rate of reduction in emissions in capped
sectors. This practice should continue to achieve effective "choice
editing" and to reduce the cost of mitigation options that
are currently too expensive, commercially unproven or perceived
as risky to for the carbon market price alone to secure investment.
Regulation may also more appropriate to remove certain actions
from the "offset" market to maintain a healthy market
price (ie HFCs).
The EU ETS
6. Unfortunately the record of Phase II
of the EU ETS, thus far, is once again poor. The recent price
slump reflects the fact that, once again, supply of permits outstrips
demand. This has been exacerbated by the recent economic downturn
but judging from our initial analysis comparing the emissions
data from 2007 with allocations in 2008-12 many industrial
sectors received far more permits, under BAU allocations, than
would appear justified. This combined with the availability of
CDM permits would have meant that prices would likely be low even
without a recession. The only reason there is a positive price
at all at the moment is due to the banking rules which allow for
unlimited carry-over of spare permits into the next phase.
7. Because caps were set politically using
economic modelling that referred to "technological potential"
and the potential price impacts on industry, and not according
to a scientific methodology, now that the underlying economic
assumptions have changed an ex-post "true up" should
be introduced to remove "hot air" from the system.
8. The prospects for Phase III, as they
currently stand, do not appear much better. The current target
of a 20% reduction by 2020 and the proposed reduction rate
of 1.74% per annum are far too lacking in ambition and need to
be at least doubled if a healthy market is to be created, irrespective
of whether a global deal is reached.
9. If a recession is sustained across the
trading period there is considerable potential for a large volume
of spare credits or "hot air" to be banked into this
phase making caps easier to meet. There is also the potential
that all of the EU's supplementary policies supporting increased
renewable energy deployment and improved efficiency will be delivered
making the meeting of the cap in the power sector akin to "Business
As Usual". Finally, continued access to overseas credits
will further dampen prices and reduce investment incentives in
low-carbon solutions in Europe, while explicitly driving investment
and jobs outside of the UK.
10. The current configuration of the EU
ETS is really only driving investment into overseas projects via
the CDM. The price could induce some fuel switching at the margin,
for instance between brown and black coal, and coal/oil and gas.
However, these are effectively short-term behavioural changes
more than investments in long lived infrastructure projects that
will be needed to achieve deep cuts in the future.
11. The impact of the current economic recession
on the EU ETS cannot be ignored. The Commission estimated that
Phase II would deliver around a 6% reduction in the cap in Phase
II compared to the cap in Phase I (2005-07). However, the first
phase cap was considerably over-allocated and a sustained recession
in which the economy is declining by around 1.5%-2% per year more
than wipes out this anticipated shortfall in allocations in the
current phase. Since the reductions arise from no conscious action
to decarbonise they must be treated as "hot air" which
dilutes the intended effect of the scheme. The effect of this
has already been to reduce the price in this phase. If banking
rules are not changed in response to this unexpected event then
they will also deflate prices in the next phase and continue to
12. The curious fact about this configuration
of emissions trading is that the caps also act as a floor. Firms
are free to cash in on their ability to pollute up to a given
level, ie can monetise any and all shortfall compared to their
allocation, irrespective of the contributing reasons for having
a shortfall. This means that in practice many UK firms who were
allocated BAU allocations at a time when they were claiming this
involved growth in output will benefit from the sale of potentially
large volumes of spare credits.
13. In 2008 we undertook analysis comparing
2007 actual emissions levels with allocations for 2008-12.
Though this comparison was made complex due to rule changes which
occurred between the two phases, nevertheless, it revealed a picture
in which all industrial sectors apart from the power sector had
been given growth targets relative to recent emissions. Certain
sectors and companies received particularly generous treatment
thanks to a Government decision to award "Business As Usual"
allocations which assumed very generous growth estimates.
14. In studying the baseline data used to
calculate allocations we also uncovered many examples of methodological
adjustments that created higher baselines for certain companies
and sectors and a spreadsheet detailing this is available on request.
We will be able to repeat the comparison exercise with a higher
degree of accuracy in summer 2009 using 2008 emissions
15. The only sector which faces a serious
short fall in this phasethe power sectorcan access
cheap EUAs arising from over allocation to industry, and they
will therefore need to do less (or nothing) to abate themselves
and be less reliant on CDM. Essentially the scheme has now become
a cross subsidy from the purses of those paying for electricity
to the pockets of heavy industry. In future all sectors must face
a cap and mechanisms should be put in place to allow for Government
intervention in the face of abrupt changes in underlying economic
assumptions at either the economy, industry or firm level.
16. It is extremely difficult to see how
the scheme could be damaging business competitiveness at the moment.
As a recent Carbon Trust report identified, a carbon price is
likely to play a very insignificant role in determining the competitiveness
of a business compared to much more fundamental economic differences
such as currency exchange rates, cost of labour and taxation policy.
17. More specifically, at the moment, since
many businesses with allocations are carrying a surplus they are,
in fact, benefiting by receiving income from the scheme, therefore
temporarily enhancing their competitivenessalbeit marginally.
18. Longer term a global carbon market with
sectoral level agreements for those few sectors that are competing
in global markets would provide a long-term insurance policy against
this potential source of competitive distortion.
19. We support the expansion of emissions
trading to cover more sectorsparticularly those which serve
largely captive markets such as surface and air transport. It
is appropriate that even though sectors may lack low-cost abatement
options in their sector that they should be required to internalise
the cost of their pollution. It is appropriate that in doing so
they should pay for the decarbonisation of other sectors which
are likely to deliver technology which will in the long term assist
all sectors to decarbonise. For example, it is appropriate that
transport pays for reductions in the power sector as we should
expect this sector to expand to assist in the decarbonisation
of transport through electrification and for it to develop CCS
which longer term will usher in the possibility of a hydrogen
based economy. Aviation should be given a challenging cap well
below current emissions and be introduced on the basis of 100%
auction of allowances; any grandfathering at current levels is
highly likely to create "hot air".
20. We fully support the use of auctioning
as the most efficient allocation methodology. We regret that auctioning
was not more widely used in this phase. We also regret that auctioning
provisions in Phase III were watered down. Revenues from auctions
can be used to fund many aspects of public spending such as defraying
any social or competitiveness impacts arising from the internalisation
of a carbon price. They can also be used to fund adaptation measures
and to support R&D into clean technology. They could also
be used to provide capacity building in other countries to speed
the expansion of the market.
Development of a global carbon market
21. The Kyoto Protocol created an international
carbon market with countries as participants. It proved to be
ineffective in curbing global emissions thanks to the non-participation
of the US and the exclusion of rapidly developing countries, most
notably China. In a recent paper we advocate the introduction
of a global sectoral carbon market focusing on the global power
22. It is clear that the US is seeking to
introduce cap and trade legislation. They are the original inventors
of emissions trading at both a domestic and international scale
and already have an operating state level scheme in the form of
the Regional Greenhouse Gas Initiative (RGGI). RGGI differs from
the EU ETS is some important respects: it applies to the power
sector only, it uses quarterly auctions to allocate all allowances,
it has a three rather than five year compliance period, it contains
price responsive triggers (at $7 and $10 per tonne)
which grant more flexible access to offset credits. And, importantly,
it allows for the cancellation of permits in response to the voluntary
purchase of renewable electricitymaking it possible for
citizens to tighten the cap in response to their voluntary actions.
23. Whilst the design may be good, however,
the overall level of effort is weakthe first period of
operation (2009-14) merely requires emissions to stabilise at
2007 levels, the cap then reduces by 2.5% per annum from
2015-18 leading to a 10% reduction overall from 2009 levels.
The EU ETS in general creates tougher caps on its power sector
(in the UK, Germany and Spain allocations in 2008 were in
the region of 30% below 2007 emissions levels) but then waters
down the effectiveness of this by granting generous allowances
24. Stakeholders in the US will have been
watching how the EU ETS has been faring and it is vital that they
do not make the same mistakes we made in Europe. At a Federal
level they will hopefully follow RGGI more closely than the EU
ETS and introduce auctioning from the outset for all power and
fuel providers, though they will have concerns about protecting
exposed industrial sectors. They may choose either to leave industrial
sectors out of the scheme at the start while they seek to agree
global sectoral agreements or they may introduce border tax adjustments
to protect domestic industry. It would be a shame if they followed
Europe's example and watered down the effort in the scheme by
protecting industry with overly generous grandfathered allocations.
25. Australia has released a White Paper
on their Carbon Pollution Reduction Scheme, and draft legislation
is expected 10 March 2009. Subject to ensuring appropriate
safeguards around scheme design linking appears desirable. One
point of note is that, as currently proposed, the Australian CPRS
will allow unrestricted access to CDM credits, which would conflict
with the EU ETS. As both Schemes will be linked via the CDM market
there will likely be a degree of price convergence.
26. The problems with the ensuring additionality
in the CDM are well known and, fundamentally, the stringency of
caps that would be required to achieve meaningful reductions in
the developing world and the decarbonisation of the developed
world are too high to be likely to ever be introduced.
27. We therefore support the expansion of
the carbon market to cover global sectors beginning with the power
sector. This would effectively reduce the scope of "offsetting"
by removing those sectors from the CDM. The CDM could remain as
a source of project credits in the least developed countries but
rather than be allowable against the cap they could be funded
from trading levies and auction revenues.
28. There has been considerable discussion
recently about the need to address and reduce deforestation with
some stakeholders advocating links to the carbon market. We have
reservations about such an approach and indeed about the linking
of land use change credits in general. We support instead a separate
"Sinks Protocol" with policies and measures dedicated
to the complex task of better understanding, monitoring and managing
biospheric sinks. We see the need to decarbonise energy and reduce
the rate of emissions of man-made greenhouse gases as a separate
issue requiring its own parallel policy to address it.
UK carbon budgets
29. To account for the fact that ~50% of
emissions of CO2 are covered by the EU ETS Government has
chosen to count traded effort towards the meeting of carbon budgets
(as opposed to counting actual emissions).
30. This is supported by the argument that
emissions reductions are valid contributions to countering global
climate change irrespective of where they occur and that trading
helps to minimise cost by uncovering least cost abatement. It
does, however, mean a relinquishing of control with regard to
whether investment will occur in the UK or overseas. Without specific
incentivies it is likely that investment and skills development
will be conducted overseas.
31. It is the initial allocation of permits
that therefore contributes towards the budget. That is to say
purchased permits/credits (CERs, ERUs, EUAs) can be used to counteract
or "offset" any emission occurring above the initial
allocation. Similarly any under emission resulting in sold or
banked permits cannot be counted towards the budget (since they
result in emissions occurring somewhere else). The budget for
50% of UK emissions in this phase of trading is therefore pre-determined.
32. The UK will only decarbonise its actual
emissions in so far as the EU ETS price signal changes behaviour
and supplementary policies exist and deliver emissions reductions.
This decarbonisation process will need to be separately measured
and reported on since the budgeting process will not necessarily
33. If the UK wishes to it may make use
of trading as a means of compliance it can:
Buy permits to cover emissions outside
of the budget in the non-capped sectors.
Withhold allowances from the capped sector
by cancelling rather than auctioning allowances set aside in the
New Entrants Reserve/Auction.
Incentivise the voluntary cancellation
of permits by civil society with offset policies and incentives.
34. Thus far the EU ETS is not widely understood
by the civil society. For meaningful rapid carbon reduction this
needs to change. While one element is public education, of greater
importance is ensuring that civil society involvement is encouraged.
35. One perverse element of a cap and trade
system is that emission targets form both a cap and a floor from
which emissions can not deviate (with the minor exception of voluntary
permit retirement). While potentially an abstract concept this
has significant real world implications. For example, any "Green
New Deal" or environmentally focused policy (insulation,
renewable energy etc) conceived and implemented after caps have
been set, will have no net impact on overall EU wide emissions.
Instead a reduction in emission demand in one element of society
will reduce the overall demand in the market and lead to a "freeing
up" of permits for heavier polluters who would have otherwise
commenced abatement activities. This will also lead to a reduced
market price, and furthermore decreased auction revenues.
36. At the individual household level this
means that any action taken will not reduce UK or EU emissions.
So reducing electricity use in the UK could inadvertently prevent
a large coal fired power plant in Germany from reducing their
emissions. Clearly this is disempowering for society.
37. This issue has been documented in the
use in respect of the RGGI, where emissions credits equal to voluntary
purchases of renewable energy on green tariffs are taken out of
the cap (ie the cap reduces), and has been recently debated in
Australia in terms of voluntary activities across the community
(including uncovered businesses and local Governments).
38. We are working with other groups internationally
on a number of policy ideas to combat this issue, and support
a "cap and slice" mechanism where caps are reduced to
acknowledge measurable voluntary action undertaken over and above
that which would be a reasonable response to the carbon price
signal. This policy would enable citizens to act to reduce the
level of emission credits in the market.
1 More information supporting our analysis, including
the spreadsheets used for the comparison, are available on request. Back
Our paper "Bending the Curve with a global power sector carbon
budget" is available on request. Back
We are currently working on a submission to Treasury proposing
a tax break to incentivise voluntary cancellation and can make
a copy available on request. Back
Our submission to the Australian Governments National Carbon Offset
Standard discussion paper is available on request. Back