Select Committee on European Union Thirty-Third Report

FOREWORD—What this report is about

Both the United Kingdom and the European Union have pinned much of their climate change policy on the effective operation of the EU Emissions Trading System (ETS). Now in its second trading period, scheduled to last until 2012, the fledgling scheme has yet to demonstrate that it can deliver the substantial greenhouse gas emission reductions that will form the yardstick of its success.

In this report, we examine the European Commission's proposed revisions to the ETS, which would take effect in the scheme's third trading period, scheduled to last from 2013 to 2020. EU negotiations on these proposals are taking place in parallel to international negotiations on a potential successor to the Kyoto Protocol, which are expected to culminate at the UN Climate Change Conference in Copenhagen in December 2009. We therefore also consider the strategic ramifications of the choices facing the EU as it adapts its Emissions Trading System.

In our view, the EU ETS has tremendous potential: it could deliver sizeable emissions reductions cost-effectively, while also providing a platform for future cooperation with other countries on the creation of a global carbon market. In a number of areas, we therefore call on the UK Government to press for ambitious revisions to the ETS. We support the auctioning of emissions allowances in most sectors from 2013; advocate a stringent, evidence-based approach to the risk of carbon leakage; and recommend that additional sectors be brought within the scope of the scheme providing that their emissions can be reliably monitored and verified.

Balanced against the great promise of the ETS, however, we see considerable risks. Monitoring, verification and enforcement could in our view become a significant challenge: the scheme's effectiveness hinges on compliance, without which the ETS would not only fail to deliver the desired emissions reductions, but also distort competition among designated participants. This risk is magnified at the international level, and we therefore note with concern that the Kyoto Protocol's enforcement mechanisms have failed to deter non-compliance. We consequently urge the Commission and the Member States to place a high priority on robust auditing and enforcement mechanisms in adapting the ETS and in the course of international negotiations on a successor to the Kyoto Protocol.

If the EU's emissions trading scheme is to live up to its full potential, the ultimate aim must be to link it up with emissions trading schemes in other parts of the world so as to make the most of emission reduction opportunities in additional countries and sectors. We warn, however, that the establishment of such links could prove arduous, particularly where alternative designs and approaches lead to significant differences in the price of carbon across different emission trading schemes. We anticipate that the EU may eventually face stark trade-offs between maintaining the environmental integrity of the ETS and extending its reach.

In other policy areas, these risks might signal that prudence is called for, and that the ETS is not yet ready for extension and expansion. We consider that the threat posed by global warming merits a bold response, and therefore support the Commission's proposal to press ahead with ambitious revisions to the ETS. We nonetheless emphasise that the environmental and economic stakes are formidable.