Select Committee on European Union Thirty-Third Report

CHAPTER 10: Summary of Conclusions and Recommendations

Chapter 2: The overall target, the EU-wide cap and the international context

199.  Like all of our witnesses, we welcome the application of an EU-wide cap supported by a clear trajectory for emissions reductions over time, as it should deliver a level playing field and provide industry with the certainty that has been lacking in the EU Emissions Trading System thus far.

200.  We agree with the UK Government that the proposed change from a 20 per cent emissions reduction target to a 30 per cent target by 2020, conditional on reaching an international agreement, is desirable. A unilateral 20 per cent target would be less helpful in achieving the desired global reductions than a 30 per cent target alongside an international agreement. A 20 per cent target would also fall below the 25-40 per cent target range recommended by IPCC scientific advice. However, we believe that the change should be conditional on a credible and robust international agreement so as to ensure that EU businesses are not placed at a competitive disadvantage in world markets.

201.  As agreed by the European Council in March 2007, an international agreement should include a commitment by developed countries to mandatory reductions of greenhouse gas emissions in the order of 30 per cent by 2020 and a commitment by economically more advanced developing countries to an adequate contribution according to their responsibilities and respective capabilities. We urge the Commission and the Member States to adhere to these minimum conditions.

202.  Some advanced developing countries' argument that developed countries ought to take "historical responsibility" for the cumulative impact of their historical emissions is compelling , but we consider that the threat posed by climate change—not least to the very countries taking that position—is sufficiently grave that advanced developing countries must commit to binding emissions reductions. Persuading these countries to take on such commitments will be particularly difficult and, as a quid pro quo, we accept the UK Government's contention that increased financial flows to developing countries, through external credits and direct assistance for adaptation to climate change, will be an essential bargaining tool in the negotiations.

203.  We believe that a final decision on the emissions reduction target for 2020 should be reached as early as possible following the conclusion of negotiations on an international agreement, in order to provide the certainty that would enable industry to make the appropriate investment. We see no compelling reason for the decision to be adopted through the co-decision procedure as this would prolong the period of uncertainty, and risk re-opening negotiations on the climate change package as a whole, which will already have been agreed by the European Parliament and Council through the co-decision procedure. It is crucial, however, that the details of the agreement are scrutinised by the Member States and the European Parliament as provided by the Treaty.

Chapter 3: Scope

204.  If the EU's Emissions Trading System is to achieve its fundamental objective of delivering greenhouse gas emissions reductions as cost-effectively as possible, it must eventually include as many sectors as possible. However, sectors should only be included if their emissions can be reliably monitored and verified. In view of the quality of data and methodology currently available, we support the proposed scope of the ETS from 2013, but recommend that this aspect of the Directive be kept under regular review.

205.  We note that the inclusion of agriculture and forestry sectors in the ETS may pose particular practical difficulties due to monitoring and verification problems and the large number of small enterprises involved. We nonetheless consider that these sectors have a major role to play in reducing greenhouse gas emissions, and urge both the Commission and the UK Government to accelerate work on assessing how those sectors can contribute most cost-effectively to a reduction in greenhouse gas emissions, drawing lessons from the experience of other countries.

206.  Swift action must also be taken to tackle emissions from shipping. If a sectoral agreement cannot be reached through the International Maritime Organisation in the near future, we believe that the sector's inclusion in the ETS should be given serious consideration, and should be delayed no further than 2013 for the largest emitters in the sector.

207.  The development of a reliable and commercially viable method of decarbonising coal is urgently necessary, as coal is likely to remain a significant—and growing—source of energy. We therefore wish to see significant investment in carbon capture and storage, to establish whether this technology could meet that need. We support the provision in the draft Directive stipulating that operators need not surrender allowances for emissions that have been captured and stored, as it should help to stimulate such investment.

208.  We accept that the de minimis emissions threshold proposed in the draft Directive may be too low, and that a large number of small emitters accounting for a relatively small proportion of overall emissions could be removed from the scope of the ETS in the interests of better regulation. We would therefore support a raising of the de minimis threshold as proposed by a number of our witnesses.

209.  We note, however, that unintended consequences may flow from a de minimis threshold, such as incentives to build smaller, possibly less efficient installations, and recommend that such effects be monitored closely and pre-empted where possible. In this respect, we welcome the Government's assurance that small installations in the UK that are excluded from the scope of the ETS will instead be covered by the Climate Change Agreement scheme or by the Carbon Reduction Commitment.

210.  We note that the UK Government is making some efforts outside of the ETS to tackle climate change but would urge the Government to intensify its pursuit of cost-effective emissions reduction measures across the economy, particularly in sectors remaining outside the ETS such as agriculture, forestry and road transport. Emissions reductions in other parts of the economy are no less important than those within the sectors and installations covered by the ETS.

Chapter 4: Allocation and auctioning

211.  We support in principle the 100 per cent auctioning of allowances from 2013 in all sectors other than those deemed subject to carbon leakage. Free allocation of allowances can lead to windfall profits and should for that reason be avoided wherever possible.

212.  We acknowledge, however, the concerns of those Member States whose energy mix is fossil fuel-intensive and who therefore fear that the Commission's proposal may have a disproportionate impact upon them. We believe that time-limited derogations from the principle of 100 per cent auctioning in the power sector from 2013 could be granted to Member States with particularly fossil fuel-intensive energy sectors, on the condition that the transition period is used to develop and trial carbon capture and storage technology. Derogations should be phased out by 2020 at the latest, by which time full auctioning should be in place for the power sectors of all Member States.

213.  Should the Commission's proposal for a gradual transition towards 100 per cent auctioning over the period 2013-20 for all but the power sector be adopted, we consider that a harmonised level of auctioning should be set across the EU, with no flexibility for Member States to either raise or lower the level set. This is crucial in order to prevent distortions of competition across the European Union. In any transition towards 100 per cent auctioning, free allocation should be based on sector-specific EU-wide benchmarking that rewards the use of Best Available Technology and stimulates further innovation.

214.  With regard to how auctioning revenues are spent, we agree with the UK Government that it would be inappropriate for this to be prescribed at the EU level as it breaches the principle of subsidiarity. Without such earmarking, we do not see any remaining justification for the redistributive element of the Commission's proposal, under which a proportion of the rights to auction allowances would be redistributed towards Member States with low income per capita or particularly high compliance costs.

215.  We are conscious, however, that the redistributive element of the Commission's proposal commands wide support among Member States. If this aspect of the proposal were to be accepted, and if any derogations from the principle of 100 per cent auctioning in the power sector were to be permitted, the levels of redistribution of auction rights among Member States should be re-considered. If the levels are not re-considered, the EU risks compensating the same Member States twice over for the compliance costs they face.

216.  It is our firm view that Member States should invest considerable funds in climate change-related measures—including R&D and demonstration projects, as well as adaptation measures—and in measures to help ease the social problems that may arise as a result of the ETS, such as increases in electricity prices. In our view, this will be essential to secure the credibility of the scheme, by signalling that governments are willing to foot part of the bill that they are imposing on the private sector.

217.  It is critical, however, that the measures into which such funds are invested should not cancel out the carbon price signal altogether by compensating industry and consumers fully for price increases arising from the ETS, as this would undermine the scheme's raison d'être. Investment should instead focus on providing viable, low-carbon alternatives and promoting the necessary transition.

218.  The balance of evidence presented to us suggests that the proposed level of the New Entrant Reserve is too high, which would have the effect of creating a large reserve of allowances whose deployment is unpredictable. We accept our witnesses' contention that the New Entrant Reserve is too large, but would support the redeployment of unallocated allowances from the Reserve towards large-scale carbon capture and storage demonstration projects free of charge, as proposed by the European Parliament's Environment Committee. A provision along these lines would stimulate the development of this important technology without undermining the overall cap on allowances.

Chapter 5: Carbon leakage

219.  While the ETS remains a regional scheme, we believe that some sectors of industry may be at risk of carbon leakage. The evidence we received suggests that vulnerable firms are concentrated in a handful of sectors, and in some cases, sub-sectors, such as clinker and primary aluminium. We consider that it would be appropriate to award special treatment to the industries or sub-sectors at risk in the third phase of the ETS until an international agreement or a global sectoral agreement putting these industries on an even footing with their non-EU competitors can be reached.

220.  Identification of the sectors or sub-sectors at risk should be evidence-based. We support the Commission's proposed criteria for arriving at these judgments, but emphasise that the analysis should distinguish between potential competitiveness lost as a direct result of the ETS and other influences on competitiveness (e.g. regulatory standards more generally) that arise from trading in a global context. The extent to which cost savings are possible through energy efficiency measures should also be considered.

221.  In order to create a predictable policy environment, decisions on the sectors or sub-sectors at risk ought to be taken as soon as possible. We therefore believe that the decision-making process should be speeded up. Sectors potentially at risk of carbon leakage should be identified by 2009 so as to minimise uncertainty for all other sectors within the scope of the ETS. Decisions on the treatment to be afforded to sectors at risk of carbon leakage should be taken in 2010 after the December 2009 UN Climate Change Conference in Copenhagen, when the full extent of that risk (or lack of it) will become clear.

222.  Free allocation of emissions allowances should in our view be the preferred policy response to the threat of carbon leakage, but international sectoral agreements on emission reductions in particular sectors must be the eventual aim as there is a risk that free allocation could, in the long term, become a protectionist measure. Border adjustment measures should be avoided, due to their potential to breach WTO rules.

Chapter 6: Compliance and enforcement

223.  The practical application and enforcement of the ETS is critical to its success. It is clear to us that, without effective enforcement, the integrity of the scheme would be severely prejudiced. We therefore welcome the European Commission's proposal that monitoring, reporting and verification rules should be harmonised across the European Union with the aim of guaranteeing a level playing field. The Commission has been vigilant in monitoring Member States' compliance with climate change legislation thus far and we urge it to continue to pursue this approach in future, taking all necessary action against Member States that are not fulfilling their responsibilities. We are not persuaded by the argument that the performance of national regulators will be kept in check by competitors in different Member States informing on each other.

224.  We note with serious concern that the enforcement mechanisms of the Kyoto Protocol have been shown to be weak and consider that these deficiencies must be addressed in any successor agreement if international efforts to address climate change are to produce the desired result. The Commission and Member States must therefore place high priority on this issue during negotiations on a new international climate change agreement.

Chapter 7: External and domestic credits

225.  External credits can play an important role in reducing global emissions cost-effectively as long as they do not crowd out developing countries' own efforts to cut emissions.

226.  Nonetheless, the EU cannot hope to set an example in the international arena without undertaking substantial emissions reductions within its own borders. It also cannot hope to secure a competitive advantage in low-carbon technologies if external credits are too freely available, as this will stifle domestic innovation and investment.

227.  On balance, we consider it appropriate as a negotiating tactic to restrict the level of external credits in Phase 3 to those available and unused under Phase 2 of the ETS, as proposed by the European Commission, until such time as an ambitious global climate change agreement has been concluded. This will be one of the few bargaining chips available to the EU in international negotiations: we urge the European Commission and the Member States to use it to press for an ambitious global emissions reduction target at Copenhagen in December 2009.

228.  In order to provide the carbon market with as much certainty as possible, it is imperative that a decision on the future level of credits is taken at the earliest opportunity in the event of an international agreement.

229.  The use of external credits must be properly audited, but this process should not lead to the development of standards separate to those stipulated by the Kyoto Protocol if the aim is to promote a liquid, truly global market. EU Member States might instead press for a review of the role of the CDM Executive Board by the Secretariat of the UNFCCC in order to assess whether it is functioning effectively.

230.  We are sceptical about the benefits that domestic off-setting might offer, on the basis that tapping cheap abatement opportunities in non-ETS sectors could push up the cost of meeting emissions reduction targets in those sectors.

Chapter 8: Linkages with other schemes

231.  It is critical that the EU ETS should be able to link with similar schemes around the world. Emissions trading will become increasingly effective as it becomes more widespread. Conversely, the EU ETS will be less effective, both in economic and environmental terms, while it remains an isolated regional initiative.

232.  The evidence presented to us suggests that linkages will only be possible between emissions trading schemes that share similar levels of ambition with respect to environmental objectives, quality-control of credits, verification and enforcement mechanisms. We note than on current projections, the third phase of the EU ETS is likely to deliver a substantially higher carbon price than the emissions trading schemes being developed in other parts of the world. This carbon price differential would in turn present a serious obstacle to establishing links between the EU ETS and other emissions trading schemes. We therefore anticipate that, due above all to the potential price differential, the EU may in future face stark trade-offs between compromising the environmental integrity of its scheme and extending its reach. It is not clear in advance which of these two approaches will deliver more emissions reductions overall, but this consideration should in our view drive EU policy on linkage.

233.  In view of the significant remaining barriers to linkage between schemes, we wish to highlight the role that the International Carbon Action Partnership could play in facilitating international dialogue on these issues. We urge the European Commission and the Member States to take a leading role in promoting such dialogue.

Chapter 9: Looking ahead

234.  The EU Emissions Trading System has become the cornerstone of UK and EU climate change policy, although its record—in delivering emissions reductions cheaply and efficiently—is as yet unproven. It is a daring, but warranted, strategy in view of the grave threat posed by global warming. By placing a cap on greenhouse gas emissions in participating sectors, and promoting the uptake of emission reduction opportunities where they are cheapest, the ETS could make a major contribution to delivering the cuts in greenhouse gas emissions that the European Union has pledged to make. The EU ETS may also be viewed as a building block in the development of a global network of emissions trading schemes, which could facilitate international collective action on climate change.

235.  Vigilance is nevertheless required if the scheme is to live up to its promise. We have highlighted the audit and compliance regime as meriting particularly close attention, and consider that the scheme's success in delivering emissions reductions must also be monitored. We have warned that on present projections—particularly of the price that different schemes would put on carbon—links between the EU ETS and other nascent emissions trading schemes would be far from straightforward.

236.  Emission reduction measures in those sectors of the economy that remain excluded from the scope of the ETS must proceed at an equivalent pace, and receive no less attention from policy-makers, as those sectors account for around half of the EU's greenhouse gas emissions. They should be accompanied by economy-wide measures to remove barriers to energy efficiency, and policies to support innovation and the deployment of low-carbon technologies.

237.  We are conscious that the present financial crisis, and the prospect of a global recession, may increase some Member States' reluctance to impose additional costs on industry through the proposed revisions to the ETS. Balanced against this, however, is the prospect that as output falls, so should emissions, thereby easing compliance costs.

238.  It has been argued that precisely because emissions may stabilise or fall in the short term, the most ambitious changes to the ETS should be postponed until industry is in a better position to absorb the costs they might entail.

239.  EU Member States should resist this argument. Revisions to the ETS would only take effect in 2013, by which time an economic recovery is expected to be underway. In the interim, adoption of the proposed changes to the European Union's Emissions Trading System would put in place a stable regulatory environment, and send out the necessary long-term signals, ensuring that when private sector investment recovers, it is channelled into the right areas.

240.  As the Stern Review pointed out, the investment that takes place in the next 10 to 20 years will have a profound effect on the earth's climate in the second half of this century and in the next. While the stakes are undoubtedly high, the EU cannot afford to falter.

---