Trading thin air: The EU Emissions Trading Scheme

Since its much-publicised launch in 2005, the EU seminal environmental-policy tool, the Emissions Trading Scheme (ETS), has managed to polarise opinions all across Europe and beyond. In a nutshell, the ETS is aimed at reducing the EU's emission of greenhouse gases by setting maximum levels of emissions for firms in energy-intensive industries in each member state (like iron, steel and power generation industries, accounting for some 40 per cent of total EU emissions of CO2). This is done by allocating a fixed number of carbon dioxide pollution permits to each firm, representing the level of emissions allowable. These permits may be traded between firms, depending on their pollution requirements. Hence, energy-efficient firms are able to sell their excess permits and generate income, whereas heavy polluters must necessarily seek to purchase additional permits or risk incurring a fine of €40 per excess tonne of CO2 emitted.

Proponents of the ETS argue that the scheme has been an unqualified success and a lesson in the use of market-based instruments to combat climate change for the rest of the world. Data published by the European Commission in November 2006 shows that the 15 EU member states who initially signed up to the Kyoto protocol recorded a decline in greenhouse gas emissions by two per cent in 2005 compared to 1990 levels. This, according to the Commission, is even more impressive when one considers that the period 2005-2007 was meant to be a trial period for the ETS to enable the necessary infrastructure to fully develop. Additionally, according to estimates, these countries should attain a projected decline by 2012 of approximately 7.4 per cent in emissions, just short of their Kyoto protocol commitments. However, a sobering Commission report in May 2008 showed that between 2005 and 2007 the EU's total carbon dioxide emissions in fact increased by an average of around 1.9 per cent, highlighting the environmental challenges that still lie ahead for the EU.

The main challenge that looms over the ETS is the delicate balance that must be maintained between environmental concern and business interests. This is because although the ETS's main aim is the protection of the natural environment, one cannot neglect the impact that such measures may have on business profits in the short/medium term. The Commission recognised this fact, and proposed an overhaul of the ETS last January and which will come into effect between 2013 and 2020. The proposed measures include a targeted reduction in CO2 emissions by 20 per cent over 2005 levels by 2020, as well as the inclusion of additional industries into the scheme (for instance, the aviation sector).

Reactions to the proposed changes have been decidedly mixed. Environmental groups like the WWF have criticised the emission-reduction target as being far below the expected target of 30 per cent. On the other hand, the inclusion of certain industries has raised the ire of several companies, most notably in the European aviation industry where skyrocketing fuel prices and the global credit crunch have already eaten away at profit margins and dampened business outlook. The prospect of the additional costs brought about by the ETS in an effort to respect emission targets has angered firms, especially since this would place them at a competitive disadvantage when compared to non-EU firms. Furthermore, by 2013 almost 60 per cent of emission allowances must be auctioned off (i.e. sold) rather than distributed free of charge as in the majority of current cases, constituting a further cost for industries. On the other hand, environmental groups have praised this proposal, maintaining that this system would encourage industries to pollute less and become more efficient in an attempt to lower their emission-allowance requirements.

As expected, discussions are already taking place in an attempt to reach a compromise. Proposals include allowing a centralised allocation of emission permits directly by the EU Commission rather than at the national level, to ensure that emission targets are respected and permit allocations are kept in check (the problem of over-allocation of allowances has blighted the ETS since its inception). Others contend that free distribution of the majority of permits should still take place; however, any firms caught polluting above the stipulated threshold would be forced to pay up the entire amount due, together with the fine mentioned previously.

Thus it is clear that the ETS must continue to be developed further in order to reconcile environmental concern with commercial interests, in tandem with other policies (both at a pan-European and national level) aimed at ensuring the EU's future sustainability.

• For more information please visit www.impetuseurope.com or contact jonathan.spiteri@impetus europe.com

• Mr Spiteri is research executive at Impetus Europe Consulting Group Ltd.