First the good news; provisional EU emission data for last year shows a healthy fall in year-on-year emissions across the bloc. Now the bad news; the emission data also clearly identifies the weak economy, and not the EU Emission Trading Scheme (ETS), as the main driver of lower emissions. With the scheme’s current second phase ending this year there is clearly a need for urgent political intervention if the scheme is to have any positive momentum in its third phase, commencing January 2013. Yet the lack of political unity on environmental policy across the EU’s membership towards long-term emission and renewable energy targets argues against a prompt positive outcome.
When the EU ETS was launched in 2005 its emission-reducing rationale was straightforward; by progressively limiting the number of free allowances made available to installations the value of the allowances (ie the carbon price) would increase, making it more economical for installations to reduce emissions than pay for costly allowances to offset their emissions. There is nothing flawed with the broad concept of a cap and trade scheme providing such a scheme accounts for economic health and renewable energy capacity. Unfortunately for the EU ETS, the latest annual emission data confirms that these variables are not accounted for.
Three factors contributed to lower year-on-year EU emissions in 2011: economic weakness caused by the eurozone crisis that reduced industrial and manufacturing output; milder weather that reduced generation and heating demand; and a second year of heavy investment in renewable energy.
The economic factor, while unavoidable from an emissions trading perspective, not only illustrates the strong causation and correlation between the economy and emissions, with increased economic output associated with increased emissions and vice versa, it also reinforces the view (not shared by the EU administration in Brussels) that a cap and trade scheme can only be truly effective in a growing economy. For almost all the current second phase of the EU ETS the European economy has either been weak or in recession. This has not only reduced the economic impact of the EU ETS as an emission-reduction driver, it has also reduced investment support for low carbon technology due to a low, and falling, carbon price.
Ironically, the second driver of reduced emissions, namely milder weather, is a consequence of the very climatic change that emission reductions are meant to mitigate. As with the economy this is largely unavoidable, yet while Europe’s economic future is uncertain and likely to be volatile there is more certainty that milder weather will continue as global climatic change becomes more apparent.
While economic and climatic factors are considered unavoidable emission drivers, the third factor, renewable energy capacity, is not. With the generation sector being the largest emissions producer any decarbonisation of this sector through increased renewable capacity will reduce overall emissions, increase the oversupply of allowances and lower the carbon price. And when combined with a weak economy and milder weather this emission reduction and allowance oversupply becomes more pronounced.
With the EU ETS being an ineffective driver of lower emissions, as the scheme has now been long on allowances for three consecutive years and six times in the last seven years, and with strong renewable capacity growth, the key issue that has to be addressed is the future relationship between emission reduction targets through the EU ETS and renewable energy targets.
In publishing a 2050 Energy Roadmap that presents multiple pathways to decarbonise the EU energy sector by the middle of this century, the European Commission has prompted debate on the energy development path over the thirty years from 2020. Environmentalists maintain that only a renewable-centric energy policy can meet the 2050 target and believe interim renewable targets between 2020 and 2050 are required to ensure there is sufficient renewable investment to meet these targets. But this thinking is flawed – the policy priority has to be to reduce emissions, not renewable investment.
There are a number of ways to reduce emissions of which investing in renewable energy is just one, and any responsible low carbon energy policy has to identify the most affordable energy mix that also supports supply security. This being so, setting long-term renewable energy targets is misleading. Of more value is a series of future low carbon targets that encourage the progressive decarbonisation of the energy sector and support renewable energy without being renewable exclusive.
One year on from the Fukushima disaster there continues to be considerable investment and policy uncertainty in new nuclear build, which suggests that the prompt development of carbon capture and storage technology will be pivotal to a future secure low carbon market. Investors have made it clear that the significant commercial risk associated with unproven large-scale CCS plant not only requires governments to underwrite these risks through direct investment or subsidies, it also requires a strong carbon price to make the economic case for investment and, in the case of the EU, an effective ETS.
If the EU ETS is to act as a credible emission reduction and low carbon investment driver through the remainder of this decade there have to be changes that address economic, climatic and renewable capacity variability. The favoured option within the EU is to set aside some of the third phase allowances to reduce oversupply and support the carbon price, but while such intervention would support the carbon price it could come at an economic cost, with a number of east European member states dependent on coal for generation and industrial output. Another option would be to introduce a carbon floor price, yet as with any allowance set aside this could have economic consequences and possibly lead to carbon leakage.
The first phase of the EU ETS was intended as a learning curve, yet a strong economy, historically seasonal weather and low levels of renewable capacity during the inaugural phase left installations and the EU unprepared for the second phase. If the scheme is to be effective in the third phase the second phase lessons need to be learned and acted upon; if not the arguments made against the scheme in 2005 will have increased potency and Brussels’ claim that its ETS is a global role model will be invalidated.
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