Memorandum submitted by Friends of the
Earth (EWNI) (ETS 23)|
1. Friends of the Earth EWNI welcomes the Energy
and Climate Change Committee's current enquiry and is grateful
for the opportunity to comment on a number of the issues that
it has chosen to examine.
2. The UK government should not support the continuation
of the EU ETS and immediately shift its resources and attention
to the better alternatives already being pursued. The EU ETS has
not and will not deliver the genuine emissions reductions necessary
to meet the UK's obligations in averting catastrophic climate
change. The first two phases have failed to cut emissions, while
Phase III looks set to start with a surplus of permits so large
that it would require no domestic reductions until 2018.
3. The EU ETS has handed over huge sums of taxpayers'
money to the power sector and industrial polluters at a time of
great austerity, with little obvious benefit: subsidies could
amount to almost £100 billion by the end of phase II.
This is the combined effect of "passing
through" to consumers the costs of permits received for free,
plus the resale value of surplus permits. A windfall tax should
be considered to re-capture these surpluses, with the income spent
on domestic energy efficiency work.
4. While the UK government should not support
the continuation of the EU ETS, the very least it can do is address
extensive loopholes throughout the scheme. These include measures
to exclude all international offsets, putting a stop to the practice
of freely allocating permits to polluters, imposing a much tighter
cap, and preventing the use of banked permits from earlier phases
of the ETS scheme. Measures to expand the ETS by linking with
schemes outside of the EU, or promoting "new market mechanisms"
(such as sectoral crediting or trading) with developing countries
should be stopped. These recommendations do not obviate the need
to reconsider support for the ETS altogether.
5. A stop should be put to the dangerous obsession
with the ETS. Instead, much greater priority should be given to
other policy options, including but not limited to regulations
such as energy efficiency standards, renewable energy incentives
such as feed-in tariffs, and financial incentives for cleaner
investment such as a financial transaction tax or redirected EU
6. Friends of the Earth has published a number
of reports analysing carbon trading, which include:
A Dangerous Obsession: The evidence against carbon
trading and for real solutions to avoid a climate crunch,
Clearing the Air: Moving on from Carbon Trading
to Real Solutions
The EU Emissions Trading System: failing to deliver
Does the EU ETS remain a viable instrument for
climate change mitigation in the EU?
7. The EU ETS has failed to significantly reduce
carbon emissions across Europe. The first "pilot" phase
(2005-07) saw too many permits handed out, with an overall surplus
of 267 Mt CO2e (Megatonnes Carbon Dioxide Equivalent),
more than the annual emissions of the UK.1 The permit
price collapsed when markets saw that the scheme was over-allocated.
8. Phase II of the ETS, from 2008 to 2012, is
also misfiring badly. The Commission has claimed some successesfor
example, emissions from installations covered by the scheme fell
by 11.6% in 2009. However, this needs to be set against falls
in production of electricity and industrial goods of 13.85% in
2009 as a result of the recession.2 This comparison
indicates that emissions reductions were the result of less production
(in the context of an economic downturn) rather than the ETS itself.
9. The combined effect of the economic
downturn and generous provisions for the purchase of international
offsets is an oversupply of permits. All credible predictions
for phase II expect there to be a significant surplus by 2012.
Permit prices have not collapsed to zero (as in Phase I), but
this is only because it is possible to "bank" them for
use in Phase III (2013-20). However, this same possibility undermines
environmental integrity. More than three-quarters of installations
have surplus permits, which means they can delay taking action
to reduce their greenhouse gas emissions at source.3
These surplus permits should be cancelled.
10. By the end of Phase II, the EU ETS could
well have awarded polluters close to £100 billion in subsidies.
This includes an estimated 19 (£16.7) billion to power
companies in Phase I, and up to 71 (£62.5) billion
in Phase II; and up to 20 (£17.6)
billion to heavy industry.4
These perverse incentives result from the "pass through"
of costs to consumers, plus the estimated worth or freely allocated
11. Phase III will still see further significant
subsidies paid to industry. The free permits being enjoyed by
three-quarters of manufacturing has resulted from lobbying by
heavy industry, and could yield at least 7 (£6.2)
billion in windfall revenues annually.5 In addition,
the Commission is currently undertaking a review of "state
aid" rules which could see the granting of direct financial
subsidies for "indirect" lossesin effect, subsidising
cost pass through. The University of Groningen Centre of Energy
Law has pointed out that this "artificially reduces the operating
costs of high carbon-content generation capacity lower in the
merit order (from hydro and nuclear to coal, combined fuel and
gas) leading to the building of more coal-fired power plant."6
Such a measure is counter-productive, in other words. The DECC
submission to the Commission's state aid rule consultation also
notes that the number of sectors exposed to carbon leakage risks
is small.7 The UK should therefore seek to address
at the earliest opportunity the over-generous allocation of free
permits to heavy industry.
12. In the process of passing the revised ETS
Directive, energy companies successfully lobbied for an estimated
4.5 (£4) billion
in subsidies for Carbon Capture and Storage (CCS), with a smaller
amount for "clean" energy that includes biofuels.8
Such investments could be an impedimentCCS delays the transition
to renewable energy; while biofuels cause significant environmental
and social harm.9 These measures are counter-productive:
auction revenues should not be used to subsidise fossil fuel infrastructure,
CCS, or other impediments to a low carbon transition.
13. The use of international offsets is a further,
endemic problem. Carbon offsetting is, at best, a zero-sum exercise:
it moves the obligation to reduce emissions away from the EU,
and counts reductions from "emissions-savings" projects
as equivalent to domestic reductions. In reality, between one-third
and three-quarters of these projects do not represent reductions
by any reckoning. The net effect of the scheme is therefore to
14. To date, the CDM has mostly substituted a
reduction to reduce CO2 emissions with spurious industrial
gas offsets (from HFC and N2O). Even though these credits are
banned from phase III, the "banking" of permits means
that they can continue to be "cashed in" until 2012,
displacing permits and so reducing obligations in the longer term.
The emissions reductions claims of the other most numerous project
types (including hydro-power and wind) are also highly questionable
- the volatility of offset prices, combined with the mix of other
incentives, makes it highly likely that such projects would have
happened anyway (they are "non-additional" in the emissions
trading jargon). Research by Friends of the Earth EWNI has further
shown that offsetting does not ensure positive sustainable development
and is profoundly unjust.10
Can the EU ETS operate effectively in a world
without legally-binding emissions reduction commitments and other
15. The ETS should exclude offset credits, and
a broader reconsideration of policy should be undertaken. The
scheme is increasingly isolated internationally. Proposed emissions
trading schemes in the USA, Japan and Canada have stalled indefinitely;
new markets in Australia and South Korea face significant delays;
and a court action in California has also delayed the start of
a planned scheme there. According to the latest World Bank figures,
the EU ETS drives up to 97% of the global trade in carbon.11
The assumptions that the ETS would lead to the emergence of a
global carbon trading system are not being borne out. This has
led to a situation in which the availability of permits and credits
already exceeds demand. New carbon market mechanisms (eg sectoral),
the expansion of the CDM into new areas (eg agriculture) or longer-term
moves towards offsets from REDD, would significantly worsen this
situation (see below).
What reduction in emissions will the EU ETS deliver
in Phase III, within the EU and abroad?
16. If current policies remain unchanged, there
are significant reasons to doubt that the EU ETS will deliver
domestic emissions reductions in Phase III. Current estimates
suggest that the second phase of the scheme could end with an
overall surplus of 1,280 Mt CO2e, which could be carried
over ("banked") for use from 2013 onwards.12
These figures are swelled by the use of offset credits. The phase
II surpluses alone could allow the scheme to continue without
any domestic emissions reductions until 2018.13
17. Beyond these loopholes, the EU ETS is fundamentally
incapable of meeting the necessary ambition to tackle the planetary
emergency and keep temperatures below 2 degrees or the 1.5 degrees
now being called for by over 100 developing countries and Christiana
Figueres, Executive Secretary of the UNFCCC. The stated aim of
the phase III cap is to achieve a 20% reduction in greenhouse
gases across the 27-state bloc by 2020 compared to 1990 levels.
This falls a long way short of what climate science suggests is
needed to avoid dangerous climate change. By comparison, Friends
of the Earth has shown that an immediate target to reduce greenhouse
gas emissions within the UK and EU by 40% or more by 2020 without
offsets and the use of carbon markets is both achievable and desirable.14,
Could the environmental and economic efficiency
of the EU ETS be improved by linking with other emissions trading
schemes and how can this be achieved?
18. In theory, the linking of emissions trading
schemes underneath a global cap would make the scheme run more
smoothly: reducing competition distortions, and doing away with
the need for offsets. However, such as scheme would be unlikely
to respect the requirement of "common but differentiated
responsibility" within the international system; and it would
still (if it worked as planned) incentivise short-term reductions
over longer-term transformative changes.
19. In practice, there is no credible possibility
that a global cap-and-trade scheme will be introduced. Linking
emissions trading schemes is far more likely to result in a patchwork
of rules, and trigger a race to the bottom. At present, the EU
ETS excludes credits from Land Use, Land Use Change and Forestry
(LULUCF) and from hydro-power projects that do not comply with
World Commission on Dams guidelines. It will also exclude HFC
and N2O offset credits from April 2013. Such measures would be
impossible to police if the scheme were linked with others that
did not share these exemptions, since it would be impossible to
tell if trading units entering the EU ETS had been freed up by
their displacement (within a linked scheme) by others that the
EU would not accept for compliance. Put simply, if the EU bans
LULUCF credits, but an Australian scheme accepts them, Australian
installations might buy LULUCF credits for compliance purposes
and sell their own permits into the EU ETS scheme. This form of
"arbitrage" is not so much an abuse of the system as
a symptom of a flawed design.
20. The claim that carbon markets are "economically
efficient" also needs to be examined more critically - again,
with an eye to looking how the practice has diverged from the
theory. In theory, emissions trading incentivises companies to
trade permits in a way that allows for the cheapest reductions
to happen first. This is the basis of the claim that it is "efficient."
In practice, cheap permits circulate because of structural surpluses
awarded to heavy industry within the EU, and because offsets are
allowed in the scheme. These are cheap because these are mostly
paper "reductions" that do not require changes in industrial
or power sector practice.
21. Emissions trading has not incentivised significant
technological changes. At best, it has had localised and temporary
effects in incentivising power generation switches from coal to
gas. But this should be set against some of the scheme's perverse
incentivesmost notably, the generous award of free certificates
to hard lignite plants in Germany (through the "new entrants
reserve") has contributed to a "dash for coal"
in German power production.16 Such generosity is not
an anomaly, but is the result of industry lobbying (and protectionism).
22. Temporary power production switches from
coal to gas can also be seen to illustrate the limitations of
the EU ETS. They do nothing to encourage the transition to clean
technology. Indeed, the "flexibility" of permit trading
tends to trigger a "lock in" of outdated forms of power
and industrial production, by offering a means to delay this transition.
Such delays can end up costing more in the long-term, however.
What actions should the UK and the EU be taking
to promote the development of compatible ETSs internationally?
23. Rather than spending money and effort on
trying to export the failed carbon trading model, the UK should
spend those resources promoting measures that directly catalyse
cleaner development. For example, the UK has pledged £7
million of its fast-start funding to the World Bank's Partnership
for Market Readiness, which promotes cap-and-trade in middle income
countries; as well as putting resources into ICAP (International
Carbon Action Partnership).
24. There are multiple actions that the UK and
the EU could take to promote and support more effective action
on climate change. These include market mechanisms, such as feed-in
tariffs, which are estimated to be responsible for almost 90%
of the growth that has occurred in Europe's wind energy sector
Could sectoral agreements form part of the future
of the EU ETS?
25. Climate Change Agreements, which agree a
significant discount from the Climate Change Levy in exchange
for an agreed sectoral target, are hampered by significant information
asymmetries between government and industry. They have so far
proven ineffective, offering a financial transfer from taxpayer
to business in exchange for what amounts to little more than "business
as usual." This model would not address the problems of the
Will the EU ETS be able to access viable alternatives
to international credits without the Clean Development Mechanism?
26. The UK should be actively trying to exclude
alternative international credits in lieu of the CDM. International
offsets offer an escape hatch for the avoidance of emissions reductions
commitments, and shift the burden of climate mitigation to developing
countriescontributing to breaches of the global carbon
budget.18 As we have shown above, the inclusion of
international credits is a considerable "hole" in the
scheme's cap, which should be closed.
27. Closing the door to CDM credits would require
a swift cut in their supply, if it is to be meaningful. This is
in contrast to the implementation of the ban on HFC and adipic
acid credits, which was delayed to April 2013 despite Commissioner
Hedegaard's recognition that such projects exhibit a "total
lack of environmental integrity."19 Delaying the
closure of this loophole is likely to see the over-surrender of
the banned credits in the short term, with surplus allowances
28. New market mechanisms, such as "sectoral
crediting", do not offer a viable alternative to international
crediting. In fact, EU efforts to pursue these new mechanisms
in the context of a declining global trade in carbon are likely
to further undermine the scheme by generating surplus credits
that would collapse the carbon price.
Is the EU ETS a constraint on unilateral action
to reduce emissions and, on the other hand, how are Member States'
own policies affecting the operation of the trading system?
29. The EU ETS does not constrain unilateral
actions, but it does have the capacity to undermine them at a
time when we should be aggressively pursuing effective alternatives.
For example, the Integrated Pollution Prevention and Control (IPPC)
Directive was modified to explicitly exclude CO2 emission
limits for installations which are covered by the EU ETS, amid
fears that efficiency requirements under the IPPC could damage
carbon prices.20 Leaked documents (from 2007) suggested
that the UK government sought to weaken energy efficiency measures
and renewable energy targets on the grounds that these could collapse
the carbon price. Such fears are not arbitrarya recent
European Commission Impact Assessment on the proposed inclusion
of industrial sectors in EU energy efficiency regulations suggested
a scenario in which the carbon price could collapse to zero.21
30. Carbon floor prices have been suggested as
a means to address this risk, and the UK has taken a lead in implementing
such measures. However, as reports by both Credit Suisse and IPPR
have pointed out, the most notable effect of the UK's policy is
likely to be a rise in consumer energy prices, exacerbating fuel
poverty, and windfall profits for existing energy generators of
around £1 billion per yearwhile doing nothing to reduce
emissions.22 Its environmental effectiveness may, arguably,
be increased if a floor price were European-widebut appending
such a measure to the ETS would remain considerably more cumbersome
(and less cost-effective) than other forms of taxation, such as
financial transactions taxes or carbon taxes. However, this should
not stop the UK introducing a windfall tax to capture the surpluses
unduly gained by energy companies which, along with income from
the carbon floor price, should be spent on domestic energy efficiency
31. The underlying point is that the EU ETS contradicts
more effective policies, and that making it the central climate
change mitigation policy is counter-productive. Member States
and the Commission should be encouraged to develop a suite of
climate-related policies, including binding energy efficiency
targets; and national climate laws to tackle industry or industry
How serious an impact have the recent cases of
fraud had on confidence in the EU ETS? Are further improvements
in security and auditing required?
32. The fraud cases have further damaged confidence,
but the recent changes to registry rules have not addressed many
of the risks associated with trading carbon. It is certainly the
case that new registry rules include basic improvements (eg know-your-customer
checks). But the new rules also include some steps in the wrong
directionfor example, a provision for "non-disclosure
of the serial number of allowances" (except for law enforcement
agencies) reduces transparency in an already opaque system, and
could actually make it more difficult for civil society groups
and the media to draw attention to fraud cases.23
33. Changes to registry rules do not fully address
the problems faced when trading carbon, however. Regulations should
consider environmental effectiveness criteria, such as those proposed
in Senator Kerry's American Power Act (the latest version of the
leading climate bill in the U.S. Senate).24 These include
mandatory exchange trading and clearing of carbon, and also measures
to orient trading so that it is mainly restricted to compliance
traders, rather than speculators. At present, the majority of
trades are for speculation, resulting in a carbon price that is
highly volatile. This means that it sends a poor signal to investors
seeking to make longer-term decisions on infrastructure investments.
Position limits and capital and margin requirements on traders
could also help to rein in some of this speculation.
34. There is a limit to what such regulations
might achieve, however. Currently, carbon traders are lobbying
for exemptions from derivatives and commodity regulations being
developed in the wake of the financial crisis.25 A
key problem with regulating carbon markets is that there is no
clarity on the underlying asset (eg it is not agreed whether carbon
is a "financial instrument"). The relative complexity
and size of this market in an intangible commodity leaves it susceptible
to gaming or full-blown fraud. These problems are better addressed
at the level of fundamental market structure, rather than simply
through derivatives legislation or market abuse rules designed
to contain their excesses. Simplifying the market structure by
excluding offsets or credits from "new market mechanisms",
and limiting the sectoral scope of the ETS, would be steps in
the right direction. However, this does not obviate the need to
reconsider support for carbon markets altogether.
1 Ellerman, D
et al 2010. Pricing Carbon: The European Union Emissions
Trading Scheme Cambridge: Cambridge University Press, p 48.
2 Morris, D and
B Worthington, 2010. Cap or Trap?How the EU ETS risks locking-in
carbon emissions p 18.
3 European Commission
DG Clima. 2011. Verified Emissions for 2008-2009-2010 and allocations
2008-2009-2010, 15 April
4 Ellerman et
al, p 326; Point Carbon, WWF. 2008 EU ETS Phase IIThe
potential and scale of windfall profits in the power sector.
The figure for industry combines an estimates of "pass through"
costs (14 billion) with an estimate for the value of surplus
permits (6.5 billion). See De Bruyn, S et al 2010.
Does the energy intensive industry obtain windfall profits
through the EU ETS? Delft: CE Delft; Morris and Worthington,
5 Ralf Martin,
Mirabelle Muûls and Ulrich J. Wagner. 2010. "Still
time to reclaim the European Union Emissions Trading System for
the European tax payer", Policy Brief, Centre for Economic
Performance, London School of Economics.
6 State Aid Group
of the Groningen Centre of Energy Law. 2011. "Comments on
the Commission's Consultation paper dealing with: 'New State aid
Guidelines in the context of the amended EU Emissions Trading
7 UK Government.
2011."UK response to The European Commission consultation
on New State aid Guidelines in the context of the amended EU Emissions
8 This figure
corresponds to the auction revenues from 300 million permits in
the New Entrants' Reserve, and assumes a 15 carbon price.
9 Bowyer, D 2011.
Anticipated Indirect Land Use Change Associated with Expanded
Use of Biofuels and Bioliquids in the EUAn Analysis of
the National Renewable Energy Action Plans. London: Institute
for European Environmental Policy.
10 Friends of
the Earth EWNI, 2009. A Dangerous Distraction: Why offsetting
is failing the climate and people.
11 World Bank
2011. State and Trends of the Carbon Market 2011 Washington:
World Bank Group, p 9.
12 World Bank
2011, p 63.
13 Morris, D 2011.
Buckle Up! Tighten the cap and avoid the carbon crash London:
Sandbag, p 16.
14 Friends of
the Earth Europe and the Stockholm Environment Institute. 2009.
The 40% Study: Mobilising Europe to achieve Climate Justice.
15 Friends of
the Earth. 2009. Cutting Carbon Locallyand how to pay
for it. London: Friends of the Earth.
16 Pahle M et
al 2011. "How emission certificate allocations distort
fossil investments: The German example." Energy Policy,
doi:10.1016/j.enpol.2011.01.027, p 12.
17 AtKisson, A.
2009. Global Green New Deal for Climate, Energy, and Development,
UN-DESA, p 11.
18 Friends of
the Earth EWNI, 2010. Reckless gamblers: How politicians' inaction
is ramping up the risk of dangerous climate change.
D 2010. "EU plans to clamp down on carbon trading scam"
The Guardian, 26 October.
T and Reyes, O 2009. Carbon Trading: how it works and why it
fails Uppsala: Dag Hammarskjöld Foundation, p 21.
21 European Commission
DG Energy. 2011. "Impact Assessment Accompanying the document
Directive of the European Parliament and of the Council on energy
efficiency" SEC(2011) 779 final, 22 June, p 30.
22 Maxwell, D
2011. Hot Air: The carbon price floor in the UK London:
IPPR; McCabe, J 2011. "£7bn windfall for UK utilities
from carbon price floor" Environmental Finance, 28
23 European Commission
DG Clima. 2011. Questions & Answers on Emissions Trading:
new registry rules, 8 July.
24 Friends of
the Earth USA, 2010. Comments to Commodity Futures Trading Commission
on Oversight of existing and prospective carbon markets, 17 December.
25 IETA, 2011.
Response to MiFID Consultation, 2 February.