Memorandum submitted by the Cambridge
Centre for Climate Change Mitigation Research (4CMR) Annela Anger,
Dr Terry Barker, Dr Athanasios Dagoumas, Dr Lynn Dicks, Dr Yongfu
Huang, Dr Serban Scrieciu and Stephen Stretton
Carbon trading is a critical policy instrument
in addressing climate change, but it is not sufficient to stabilise
the climate at 2°C, even if it operates globally. Direct
regulatory measures and technology-push policies will also be
required, as well as establishment of carbon price signals that
are loud, lasting and clear. We recommend setting a minimum carbon
price to ensure the carbon markets function effectively.
Stringent climate change mitigation could provide economic benefits,
in terms of increased GDP growth, relative to a business-as-usual
baseline where fossil fuels dominate across the 21st century.
Contrary to the conventional view in the literature, our research
argues that the benefits of mitigation increase with the stringency
of the stabilisation target. Carbon trading and other climate
change mitigation policies are currently being undermined by the
economic recession. The solution to this is to announce more stringent
emission reduction targets, sending a strong signal of a long-term
stable carbon price, and to use revenues from auctioning emission
allowances to subsidise low-carbon technologies. The resulting
increase in investments in a low-carbon economy may contribute
towards the dual goal of solving both the economic and climate
The fate of auctioning revenues is critical
to the success of emissions trading in mitigating climate change.
One recent study shows that if auctioning revenues from introducing
aviation in the EU ETS are added to general government budgets,
they may cause a slight increase in overall European greenhouse
gas emissions at lower allowance prices, the opposite of the policy's
Auctioning revenues should be directed
towards new abatement technologies and used to support households
and businesses that suffer unfairly from higher energy prices,
without subsidising their fuel costs.
4CMR is an interdisciplinary research centre
within the Department of Land Economy at the University of Cambridge.
Our objective is to foresee strategies, policies
and processes that are effective in mitigating human-induced climate
change. We combine computer modelling with expert knowledge from
economics, energy systems, engineering, applied mathematics and
environmental science to understand how the transition to a low-carbon
economy can happen quickly, efficiently and equitably. www.4cmr.org
1. For a reasonable chance (50:50 or better)
of meeting the 2°C target for global average temperature
rise, the world should be aiming for complete decarbonisation
by 2050 or earlier (Barker, 2008). This statement is based on
the model predictions presented in the IPCC's Fourth Assessment
Report on climate change mitigation (IPCC, 2007).
2. The safe level for the 2°C target, allowing
for uncertainty in the sensitivity of the climate to greenhouse
gas concentrations, is 380 ppm CO2-eq, lower than the current
level of about 430 ppm CO2-eq (Barker, 2008). This implies that
to be sure of stabilising the climate at 2°C above pre-industrial
average temperature, we need actual reductions in atmospheric
greenhouse gas concentrations.
3. Carbon trading is one of the critical
policy instruments for accelerated decarbonisation. But it is
not sufficient on its own. Other measures, such as direct regulation,
carbon taxes for non-trading sectors and direct investment into
low-carbon technologies are also needed.
4. We have shown that the G8 target of a
50% reduction in CO2 emissions by 2050 cannot be met by carbon
price alone, even when there is a global carbon price that rises
to $100/tCO2. To make such a reduction, on a world scale, governments
must use a substantial percentage of the revenues raised from
taxing carbon, or selling emission permits, to stimulate investment
in low-carbon technologies and energy efficiency improvements,
and promote environmental friendly behaviour (for example in the
transport and buildings sectors). Even with all those investments,
the 50% reduction target is unlikely to be met without guaranteeing
the carbon price, so that it has an accelerated rise to $100/tCO2
by 2030 (Barker, Scrieciu and Foxon, 2008).
5. Our E3MG model
shows that in a low-carbon society, where the 50% reduction in
CO2 emissions by 2050 has been met, GDP is slightly above the
baseline case with no reduction in emissions. In other words,
there are economic benefits of this stringent mitigation. This
is a consequence of more rapid development induced by extra investments
in low-carbon technologies and practices and increased technological
change (Barker, Scrieciu and Foxon, 2008).
6. Unfortunately, the current allowance
price in the EU ETS is well below the required level, around 10/tCO2
on the date of writing (see paragraph 14 below). And there is,
as yet, no global emissions trading scheme.
THE EU EMISSIONS
7. To be an effective part of a portfolio
of policies that achieve the 2°C target, emissions trading
will have to become global.
8. Action is needed to make the future carbon
price high and reliable. The earlier and stronger these actions,
the higher are the investments and the greater the benefits from
decarbonising the economy.
9. The 20% reduction on 1990 levels by 2020
incorporated into the EU ETS Phase III is too low and creates
a weak signal. Carbon prices and auctioning revenues will be too
low, at this level, to stimulate the technological changes and
emission reductions necessary to meet a 2°C target. We have
previously recommended setting the reduction target at 40% or
higher by 2020.
10. Penalties for non-compliance in the
EU ETS should be adjustable not only to changes in inflation but
also to the carbon price. Otherwise, they effectively signal a
ceiling on the carbon price, at 100/tCO2, the current penalty.
11. We strongly oppose the recent suggestion
from the European Parliament (Article 29) that there should be
a ceiling on the carbon price in the EU ETS. We would prefer to
see governments guaranteeing a minimum price for carbon. A carbon
price floor would provide much greater long-term certainty and
encourage investment in low-carbon technologies. It is especially
helpful during recession, when both energy demand and investment
are likely to be lower.
12. We welcome the longer trading period
in Phase III of the EU ETS (eight years instead of five), as this
increases predictability and certainty.
13. We also welcome the diminishing cap,
the high levels of auctioning, the increased intertemporal flexibility
(banking of allowances) and the harmonised allocation methodology
in the proposals for Phase III.
Impacts of the economic recession
14. Allowance prices in the EU ETS have
been falling over the last six months, undermining prospects for
profits and growth in the carbon markets. This loss of confidence
is a result of the drop in demand for allowances due to falling
demand for carbon-based electricity and other products from industries
covered by the EU ETS as a result of the on-going global economic
15. If the short-term reduction in demand for
emission permits leads to a further collapse of allowance prices
to near zero, we risk losing the experience and institutional
knowledge in the carbon market gained since the EU Emissions Trading
Scheme and the Kyoto Protocol began. The loss of knowledge and
learning will be through bankruptcies and failure of individual
carbon reduction projects.
16. One way to restore profitable allowance
prices in the Scheme is to tighten the emission reduction targets
for 2020. Even an announcement that such tightening is being considered
may be enough to support the prices, through encouraging entities
to bank their allowances for the future.
17. Revenues raised from carbon taxes and
auctioning revenues from emission permit sales could also be used
to reduce taxes that bear on employment and investment. This is
a particular benefit for economies with chronic unemployment or
Use of auctioning revenues
18. All permits in the EU ETS should be
auctioned. This provides fair treatment and avoids possible windfall
profits in all sectors. Current proposals for EU ETS Phase III
include 100% auctioning for the power sector only. Other industries
will start with only 20% auctioning, rising to 100% by 2020 (or
2027). The aviation industry is likely to have to purchase only
15% of its allowances by auction throughout Phase III, although
this is subject to change. Also, auctioning levels can be lowered
if an industry is seen to be at risk of carbon leakage.
19. The fate of auctioning revenues from the
emissions trading scheme is critical to the overall success of
the scheme at reducing greenhouse gas emissions. Our evidence
for this view is presented in paragraphs 22 to 32 below.
20. Auctioning revenues should be returned
as subsidies for re-structuring to low-greenhouse-gas products,
processes and practices, and for financing adaptation to climate
change. We agree that the amount of revenues returned and the
list of who gets them should be revised every three years, as
21. We would advise that auctioning revenues
are partly used to help low-income households (and small businesses)
who will be unfairly disadvantaged by increased fuel prices. However,
the revenues should be directed towards lowering income tax, or
improving the quality of housing, not towards subsidising fuel
bills. The latter reduces incentives to develop low-carbon technologies.
A case study on including aviation in the EU-ETS
22. 4CMR has carried out research on the
economic and environmental impacts of introducing aviation into
the EU ETS, in association with Cranfield University and the University
of Maine (USA). The project "Air Transport in the European
Emissions Trading Scheme" was completed and reported on in
February 2009. Results have not yet been published in the peer-reviewed
literature, but were presented at an Omega workshop on 11 December
23. The study used was the energy-environment-economy
model E3ME to predict the likely impacts of introducing aviation
into the EU ETS. This model describes the European economy as
42 industry sectors, one of which is air transport. It uses real
historical data from 1970-2004 to estimate the interactions between
different sectors of the economy. Taking these interactions into
account, it estimates the impacts of short and medium-term greenhouse
gas mitigation policies and predicts future economic changes to
2020. More information about the model can be found at: www.e3me.com.
24. E3ME treats emissions trading as a tax
on fossil fuel use. It adds a cost to fuel, based on the carbon
content of that fuel. The model has been run with and without
aviation being included in the EU ETS, so the economic and environmental
effects of including aviation can be analysed.
25. The study assumes that aviation is included
in the EU ETS with 85% of allowances allocated free and 15% auctioned.
It assumes that up to 15% of allowances for each airline can be
bought from the Kyoto Clean Development Mechanism (CDM). It also
assumes that there are no emissions reduction targets for non-ETS
sectors. Finally, it assumes that the allowances for aviation
are capped at 97% of 2004-06 levels in the first year, 95% in
the second year, and then diminish at around 2% per year until
2020, as proposed for Phase III (2013-20) of the EU ETS for other
For this study, E3ME was run with three allowance price scenariosallowance
prices of 5, 20 and 40 per tonne of CO2.
26. The results showed that with emissions
trading, actual CO2 emissions from air transport will be reduced
compared to the reference scenario with no aviation emissions
trading. However, the reductions will be small. Carbon emissions
will be less than 1% lower with an allowance price of 5/tonne.
At 20/tonne, CO2 emissions will be reduced by 3.4% in 2020,
and by around 7.4% at 40/tonne.
27. Similar reductions in emissions from
aviation can be achieved by running the model with moderately
high oil price scenarios and no emissions trading.
28. The model predicts a very small drop
in demand for air travelless than 1% reduction in 2020
even at the high allowance price. The air transport sector is
able to continue to grow, because it becomes a net purchaser of
allowances, buying allowances largely from the power sector.
29. However, contrary to expectation, the
model does not show a reduction in CO2 emissions from the entire
economy (including the power sector), despite an increased demand
for emission allowances created by the aviation industry.
30. In fact, CO2 emissions from the wider
European economy are predicted to increase slightly when aviation
is included in the EU ETS, at lower allowance pricesby
0.2% at 20 per tonne and 0.1% at 5 per tonne. This
effect is a result of auctioning revenues being returned into
the general economy and increasing other economic activities in
non-trading sectors. The study assumes there are no greenhouse
gas reduction measures in sectors outside the EU ETS. At the highest
allowance price, emissions from the wider economy are reduced,
although only by 0.2%.
31. In other words, when the entire economy
is taken into account, introducing aviation into the EU ETS may
not be very effective at cutting carbon emissions, because of
the counter effect of allowing auctioning revenues to enhance
other economic activity. If auctioning revenues were earmarked
for spending on carbon reduction technologies, or used to support
air transport companies through the tax system, this effect may
32. More research is needed to analyse how
sensitive overall CO2 emissions might be to different treatments
of auctioning revenues in this context.
33. In its current form the cap and trade
system applied only to EU is necessary but not sufficient to dramatically
reduce emissions and avoid catastrophic climate change. A global
scheme involving at least the main greenhouse gas emitters is
34. To meet the 2° target, we would suggest
that a carbon price rising to at least $100/ tCO2 by 2020 is needed,
for OECD countries. This is in line with the necessary carbon
price suggested by the IPCC. This could emerge from emissions
trading schemes for the energy-intensive sectors with a strong
greenhouse gas reduction target of at least 30% below 1990 levels
35. Such a scheme would lead to a gradual
increase in the cost of electricity (we estimate an increase of
about 70% in the USA, over 10 years, for example). But revenues
from auctioning emissions allowances would accrue to countries
regulating their emissions, not to the oil producers. They can
be used to compensate those who lose employment and to provide
incentives for low-carbon alternative sources of energy.
36. If the energy sector responds rapidly,
the CO2 allowance costs will fall rapidly and the electricity
price rise will be lower.
37. Emissions trading schemes are less suitable
for other sectors, especially transport, buildings and agriculture.
These sectors contain a large number of small entities, so the
administrative costs of carbon trading are problematic. Here,
a portfolio of measures is necessary, including regulation and
subsidies targeted at market failures, to address institutional,
technical and behavioural barriers to change.
38. Markets are not as good as they should
be at driving innovation, because innovators are not able to capture
all the benefits that accrue from innovation, even with the patent
system. This is why a complete overhaul of our energy technology
system requires public investment, subsidy and regulation in addition
to the carbon price. Auctioning revenues from carbon markets can
also be used to reduce or offset the financial risk of implementing
Comments on the shadow carbon price
39. The shadow carbon price set by Defra
(£25.50/tCO2 for 2007, rising to £59.60/tCO2 in 2050)
is too low. It was not estimated as the level that would achieve
the 2° target, but using a cost benefit analysis, with an
outdated estimate of the costs of climate change that substantially
discounts the value of health and lives of future generations
and ignores the significant risks of catastrophe.
40. This shadow carbon price is recommended for
use in cost benefit analyses for major energy projects such as
for new coal-fired power stations like the one planned at Kingsnorth
on Kent. As such, it seems likely to slow our progress towards
achieving emission reduction targets.
Linking the EU ETS with other cap and trade schemes
41. Linking the EU ETS with other national
or subnational schemes will widen the scope and increase the efficiency
of the scheme. In theory, joining schemes from regions with different
abatement costs will adjust the carbon price and stimulate a more
efficient global effort to reduce emissions, by targeting mitigation
in areas where it can happen the most cheaply. However, this only
holds if the schemes are based on similar rules regarding allocation,
auctioning and the stringency of emissions caps.
42. Linking emissions trading schemes without
an obligation to have similar rules can provide an incentive for
regions to set less stringent emission reduction targets as a
way of increasing their supply of allowances. The current allowance
in the US Regional Greenhouse Gas Initiative (RGGI) is $3.38/tCO2,
compared to 10.25/tCO2 in the EU ETS. The lower price in
the US may be a function of low demand, due to less stringent
reduction targets (10% reduction in emissions by 2018), rather
than cheaper abatement options.
The CDM (Clean Development Mechanism) and other
43. Econometric research carried out at
4CMR studied the effect of CDM projects on national CO2 emissions
for 34 CMD host countries. The research found that CDM projects
lead to reduced per capita CO2 emissions in the host countries,
especially in the manufacturing and energy sectors (Huang and
44. Even so, we argue that allowing high levels
of CDM and JI credits (flexible mechanisms under the Kyoto Protocol)
to be used under Phase II of the EU ETS contradicts the Linking
Directive, which stressed that usage of CDM/JI credits should
be supplemental to domestic efforts in greenhouse gas reduction.
In Phase II, Member States were each able to decide their own
limit for the use of flexible mechanism offsets, up to a maximum
of 20%. As a result it is possible to use these credits to offset
up to 13.4% of allocated emissions overall, about 1.4 billion
credits. These credits represent carbon emission reductions outside
Europe. They are not included in the cap imposed under the
EU ETS. The effect of using them is that, rather than dropping
by 6.5% on 2005 levels, emissions from EU ETS industries within
Europe could actually rise by just over 6%.
45. The access to credits from flexible
mechanisms in Phase III of the EU ETS is unclear, because it depends
on whether or not an international agreement is reached. This
adds to uncertainty. It would be better to clearly specify how
many credits from flexible mechanisms can be used by Member States/trading
46. We welcome the proposal that once an
international agreement has been reached, only credits generated
in countries ratifying the agreement should be accepted in respect
of emissions in Europe.
47. Issuing allowances in respect of domestic
offsetting projects in non-ETS sectors (Article 24a) is not advisable.
This will reduce the responsibility of non-ETS sectors for their
emissions and could reduce the effectiveness of the EU ETS. There
are currently no institutions or rules in place to assure the
quality of this kind of offset project. Establishing rules and
institutions would have high administrative costs.
T (2008). Achieving the 2°C target through carbon trading.
Tyndall Centre Briefing Note no 25. Available at http://www.tyndall.ac.uk/publications/briefing_notes/bn25.pdf.
Barker, T, Scrieciu, S S and Foxon, T (2008). Achieving
the G8 target: modelling induced and accelerated technological
change using the macro-econometric model E3MG. Climate policy
Huang, Y and Barker, T (2009). The Clean Development
Mechanism and sustainable development: a panel data analysis.
Tyndall Centre working paper 130. Available at
IPCC (2007). Summary for policymakers. In: Climate
Change 2007: Mitigation of climate change. Contribution of
working group III to the Fourth Assessment Report of the IPCC.
Eds: B Metz, O R Davidson, P R Bosch, R Dave and L A Mayer. Cambridge
University Press, Cambridge.
3 March 2009
27 E3MG is a 20 region structural, dynamic, annual
econometric simulation model based on data covering the period
1972-2006 and projected forward to 2100. It has been developed
by 4CMR and Cambridge Econometrics. More information can be found
at http://www.camecon.com/suite_economic_models/e3mg.htm. Back
Rising to 30% given a post-Kyoto agreement. Back
We understand it has now been agreed that for aviation, the cap
will remain at 95% of 2004-06 levels until 2020, but this percentage
may be reviewed. Back
These prices were correct at the time of writing. Taken from http://www.rggi.org/home
and www.pointcarbon.com, accessed 3 March 2009. Back