Blame a combination of factors–bad information, the coddling of domestic industries, the recent economic downturn–for blunting the European Union’s emission trading system.
The European Commission proposed the carbon-trading scheme in late 2001 as a means of getting the European states to meet their commitment to reducing greenhouse-gas emissions under the Kyoto Protocol. Barely three years later, European countries had allocated EUAs to more than 11,500 power plants and industrial facilities such as steel mills, oil refineries, and cement works, representing close to half of European carbon emissions. Nearly all the EUAs, which were valid for a trial period running from 2005 to 2007, were handed out free of charge in order to short-circuit complaints from industry interests that the added cost of pollution permits would crimp their global competitiveness.
At first the trading system looked healthy; virtual trading pits such as the London-based European Climate Exchange thrived. Futures contracts on a 2007 EUA climbed steadily from about seven euros in January 2005 to more than 30 euros by April 2006. In 2005 alone, carbon exchanges traded 362 million EUAs with an estimated financial value of 7.2 billion euros, according to Oslo-based market consultancy Point Carbon.
Then, in May 2006, EUAs plummeted in value, to less than 15 euros. After recovering briefly in the summer of 2006, EUA futures settled at close to zero for the remainder of the trial phase. Emissions data released in May 2008 revealed that European states, relying on unreliable emissions estimates and under pressure from various industries, had handed out EUAs for 6,321 million tons of carbon dioxide during the first phase, exceeding total actual emissions during the period by 107 million tons.
Global recession is now undermining the second phase of the trading system, which started last year. The European Union set the cap for the 2008-2012 period at 6.5 percent lower than the cap for the trial period. Trading volumes initially exploded, according to Point Carbon. But the rally proved short-lived. The EUA price slid to an average of just 11 euros in the first quarter of 2009, as manufacturing slowed in the face of the recession.
The faltering trading scheme may be doing real harm. Free permits and weak carbon pricing have rewarded the heaviest carbon polluters while hurting Europe’s consumers. Most EU states gave extra allowances to heavy industries such as cement and steel, because they didn’t want to threaten the manufacturers’ international competitiveness; by the same logic, states gave relatively few allowances to producers of electricity, a commodity that must be generated close to consumers and thus is not forced into global competition.
This allocation strategy means that electricity consumers have felt the brunt of the price increases. Power producers jacked up the price of electricity to cover the anticipated costs of their allowances. Power companies also add a theoretical “opportunity cost” to their consumers’ bills for using the free EUAs they could have sold on the carbon market instead.
But consumers aren’t the only ones penalized by the trading scheme and its process of handing out EUAs. Power producers using relatively clean technology are also suffering. Perversely, coal-heavy utilities with the highest emissions benefit the most from carbon trading, since most states allot them more EUAs. This gives them an unfair advantage over producers generating power with natural gas or renewable sources, which release less carbon.