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In other words, many European power companies have seen windfall profits under cap-and-trade.

The trading system “increased the price of power, but [power producers] didn’t face a real increase in their costs,” explains Jos Sijm, a senior economist at the Energy Research Centre of the Netherlands. Sijm estimates that in markets such as the Netherlands, the U.K., and Germany, the trading system increased power prices by a “quite substantial” 4 to 10 euros per megawatt-hour in 2005 and 2006. “For the Netherlands it led to windfall profits on the order of 300 to 600 million euros,” Sijm says. “For Germany, the amount of windfall profits would be much higher–a few billion euros.”

It would be easier to accept the profit taking as an unfortunate transitional side effect of the trading scheme if the program achieved its goal of reducing carbon dioxide emissions. But teasing out the program’s real impact on emissions is tough.

Emissions from power generation actually edged up by 1 percent over the previous year in both 2006 and 2007. Last year, emissions dropped by 3 percent, according to preliminary data released by the European Commission. But observers say the global economic recession probably accounts for most of that decrease. In any case, it is not likely that the trading system has prompted many technology changes. “If you really want to induce investments and major technological innovations, the price has to be higher and more stable,” says Sijm.

How much higher? Surveys of business leaders suggest that they will not seriously reconsider the way they use energy until the price of carbon exceeds 30 euros per ton. The late Dennis Anderson, a professor of energy and environmental studies at London’s Imperial College, concluded in 2007 that significant change will come only when carbon prices “move to the upper end” of a range that he put at 40 to 80 euros per ton. Anderson estimated that the 40-euro threshold would have to be met to make onshore wind farms and nuclear power a better investment than natural-gas or coal-fired power plants, while prices would have to approach 80 euros to make carbon capture and storage worthwhile. Even higher prices would be needed to make solar and offshore wind economical.

Economists at the International Energy Agency have recently calculated that holding global warming to a reasonable level would require an annual investment of $1.1 trillion per year. And it would require a $200 per ton price on carbon, said the IEA, to drive the necessary innovation.

Reluctant Reformers
Efforts to improve the EU trading scheme have been blunted by politics. Auctioning EUAs rather than giving them away would eliminate the windfall-profit taking and other perverse incentives wrought by free allocations. It would also generate revenues that some European countries promise to spend on alternative-energy R&D and energy-efficiency incentives, thus taking the sting from rising energy costs. But for the program’s second phase, now in effect, less than 10 percent of the total number of allowances are available at auction. And the European Commission’s proposal to auction all EUAs to power producers by 2013 took a hit when fast-growing, coal-dependent states such as Poland insisted on phasing in their auctions through 2020. Similarly, auctioning will phase in more slowly for those industrial sectors at greatest risk of competition from manufacturers outside the EU.

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Credit: Epanchincev Evgeniy/ITAR-TASS/Corbis

Tagged: Business, Energy, greenhouse gases, carbon dioxide emissions, cap-and-trade, carbon trading

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