Researchers: EU must allocate fewer emission allowances and stop making free allocations

September 28, 2009

EU emissions trading has put a price on something that used to be free - the right to pollute the atmosphere.

Allocating free allowances creates problematic expectations among companies; "If we emit a lot today, we'll be given a large number of emission allowances tomorrow." This runs completely counter to the idea of encouraging emission reductions, says the researcher Markus Wrľke, at the University of Gothenburg, Sweden.

Markus Wrľke is a researcher at IVL Swedish Environmental Research Institute Ltd, and in his doctoral thesis he examines European energy and climate policy, in particular emissions trading. He believes that the academic discussion on emissions trading made a relatively deep impression on the European Commission and the Swedish Government when the revisions of the EU ETS that will apply from 2013 were drawn up.

"It was disappointing that the negotiations between the Member States and the European Parliament then resulted in a somewhat watered-down decision. I nevertheless feel that my research is contributing to making the system better. It is worse that while I and other researchers identified shortcomings in the trading system early on, back in 2004, no serious changes will be made until 2013.

Wrľke feels that the EU emissions trading system offers great potential and could play a key role in reducing European greenhouse gas emissions. With a correctly designed trading scheme, the EU can attain the targets that are set, at the lowest possible cost to society.

But in important respects the present-day system and rules provide incentives that are completely the opposite of what was intended. As emission allowances have been allocated free and on the basis of historical emissions, expectations have been raised that high emissions today can be rewarded tomorrow. As a result, investments in climate-efficient technology which would have happened if the emission allowances had instead been auctioned have probably been counteracted and delayed. Another example is that in several countries, including Germany and Denmark, an investment in coal-based electricity production has provided entitlement to more emission allowances than an investment in biofuel-based electricity production.

"The most important changes to the system would be firstly to reduce the number of emission allowances in the market. The total volume of emissions is determined by how many emission allowances are allocated or sold by the EU to companies. The volume of emissions becomes exactly the same as the number of emission allowances. Secondly there is a need for a sharp increase in the proportion of emission allowances sold to companies, rather than allocated to firms at no cost as is done at present.

The changes proposed to come into effect in 2013 signify important steps in the right direction, according to Wrľke. The number of emission allowances decreases somewhat in comparison with today, by 1.74 per cent annually starting in 2013, compared with the average number over the period 2008-2012. Another change is that roughly half the emission allowances will be sold at auctions instead of being allocated for free. Only 4 per cent of emission allowances are sold at present. But important questions remain:

"Who is to receive the 50 per cent of emission allowances that are to be allocated free? On what grounds is the number each company is to receive to be decided? The EU has established assessment criteria, but they are so woolly that they have led to intensive lobbying by industry. It has not been decided how the auctions will be held in practice," Wrľke notes.

Facts: Emissions trading

The principle underpinning EU emissions trading is that the EU decides the maximum total carbon dioxide emissions that can be permitted from industry each year. On the other hand, the EU does not involve itself in who makes these emissions. Instead companies are allowed to buy and sell carbon dioxide emission allowances among themselves. The company must have an "emission allowance" for each ton of carbon dioxide that is emitted..

The price of an emission allowance is presently around €14per tonne of carbon dioxide. This is less than one-fifth of the Swedish tax on carbon dioxide. The EU decides the total number of emission allowances available to the market. At present there are just over 2 billion. Emission allowances in the market created by the EU.

The idea behind emissions trading is to meet a particular environmental target at least cost to society. When companies are allowed to trade emission allowances, those companies that face high costs in reducing their emissions will instead buy emission allowances from companies whose costs in taking measures are lower.

If, instead of emissions trading, all companies were forced to reduce their emissions by the same amount, it would be very expensive for some companies while it would hardly cost anything at all for others. The total cost to society would be higher than if there was emissions trading.

Source: University of Gothenburg (news : web)