The EU ETS double potential

Reducing GHG emissions and raising funds for international climate finance

In this blogpost I would like to investigate if and how the EU ETS (European Union Emissions Trading Scheme) could represent a tool to drive financial funds to climate actions besides being a flagship programme in the EU to reduce the emissions and move forward towards a greener and low carbon society.

The EU ETS is the largest carbon market worldwide (75% of the total) and covers about 50% of the total EU emissions. It is a market-based mechanism that – putting a price on carbon – has created a financial incentive for the big emitters (mainly power plants and factories) to reduce the emissions. Since 2005 it sets a cap on the emissions of the total amount of certain GHG (GreenHouse Gas) that companies can emit each year. A fixed amount of allowances (the EUAs, the currencies of the European carbon market) are issued or auctioned. Each year companies can use those allowances to meet their targets or else buy more credits from other emitters or on the market or funding other projects to get the corresponding offset credits (CERs, Certified Emission Reductions, from CDM Clean Development Mechanism projects – implemented in non-annexe1 countries, mainly developing and emerging economies – or ERUs, Emission Reduction Units from Joint Implementation projects – in annexe1 countries: but there are tighter limits on the amounts of credits possible for these two offsets). Therefore, the EU ETS provides flexibility in the means and it is cost-effective because emissions are cut where it is most convenient.

The key points I want to highlight are that the cap will be reduced over time (thus causing more investments in clean technologies or increased purchasing of allowances) and since phase 3 of this system (2013-2020) fewer allowances are grandfathered (free allocation) as the default method for allocating EUAs allowances will be through auctions: more than 40% in 2013 and then growing year after year.

Actually, during phase 2 (2008-2012) the annual quantity of the allowances that have been auctioned was only about 3% in average: Germany about 9%, UK 7%, The Netherlands  3,7%, Austria 1,3%, Ireland 0,5%, Hungary 2%, Czech Republic (2million). (EU Commission, 2014).

Yet, with the new mentioned regulations of phase 3 the revenues related to the auctions could be consistent – upon the condition that the demand for allowances will pick up (as at the moment there’s a large surplus of about 2 billion allowances). Estimates of the total value of these revenues obviously depend on the carbon price, whose price is currently very low, about €4/tonne. To have a figure, as of 2012 (with a price of €7/tonne) estimates of revenues of the next trading period were of about €10 billion per year (CAN-Europe, 2012).

Now my point is to focus on how member states use these resources: could the revenue streams of these auctions be used to have a further positive impact on climate change?

In 2008 the EU Commission and the environmental committee of the EU Parliament had tried to introduce a binding earmarking of the EU ETS revenues to finance climate action (with about 50% in developing countries and the rest in EU climate projects) but this had been opposed especially by some new EU members, and at the end it was left as a voluntary tool, left open to the decisions of the Member States, i.e., it is voluntary.

This is reflected in the EU ETS Trading Scheme Directive which reports a non-legally binding recommendation according to which member states should spend at least 50% of auction revenues on measures addressed to tackle climate change “..to reduce greenhouse gases; to develop renewable energies, and other technologies contributing to the transition to a low-carbon economy; measures to avoid deforestation and increase afforestation and reforestation; forestry sequestration; capture and geological storage; a shift to low-emission and public forms of transport; research in energy efficiency and clean technologies; improvements in energy efficiency and insulation; to cover administrative expenses of the management of the European scheme” (Emissions Trading Scheme Directive, Article 10, Directive 2009/29/EC)

Unfortunately it is very difficult that voluntary allocation will work properly. There’s a lack of international cooperation. What are member states doing? Have they earmarked the EU ETS revenues either through budgetary or political decisions? Apparently only seven countries have done so. In the EU, Germany is the only country that decided to fully allocate the ETS revenues to climate financing. It set up a the Special Energy and Climate Fund (EKF) which receives since 2012 basically all the revenues from the EU ETS and – through a separate budget structure – operates climate related expenditures at national and international level. France has earmarked its revenues but for national political expenditures and social objectives. Poland might set up a special fund and address 50% of the revenues to national climate actions. Romania has an Environmental Fund and about 70% of the revenues go to it for national actions. Czech Republic earmarks at least 50% for national energy efficiency and international climate finance through and existing State Environmental Fund. Finland is addressing 100% of the resources to international ODA on climate change, through political earmarking. Hungary through political earmarking has addressed 50% of the auction revenues national spending for climate change (Esch, 2013).

Yet, the global arena is eager for climate finance. For instance, at the climate conferences (UNFCCC COP) made in Copenhagen in 2009, in Cancun 2010 and at every single summit since, countries of Annexe-1 (mainly the EU and other developed countries such as the USA, Japan and Australia) committed to provide by 2020 US$ 100 billion a year to developing countries from a variety of sources to fund mitigation and adaptation measures. But no clear way to fund that was set! Again, the revenues of EU ETS auctions could be one way to fund that commitment.

To mention that at the same conferences the EU and other developed countries “pledged jointly to provide nearly $30 billion in ‘fast start’ finance to developing countries in 2010-2012 to support immediate action on the ground”, commitment that has been already respected by the EU that managed to “pledge €7.2 billion over 2010-2012” (about ⅓ of the total pledged) despite difficult economic circumstances. This money is being spent on concrete climate actions in developing countries” (EU Commission, 2014).

Another example of a climate change mitigation policy that might benefit of binding earmarking of EU ETS revenues to climate change actions is the REDD program (reducing emissions from deforestation and forest degradation). Global emissions are roughly 25-30 billion tons of CO2 equivalent and deforestation accounts for about 15-20% of these: the potential relevance of REDD is quite obvious. Yet, how is it funded? REDD at the moment is funded through voluntary pledges / bilateral compensations, with Japan and Norway being the most “generous” countries. Cutting deforestation by 50% in the next five year period 2015-2020 would generate emissions “savings” between 3,300 and 9,900 Million tons of CO2e (IPAM GCP, 2014): these tons represent the supply available to be funded. But the actual total potential demand for REDD emission reductions for the same time period (based on voluntary pledges as of January 2014) is only 253 Mt CO2e. Therefore there’s a large gap between supply and demand. To make REDD working it would be necessary to link it to a direct market-based mechanisms (such as a carbon market) for those jurisdictions ready for it. Therefore, the EU ETS could provide the solution to address to REDD the necessary amount of money. Yet, with the actual surplus, it is necessary to look at the 2030/2050 timeframe: in this perspective the REDD credits could serve both to meet future compliance obligations and represent a reserve of allowances to hedge risks.

Therefore, to conclude, the EU ETS system – besides having a positive impact on emission reductions and investments in green technologies – it might also play a relevant role in channeling money towards international climate finance in the medium-term. To unleash this second potential and provide predictability of resources, policy makers should solve the current issues of the EU ETS (which is determining for instance such a low price of the allowances) and probably set for the member states a tighter regulation with stronger binding commitments and earmarking of the revenues.

References

A. Esch, Using EU ETS auctioning revenues for climate action, GermanWatch, May 2013 – http://germanwatch.org/en/download/7749.pdf

CAN-Europe Position Paper -Best use of auctioning revenues from the EU Emissions Trading Scheme, July 2012 – http://www.climnet.org/resources/doc_view/2056-can-europe-position-paper-best-use-of-auctioning-revenues-from-ets-july-2012

Emissions Trading Scheme Directive, Article 10, Directive 2009/29/EC – http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32009L0029&from=EN

EU Commission, Climate Action, Policies, Phase 2 Auctions, 2014 – http://ec.europa.eu/clima/policies/ets/pre2013/second/index_en.htm

European Commission, Climate Action, Policies, International climate finance, 2014 – http://ec.europa.eu/clima/policies/finance/international/index_en.htm

IPAM GCP Report 2014 – http://www.globalcanopy.org/about/press-enquiries/press-releases/new-report-calls-us12bn-boost-pre-2020-emission-reductions-fore

Comments Off on The EU ETS double potential / 29 Apr 2014 por guidopreti
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