How the EU ETS restricts climate ambition

The EU faces an internal rift over its climate ambition. And not because of the potential for Brexit — although this could also cause problems — but because, following the historic Paris agreement, some countries want to go much further in terms of emissions reductions than others.

The EU Council has said it will not increase the ambition of the region’s greenhouse gas reduction commitment following the Paris deal, aware that getting political agreement to do so would be fraught.

But the decision means that the bloc drifts further from its initial position as a global leader on climate, just as China and the US are starting to do more. The EU is now at the absolute lower limit of what it needs to do by 2030 to hit its target of an 80-95pc reduction in greenhouse gas emissions by 2050 compared with 1990 levels, and cuts after 2030 will need to be much steeper.

Concerned about this, countries including Austria, France, Germany and the Netherlands are considering doing more. Even the UK’s Conservative government has pledged to phase out unabated coal-fired power by 20205.

Why is this a problem? Because as long as the EU emissions trading scheme (ETS) is in place, emissions cuts in one country can re-emerge in another because of the ‘waterbed effect’.

Furthermore, because the ETS has an inflexible cap, any reduction in emissions by one country simply creates space for another to fill that space by buying cheap emissions allowances.

With plans as ambitious as Germany’s, that could allow countries in eastern Europe to continue to burn coal way beyond 2030.

The European Commission likes the ETS because it provides an absolute guarantee that emissions reduction targets will be hit. But in doing so it also makes it hard for them to be exceeded. There is already a 1.7bn surplus of allowances in the ETS — equivalent to 1.7bn t of emissions that can be bought and burned at any time. And this surplus will only increase as individual nations ramp up their ambition.

Is there an alternative? Well, countries that do more could have their ETS allowance auction supplies cut voluntarily. But doing so would mean reducing auction revenues, which finance ministries will not like.

One suggestion is that a nation’s additional emissions cuts could be triggered by a domestic carbon tax, the revenues from which could then be used to buy and cancel the corresponding number of allowances in the ETS — so that the cap is effectively reduced in line with the additional ambition.

Allowance auction revenues were seen as a key factor in getting reluctant countries on board with the concept of an ETS. But they have become the scheme’s greatest millstone. A willingness to forego them will become absolutely key to the EU’s ambition to be a global climate leader going into the second half of this century.

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