Greater role for auctions in ETS

The price of carbon will measure the success of the Commission's energy strategy, writes Jennifer Rankin.

When the European Commission published its climate and renewable energy package on 23 January, everyone had something to say - green campaigners, politicians and business leaders - but the bluntest verdict came from the markets. As European politicians spoke of a "historic day for Europe" the price of carbon fell sharply, pushed downwards by recession jitters and a small fall in oil prices. On 23 January the market saw its biggest fall for nearly two years: the cost of emitting one tonne of carbon dioxide (CO2) fell to Û18.50. A few days earlier it had been as high as Û24. Although markets were responding to gloom about the global economy, the Berlaymont had nothing on offer to lift their spirits.

The emissions trading scheme (ETS) is the centrepiece of the EU's climate and energy policy. This 'cap-and-trade' scheme puts a price on the right to emit CO2 and allows industry to trade its right to pollute. The teething troubles of the scheme have become infamous. In the first phase (2005-07), too many permits to pollute were given away for free, causing the price of carbon to dwindle to just a few euros. One of the most keenly awaited elements of the Commission's climate and energy package was the review of the trading scheme during its third phase from 2013-20.

The biggest change proposed is more auctioning of permits. Openly acknowledging past problems, the Commission says that auctioning should be the "general principle" of the ETS and estimates that at least two-thirds of allowances will be auctioned in 2013. The proposed reform includes an EU-wide cap on emissions, rather than individual caps for each member state, which were more likely to lead to the EU overshooting emissions limits.

But some energy-intensive businesses will continue to get free allowances, because they could struggle to compete with industry outside Europe. Hardest-hit would be the steel, chemicals and paper industries. However, the Commission is not specifying which sectors will be eligible for free permits until mid-2010 at the latest. The Commission thinks it could take a further year (until mid-2011) before it proposes measures to deal with the problem of carbon leakage - European businesses exporting their carbon-emitting practices or losing out to competitors.

Business groups complain that the delay will leave industries in uncertainty, while unions worry about jobs disappearing. Last week (15 January) France, Germany and five other European countries called on the Commission to act in due time before 2011 to deal with carbon leakage. The European Trade Union Confederation has called for a tax on carbon-heavy imports to stop companies re-locating to cheaper, dirtier locations. Some national governments, including France favour the idea as well. But divisions between member states have led to stalemate on taxing carbon. Last week (12 February) finance ministers promised to consider "any necessary measures" to manage the risk of carbon leakage to countries with lower environmental standards, but failed to define what those necessary measures might be.

Deadlock in the Council and caution in the Commission leave some of the most important details about the ETS up in the air. But some think there is a case for being cautious. First, a successor to the Kyoto Protocol on climate change will not become clear until the end of 2009 and even then many details will not be worked out until 2010-11. Second, the Commission lacks a sound evidence base to make decisions on which sectors will be most affected by carbon leakage. Christian Egenhofer of the Centre for European Policy Studies (CEPS) says: "It is the question of to what extent you want to base your political decisions on evidence. It is not possible to take a decision now because we don't have conclusive evidence that energy-intensive sectors are very negatively affected." Some business lobbies have cited examples of so-called climate closures, but Egenhofer thinks only the aluminium sector is "almost certainly suffering" because of high carbon prices.

But hanging around for evidence, delaying difficult decisions until 2010-11, has risks. The third phase of the ETS is to begin in 2013, possibly leaving only around 18 months for European investors to find their feet. Leaving so many questions unanswered effectively hands over power to the Commission, rather than making decisions through a legislative deal with European ministers and parliamentarians. Egenhofer suspects that many MEPs will be reluctant to cede so much power to the Commission.

Eija-Riitta Korhola, a centre-right Finnish MEP, says: "Major free allowances are still needed for those industries that are exposed to competition." Korhola is cool on the idea of carbon taxes, suggesting they would be difficult to combine with World Trade Organization rules and that such taxes would be beyond EU competence.

Other MEPs find arguments for waiting unconvincing. Anders Wijkman, a centre-right Swedish MEP, wants to see a link made between the ETS and preserving forests. The Commission says that it is impossible to include emissions from deforestation because they are not capable of being monitored and reported with accuracy. But Wijkman dismisses this plea for lack of evidence: "It is the same argument they used in 2001, so I wonder what they have been doing for seven years." Wijkman also wants more clarity on auctioning and how the ETS is going to adapt to a 30% cut in emissions by 2020, the reduction the EU has promised in the event of an international agreement.

The difficulty facing the EU is how to reconcile policy wonks' calls for time and evidence with political demands for action in the face of accelerating climate change. In the long run, the price of carbon should show whether the EU has pulled off this difficult balancing act.

The price of carbon will measure the success of the Commission's energy strategy, writes Jennifer Rankin.