Improving Emissions Trading
With the European emissions trading scheme starting this year, Stefanie Meilinger and Nils Steinbrecher of ERM say that the unbalanced markets need modification
The European Union Greenhouse Gas Emissions Trading Scheme (EU-ETS) will become the first mandatory, multi-country and multi-sector emissions trading scheme in the world when it starts on 1 January 2005. All Member States of the enlarged EU are participating, and the scheme will cover carbon dioxide emissions from fossil fuel generators, oil refineries, and producers of steel, cement, glass, pulp and paper, and bricks. In total the scheme covers an estimated 12,000 installations in the 25 EU countries.
It has been hailed as a major step towards addressing climate change, but based on the German experience it could be somewhat inefficient economically. There are two main reasons – the market will be dominated by a small number of large players; and administration costs for smaller emitters could be extremely burdensome.
An unbalanced market
Yearly emission allowances under the National Allocation Plan (NAP) for Germany are 503 million tonnes for 2005-2007. This will be distributed to about 2,400 installations – many more than in most countries. But this large number of players will not necessarily result in an efficient market.
According to the baseline data for 2003, about 10% of the installations are responsible for 88% of the emissions. Only five companies are responsible for about half of the German CO2 emissions: the four largest energy suppliers and a steel producer. This suggests an imbalanced market. The ‘big five’ could easily dominate the market whereas the majority of participating companies will not be able to influence the market at all. This is not just a German characteristic, nor is it typical only for countries with a large number of installations. In most countries 10% of the installations are responsible for more than 70%-80% of the national emissions (eg Slovenia 83%, Ireland 75%, Austria 72%, Denmark 79%, Sweden 81%).
The burden on small emitters
This inequality of market power could lead to trading conditions becoming extremely unfair for the large number of small emitters.
Costs will also be significant for these smaller polluters. The German NAP requires an average yearly reduction of 2.91% for each installation. A small emitter, with average yearly emissions of 35,000t CO2 who is not able to realise any reductions on his own premises, would therefore have to buy allowances for about 1,000t CO2 for each year.
Assuming a price of €8/tonne this company would have to pay around €8,000 per year. This is about the same amount the company has to pay for its verifier in order to have its baseline data verified, and almost the same amount again must be paid to the German emissions trading desk to cover its costs. The annual monitoring reports and their verification will also produce additional costs. These are only the external costs, the internal costs could be significant too. Assuming this is similar to many other EU Member States it is worth asking what could be done to reduce costs and so improve the efficiency of the market.
Making the market work better
ERM believes that the following four ideas would make the scheme more effective:
There are numerous administrative processes connected with the EU-ETS. In Germany they include company internal processes as well as the interaction between the trading organisation and the industry.
Administrative costs could be reduced significantly by introducing complete electronic administration and standardised data processing, including seamless technical interfaces between the various administration processes.
Experiences from the US SO2-Program clearly show that this brings greater efficiency and cost saving potential. For the EU-ETS it would be appropriate to have a software solution, which could be used for the application procedure, accounting and monitoring and yearly reporting. An efficient starting point especially for SMEs could be the ‘European Monitoring System’ which can be found at www.eumos.de. This is a freely available, open source software which has been developed by some of the German ‘Länder’ in co-operation with more than 50 companies from different sectors.
The integration of more large emitters could reduce the current tendency for unequal market power. The EU Commission has already considered such a possibility and will initiate a review in 2006, which may propose including sectors such as chemicals, aluminium and transport.
The main argument for a market based CO2 regulation was the hope that it would be to the most cost-efficient way to reduce emissions. But small emitters may not be motivated to reduce emissions or to trade in the market due to comparatively higher costs. It might be more efficient to have them pay other fees or taxes instead. Alternatively, the allowances of small emitters could be managed by their fuel suppliers, who would hold and manage the respective allowances according to the supplied energy.
In order to streamline verification standards there should be mutual recognition of European GHG verifiers. This would help to combat industry concerns that a tonne of CO2 in, for example, Portugal might not be the same as a tonne of CO2 in Germany. This would lead to greater credibility and fairer competition within Europe.
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About the authors
Nils Steinbrecher and Stefanie Meilinger work in ERM’s Climate Change team and are based in Germany. ERM has a well established reputation as one of the world’s leading providers of environmental management and technical consulting services.
This article first appeared in ERM’s client newsletter Perspectives and is the property of ERM. If you would like to use this or any other articles written by ERM (see www.erm.com/perspectives) then please contact Richard Ellis. Richard.email@example.com
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