or better – or worse

Most economists argue that the value of emissions trading is axiomatic. Trading opens up the potentially lower-cost option of buying emissions permits from those with lower abatement costs and continuing to emit at above target levels.

Furthermore, where a facility has the opportunity at low cost to reduce emissions below its target level, selling surplus emissions permits can generate additional revenue.

But does that mean that a business enterprise should be unequivocally in favour of emissions trading? As usual, the devil lies in the detail.

A question of targets

The first caveat relates to the setting of targets. Emissions trading does not reduce emissions per se, it is simply another route to meeting a defined goal. As such, it has to be considered against criteria such as scientific justification, cost-effectiveness and the potential impact on the

competitiveness of enterprise.

Concern over target setting does not, however, end there. The proposed European Union Emissions Trading Scheme (EU ETS) delegates considerable discretion to member states in developing their National Allocation Plan (NAP). This raises the possibility of a very uneven playing field.

Under the EU burden-sharing arrangement, the UK is committed to a 12.5% reduction in six greenhouse gases by 2008-2012 against a 1990 baseline. Many believe the UK is on course to meet this goal through policies and measures already in place – which would imply that the UK NAP would have to deliver little in terms of additional emissions reductions.

However, there is also a government aim of a 20% reduction in carbon dioxide emissions, and the fact the recent Energy White Paper confirmed the desire “to put the UK on a path to a 60% reduction in its carbon dioxide emissions by 2050”.

Given that under the burden-sharing agreement the Netherlands is only required to meet a 6% reduction in greenhouse gases, that France simply has to hold emissions at 1990 levels, and Spain is allowed to increase emissions by 15%, the imposition of a more arduous target on UK business will inevitably have adverse implications for

competitiveness and economic growth.

There is also the question of how the effort to meet the UK national reduction target will be split between the trading and non-trading sectors. In a rational and economically efficient approach, the marginal costs of a tonne of carbon dioxide reduction would be calculated across all sectors of the economy with the lowest cost options being pursued first – regardless of where they occur.

A less optimal outcome will result where some sort of “equal sharing of the burden” approach is used. Worse still would be a decision to abandon attempts to influence energy demand in the residential and transportation sector as being “too difficult” or “vote losers”.

This would place the entire burden of meeting the emission reduction target on the trading sector. In a worst case scenario, where emissions from the residential and transportation sectors continue to rise, the trading sector would also have to compensate for those increases.

Within the trading sector, a multiplicity of issues arise in the allocation of the overall trading sector target among industrial sectors and individual plants within those sectors. Take the UK oil refining sector, which is almost unique in its exposure to competitive market pressures – UK refineries not only compete with each other but with all other refineries in the EU (and further afield in certain circumstances).

If each member state treats the refining sector differently within its own NAP, competitiveness will be harmed. Other countries will become more attractive locations for new investment and this will harm the UK’s economic growth, employment and diversity of energy supply sources. Carbon dioxide emissions could even increase as production shifts to countries with no absolute Kyoto Protocol reduction targets and shipping movements increase.

The longer term

In addition, critical issues arise when considering the longer term – beyond the 2012 end date of targets in the current EU ETS and burden-sharing agreement.

Investments in the energy sector usually involve financial and business planning horizons that extend well beyond 2012. The evolution of the EU ETS could raise economic hurdles in the short term and make projects untenable in the long run.

Emissions trading is potentially a market-friendly tool allowing sound policy goals to be met at a lower cost than would otherwise be the case. Precisely how market-friendly, however, very much depends on the way in which the trading regime is set up and implemented.

Failure to adopt a rational and efficient approach to its establishment could result in a disproportionate burden being placed on the traded sector and particularly harsh impacts on individual sectors.