TCS Daily

Running on Empty

By Carlo Stagnaro - June 2, 2005 12:00 AM

Does unilateralism work? As far as environmental regulations are concerned, it definitely doesn't. The European Union decided it would cut emissions and pursue its Kyoto Protocol targets even if the US and other big emitters (including developing countries such as China and India) are not submitting to any caps. In order to lower the cost of the reductions, the EU implemented the European Trading Scheme (ETS), which allows for an inter-country trade in emissions allowances.

When the process began most European media and politicians told the public that it would allow the EU to pursue its objectives at a reasonable cost. But instead, it looks as if the cost of reductions is going to be high, indeed. Just a few days ago a Financial Times story informed that "Carbon emissions prices peaked at €19 a ton on Monday, a 170 percent rise since the scheme started in January, before slipping in late London trade to close at €18.30 a ton." Initially, it has been predicted that the price for allowances would not exceed 15 euros per ton.

The problem is that we are only just taking the first steps of a long uphill walk. A "cap & trade" mechanism will result in significantly lower costs than a mere cap only as long as you have a relevant number of sellers. Unfortunately, most European countries are not meeting their targets, so they are going to be buyers rather than sellers. According to the European Environment Agency only two countries are on track to comply with the Kyoto targets, the UK and Sweden. Funnily enough, both of them are doing well because of political decisions that (1) date back to the 1980s and (2) have nothing to do with climate. In other words, climate policies aren't helping them move towards their supposed target, whereas other policies (that may or may not be wise for other reasons) do. Such policies include the shift from coal to natural gas (as is the case for the UK) and a strong reliance on nuclear power (which provides some 45 percents of Swedish electricity needs).

Policies that could result in lower levels of emissions (including but not limited to the shift towards "cleaner" energy sources) need time to be implemented. In fact the driving force behind reducing emissions is technological progress, which will answer the demand for cleaner, more efficient, and cheaper energy. Now, technological progress requires time and investment. ETS doesn't offer either of them.

ETS is designed to work in the short, not the long, run. Emission reductions are targeted to 2008-2012. The risk then is that we invest in inefficient ways to reduce emissions because we need to do it quickly - instead of taking more time to find more efficient and beneficial methods. Moreover, emission reductions under ETS are going to be fake: a form of money redistribution between those who exceed the Kyoto targets and those who have been good negotiators and have obtained national goals that they would have met anyway for unrelated reasons. That means most companies will have to pay a lot to buy allowances, and will have less to spend on innovation. Some will get richer, some will get poorer, but nobody will end up with cleaner technologies because nobody will invest in research & development.

Also, we are just at the beginning of this process. The price of allowances is going to go up even more. As the deadline for the climate treaty approaches, and as European countries realize that they are far from the targets they accepted, those who can sell quotas will make a lot of money. Who'll pay for it? Both consumers and companies. The price of quotas is going to converge with the sanctions, which are very high (€40 per ton in the period 2005-2007 and €100 euros in 2008-2012.)

This is precisely the cost of the Kyoto Protocol, and Europeans will probably realize soon that it is a high price to pay for no environmental benefit.


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