An Expensive Way to Combat Global Warming: Reform Needed in the EU Emissions Trading Regime by John FitzGerald

March 26, 2004

News

26/03/2004

 

An Expensive Way to Combat Global Warming: Reform Needed in the EU Emissions Trading Regime by John FitzGerald

Article appearing in the Quarterly Economic Commentary, Spring 2003



With Ireland submitting its National Allocation Plan at the end of March as part of the EU scheme of tradable emissions quotas, this paper critically assesses the well intentioned but badly designed European policy to help combat global warming.

 

 

  • Each EU member has agreed to limit its emissions of greenhouse gases for the period 2008-2012 relative to emissions in 1990. While Ireland secured a 13% increase, this target has already been has been greatly exceeded and will require abatement to fulfil Irish EU obligations.
  • A key instrument in achieving this reduction will be a permits scheme that will apply to a range of energy-intensive sectors, such as electricity generation and cement, from the beginning of 2005. The Irish plan allocates these permits free to the sectors involved.
  • For the key power generation sector the price will rise by the cost of the permits and the generators will also receive the permits for free, creating a large windfall gain for shareholders. Because of a promise of a second round of permits from 2008 for surviving firms, it will pay dirty firms to stay in business, defeating the point of the scheme.
  • The Irish draft plan aggravates this with a "use it or lose it provision": if a dirty firm closes it loses the windfall gain, encouraging it to stay in business. It is these big emitters of greenhouse gases that the EU expects to close. If they do not close, the price of the permits will rise, so penalising consumers.
  • Because the EU requires at least 95% of the permits to be given away for free rather than auctioned, the Irish and other EU governments will have no revenue to reduce other taxes on business or to compensate the fuel poor, who will be especially badly affected by the rise in energy prices.
  • The key changes needed at this point are for the Irish government to commit to auctioning the 5% maximum allowable proportion of the permits and to drop the "use it or lose it" provision.
  • The badly designed EU trading scheme needs to be replaced by the auctioning of all the quotas. The only exceptions should be for plant in sectors that are carbon intensive AND which face real competition from outside the EU. Such a reform would still ensure the necessary reduction in EU emissions and it would cap the loss of competitiveness to the Irish economy in particular, and to the EU economy in general, from the current ill-conceived policy.