THE EU AND CLIMATE CHANGE
By Richard Benwell
In order to identify the influence of the European Union in moving the issue of climate change up the international agenda, it is necessary to separate out the distinctive contribution made by the EU from the many other factors influencing the global mitigation effort. This paper argues that although the EU has been a contributor on many levels, it is the creation of an international price for carbon that sets the EU apart as the international actor that has most shaped the climate change agenda in recent years. It will show that the creation of the EU Emissions Trading Scheme (EU ETS) has moved the international agenda forward in three ways.
First, the EU ETS has provided a “life support system” for the Kyoto Protocol. It has provided a sign of political intent and proof of the practicality of international emissions trading through its internal operation and through the stimulation of demand in the Kyoto mechanisms. Second, the EU ETS has shown that economic success and environmental integrity can go hand in hand. Third, the scheme has proven the most tangible sign of developed-country leadership which may help break the “development deadlock” in future climate negotiations. In addition, this paper will suggest that the leadership contribution of the EU ETS was not a one-off event, completed with the Emissions Trading Directive, but an on-going enterprise. The development of a viable market has required long-term commitment from the European Commission to safeguard the integrity of the market. Over time this has begun to create political and private sector confidence in the long term environmental and economic robustness of the scheme, without which the ETS could not have achieved such a central role in establishing greenhouse gas emissions reductions as a priority among competing global objectives.
It is not in the sphere of international political rhetoric, nor even in the field of scientific understanding that the European Union has most influenced the climate agenda, although it has certainly been a contributor to both. For a long time, rhetoric concerning climate change mitigation has been bold and the European Union has not been the only international actor to make ambitious policy proclamations about its intention to tackle climate change. President Bush promised has promised an ‘effective and science-based response to the issue of global warming’; Stephen Harper has promoted a ‘made in Canada’ approach to the problem; and in 1992, China was the first country in the world to respond to the Rio Declaration with a national climate plan. The EU has added to this corpus of international policy declarations with its own commitments, most notably through the European Climate Change Programme 2000. Similarly, among the scientific community, the consensus that climate change is a threat has developed over many years and has been given political weight by an intergovernmental group of scientists from 154 different countries. Despite this powerful rhetoric, scientific consensus and a series of high-level conferences, substantive action to curb emissions was not forthcoming and global emissions continued to rise unabated.
It was when the future of the international climate regime was most in doubt that the EU began to act as global leader in climate mitigation, first politically and then practically. When the United States pulled out of the Kyoto Protocol in 2001, it was largely the commitment shown by the EU that kept the Protocol alive. Between 2001 and 2002, The Economist pronounced the Kyoto Protocol dead on several occasions, citing the non-participation of the world's largest emitter and apathy among others as evidence of the ineffectiveness of the agreement.
The contribution of the European Union has been to move beyond scientific discussion and political rhetoric to take action to curb emissions. Through the EU ETS, the EU has begun to substantiate its mitigation rhetoric, providing a signal of intent to the international community plainer than any policy document could achieve. The first major achievement of the EU ETS has been to act as a life support system for the Kyoto Protocol and thereby to keep the international climate regime in action so that whatever is decided in 2012 can be a “next step” rather than a new start.
Emissions trading is written into the core of the Kyoto Protocol, Article 17 providing for international emissions trading and Articles 12 and 6 creating the Clean Development Mechanism and Joint Implementation respectively. Emissions trading is the basis of both the environmental certainty and the social equity of Kyoto. The “cap” on the Assigned Amount Units (AAUs) given to developed countries limits their emissions, while prospects for project participation in developing countries provide a means for technology sharing and the transfer of capital from the global North to the South. In order for an emissions market to function, however, it requires participants with confidence in the scheme who will provide the capital necessary to make the market a reality. This confidence and a lot of this capital have been provided by the European Union, through the early development of the EU ETS.
While Phase I of the Scheme did not officially open until January 2005, the influence of the EU ETS began long before that. After a common position was agreed in December 2002, the final text of the Directive was published in September 2003 and the Directive came into force on 25 October 2003. The first trade was made on 27 February 2003 with a forward contract between Shell and NUON. Through the Linking Directive, 2004, demand for emissions allowances under the EU ETS has been opened up to the markets for Certified Emissions Reductions (CERs) from the Clean Development Mechanism and Emissions Reduction Units (ERUs) from Joint Implementation.
By creating tradable emissions allowances and then placing a restriction on the overall amount of carbon dioxide that can be emitted by covered installations in the EU (the “cap”, which currently covers c.40% EU emissions), a market price for allowances emerges. Effectively, this is the price of carbon, making the polluter pay for the right to emit CO2 which may cause negative environmental and social externalities. Despite a collapse in the price of EUAs in April 2006, when leaked information showed that over-allocation had caused the market for Phase I of the scheme to be “long” by millions of tonnes, the EUA price has since recovered and it is now clear that the EU ETS is capable of maintaining a stable carbon price in the long-term.
The emergence of a strong emissions market in the EU, linked to the Kyoto flexibility mechanisms, has provided confidence in the future of an international market and liquidity for traders now. In 2006, the EU ETS was worth over $24bn in a global market of just over $30bn, providing the core of international emissions trading activity. Moreover, Europe has consistently represented the lion's share of activity on the demand-side of the Kyoto flexibility mechanisms, directly injecting liquidity into the Protocol markets. For example, in 2006, European buyers represented 86% of international market share in the primary CDM and JI markets. Without this core of European demand, activity in the flexible mechanisms may not have amounted to more than a sideline consideration, propped up by the World Bank, and without the operation of these mechanisms, the Kyoto Protocol may truly have failed. By generating genuine demand for international offsets for compliance, the EU ETS has stimulated the operational aspects of the Kyoto Protocol, providing the liquidity necessary to tempt significant players into the markets and the activity necessary to develop the technical modalities of emissions trading. It has also begun to create the flows of capital transfer from the developed to the developing world that are central to the credibility of the Kyoto Protocol. In this way, the EU scheme has been central to the survival of the international climate regime.
The second achievement of the EU ETS has been to help to change the perception that climate change mitigation is necessarily a prohibitively costly exercise. This has prompted similar forays into substantive mitigation efforts across the world. Emissions trading is designed as a tool of cost-minimisation, giving covered installations access to the most economical emissions reductions. The EU ETS has gone beyond that to show that emissions trading can stimulate new efficiencies and new markets, propelling Europe to the forefront of emerging business opportunities such as renewable energy technologies and the financial services necessary to support emissions trading itself. Evidence of the influence of the ETS in enlivening interest in climate change mitigation can be seen in the emergence of emissions trading at all levels of governance. Notably, the strength of these new markets has been linked to the strength of the EU ETS itself, with the influence of the price of EU allowances (EUAs) on other emerging emissions markets being dubbed the “EUA-effect”.
In 2001, one of the major reasons for US withdrawal from the Kyoto Protocol was the fear of economic disadvantage. American economic analysts predicted that compliance would risk 'significantly harming' the US economy and President Bush warned that “for America, complying with those mandates would have a negative economic impact, with layoffs of workers and price increases for consumers”.
The EU ETS, however, is helping European Member States to achieve their Kyoto targets without economic disadvantage. The economic interests of key European sectors were provisionally protected in the first phases of the EU ETS by the free allocation of EUAs. By grandfathering allowances, the EU Commission allowed industry and other large emitters to participate in the scheme, and obliged them to meet its cap, without exposing them to the competitive disadvantage of having to pay for carbon when international competitors still pollute for free. In fact, in some sectors (electricity generation in particular), emitters were able to pass on the opportunity costs of their free allowances to consumers and make considerable windfall profits in the process. In the long term, from 2013 onwards, free allocation will be phased out in most sectors under plans announced in the EU ETS reform package. For those sectors exposed primarily to EU competition, the playing field will be level – all will face the same incentive to reduce emissions. For those sectors most exposed to international competition, as reduction requirements increase, the Commission proposes a variety of safeguards, such as continued free allocation, or the requirement that importers comply with the ETS. In this way, the environmental benefits of the scheme have been gently introduced, while progressively creating safeguards to ensure economic fairness for the industries involved.
Alongside the cost minimisation function of the EU ETS, there are also considerable benefits attendant on emissions trading. The financial analysts of the City of London, for example, predict that 'the climate change industry promises to be one of the largest in the world and offers the prospect of substantial financial rewards to the City of London'. Already, the infrastructure and services required to support an emissions trading market are attracting business to European financial centres, as lawyers, brokers and accountants, for example, begin to enter the marketplace. In Germany, the price of carbon is helping to further the market for renewable energy technologies already kick-started by the Renewable Energy Sources Act 2000. These opportunities have won the attention of businesses across the world, with the idea that delayed entry in the carbon markets might actually cause them to miss out on prospective advantages.
It is the combination of cost minimisation and added benefits that is stimulating new interest in emissions trading across the world. By leading the way with an active emissions reduction scheme, the EU is prompting other state and sub-state actors to take their own substantive steps. There are now emerging or operational schemes in Switzerland, Norway, Liechtenstein, Iceland, Canada, Japan, Australia and New Zealand and, significantly, there are several sub-federal schemes in the United States. The Norwegian scheme, for instance, was designed for compatibility with the EU ETS and, with Iceland and Liechtenstein, the European Economic Area has now concluded a linking agreement with the EU Commission to participate in the EU ETS.
The third contribution of the EU ETS to maintaining momentum in the international climate regime has been to begin to break down the “development deadlock”. This deadlock is created by the impasse between developing countries, who claim a right to continue their economic progress which may well entail increasing emissions, and certain developed countries that would only consider curtailing their own emissions if key developing states such as China and India were to accept binding targets of their own. In 2001, for example, President Bush complained that 'the world's second-largest emitter of greenhouse gases is China. Yet China was entirely exempted from the requirements of the Kyoto Protocol'.
The EU ETS has begun the process of breaking this deadlock in two ways. Firstly, the acceptance of binding emissions caps with serious non-compliance penalties demonstrates a practical leadership role. Secondly, the Linking Directive has made the idea of international capital flows for mitigation and adaptation into a reality. As shown above, the EU ETS is responsible for the majority of demand in the Clean Development Mechanism. As well as giving credibility to Kyoto, this injection of finance demonstrates that Europe, at least, is willing to take part in the capacity improvements that will allow the developing world to continue to move forward economically, without following the polluting path trail-blazed by the industrialised North. Negotiations at the Bali Conference, COP 13, in December 2007 showed that this is a crucial issue in the development of a climate deal and it is the EU that has shown most practical progress in implementation as well as taking the political lead at Bali by accepting India's proposal that developing countries should undertake 'nationally appropriate mitigation actions' in return for finance and capacity-building.
The political success at Bali was a modest step forward: the re-engagement of the United States in the political process and the deal on the roadmap, containing some statement of intent by developing countries, show that international attitudes towards climate mitigation are becoming more positive. The role of the European Union as negotiator and policy-maker has been important in this process. More important still, however, has been the success of the European Union in building a viable international emissions trading scheme with an increasingly stable and realistic carbon price. It is this development that has shown genuine commitment to achieving a low-carbon economy in the future and demonstrated that it can be done in an economically and environmentally efficient manner. The process is far from over – an emissions trading scheme requires sustained commitment over time in order to achieve its goals and states such as the US and China will require lots of convincing yet – but the package of reform measures for the EU ETS and the wider ECCP goals for 2020 and beyond show that the Commission is committed to maintaining the integrity of European greenhouse gas reduction goals. If this is the case, then the example set by the EU should continue to develop climate change mitigation as an international policy priority in the future.
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