Time to Tighten up the Carbon Trading System

Financial Times, 24 November 2006 - European industry will have to slash its greenhouse gas emissions from 2008 under plans by the European Union to tighten up the carbon trading system seen as a pioneering weapon in the world's battle against climate change.

Next Wednesday, the European Commission will require some member states to cut the number of carbon permits they give companies for the second phase of trading from 2008 to 2012.

Most member states have proposed awarding themselves a generous allocation of permits to lighten their companies' obligations to cut emissions from the burning of fossil fuels. Under the scheme, launched in January 2005, companies are issued with permits to emit carbon dioxide. Cleaner companies with spare capacity can sell permits to dirtier businesses needing to emit more.

The scheme is increasingly the focus of international interest as other developed countries take climate change more seriously. However, Brussels must rescue the credibility of the system, which suffered a serious blow this spring when it emerged that member states had given their industries many more permits to emit carbon than they needed for the first phase, which ends on December 31 next year.

This ran counter to the purpose of the scheme – to force companies to reduce emissions by ensuring they have fewer permits than they need, in effect, putting a price on pollution.

Stavros Dimas, environment commissioner, told the Financial Times: “If it appears there are over-allocations, we will adjust to the right numbers.”

He said governments would not be allowed to allocate more permits in the second phase than in the first. Some assessments had suggested the plans submitted by member states were about 15 per cent above the limits required to meet the EU's commitments under the Kyoto protocol, which required a 6 per cent cut in emissions compared with the first phase. Mr Dimas would not say how many would be rejected. “All of the plans have some small things wrong with them,” a senior Commission official told the FT yesterday.

Research by the UK's government-funded Carbon Trust found all member states, except the UK, Spain and Italy, would have to cut emissions by more than they had planned. The report said the countries requiring the biggest revisions were Austria and Finland, while Germany, the Netherlands, Belgium and France would have to make significant cuts.

The biggest losers are expected to include Germany, which is heading for a showdown with Brussels over a loophole in its carbon trading scheme, which generated windfall profits for its big power producers. The Commission will ask Berlin to remove an exemption for new coal-fired power stations under which stateowned banks will be able to buy extra permits on their behalf for the next 14 years. Mr Dimas believes this amounts to illegal state aid and is among the worst flaws in governments' national allocation plans.

The stakes are high for both sides. Germany argues companies need legal certainty to embark on a new generation of more efficient generators. It also needs to prop up the mining industry of the former East Germany, where jobs are scarce. RWE yesterday announced a €2bn ($2.6bn, £1.35bn) investment in a new coal-fired plant in Saarland, but said any change to emissions trading “would put question marks on these investments”.

Electricity generators, making decisions on power stations that will last for three or four decades, want as much clarity on the future system as possible. Carbon traders want tough curbs to bolster the market.