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EU: Emissions Trading System (EUC Report)

I thank the noble Lord, Lord Sewel, both for his excellent introduction to the debate and for his chairmanship of the committee, of which I was a member. The noble Lord, Lord Sewel, described the emissions trading scheme as hugely complex and cumbersome. Yet, in essence, it is actually a very simple scheme. Once—this in itself is something of a question—you can measure carbon emissions among large carbon emitters, you place a cap and, in principle, the tighter you screw that cap, the greater the demand for permits and the higher the price. As the price rises, so this encourages those who can easily make savings in emissions to do so, thus providing an incentive to energy efficiency and innovation. The cap puts on the pressure to reduce emissions while the trading allows this pressure to be absorbed flexibly by those who can most easily change their ways. This hands-off market mechanism has a lot of attractions for government because it is neutral—it is the market that is effecting the changes—and it has indeed been the Government’s favoured way of cutting carbon emissions not only within the EU as a whole but specifically for the UK. A series of White Papers has come out. In the 2006 White Paper, the Government described the EU Emissions Trading Scheme as the cornerstone of the Government’s policy framework to tackle climate change. It is the main policy that we have picked up in this country for tackling climate change. The energy policy White Paper of May 2007 said: ""The best way to encourage a change in investment patterns towards a low-carbon economy, and the most cost-effective way of reducing global emissions, is to establish a price for carbon … Trading mechanisms such as the EU ETS and the CDM"—" the clean development mechanism— ""allow cost-effective sharing of the burden of reducing carbon emissions"." Phase 1 of the EU scheme ran from January 2005 to December 2007—three years in all—and in many respects was a success, although I know that the noble Lord, Lord Sewel, has picked up some of the other aspects of it. It embraced more than 11,000 firms, and covered all major power stations and industrial installations in 25 countries, which together are responsible for some 45 per cent of carbon dioxide emissions in the EU, with the vast majority of these installations reporting their independently verified CO2 emissions and surrendering the appropriate number of allowances to cover them to the required deadlines. In addition, an active market for emission permits was established, with the City of London as its headquarters. Nevertheless, phase 1 failed miserably to achieve its main aim: the reduction of carbon emissions. Allocations to emit carbon, which were agreed by national Governments for each member state under a national allocation plan, were much too generous, and as a consequence the market price of carbon collapsed before the end of the three-year period. That provided no incentive to any installation to cut emissions. Instead, it put large profits—both noble Lords mentioned this—into the pockets of utilities that had raised prices to consumers in anticipation of increased costs. Phase 1 has generally been regarded as a learning phase. Phase 2 came into play on 1 January 2008 and is for five years, lasting until 31 December 2012. It has promised to make good many of the deficiencies of phase 1. The Commission has set a much tighter cap—6.5 per cent below 2005 levels—to meet our Kyoto targets, and has vetted the national allocation processes to prevent overgenerous allocations. Only 90 per cent of the allocations were awarded free of charge; the remaining 10 per cent are to be auctioned. More plants and installations were brought into the scheme and include the aviation sector, which is to come in on 1 January 2012. As the noble Lord, Lord Sewel, said, with only one year’s trading to date it is much too early to judge how far the new scheme will succeed. However, it is noteworthy that, as in phase 1, the price of emissions permits has fallen. On this occasion, the blame is very much with the recession; the noble Viscount, Lord Ullswater, mentioned the degree to which the price of permits has fallen. Our report, as the noble Lord, Lord Sewel, said, is not about phase 1 or phase 2, but actually about phase 3, which is to start in 2013 and run through to 2020. The Commission’s proposal for phase 3, which it produced last spring, was successfully negotiated through the Council in December, with final clearance due later this week. Again, the proposals take into account the lessons learnt from phase 1. Instead of a series of national caps, there is to be a single EU cap which would hold, and the aim would be to cut emissions by some 21 per cent. A number of new industries such as petrochemicals and aluminium are to be brought in, and a much larger proportion of emissions licences will be auctioned. As the noble Viscount, Lord Ullswater, mentioned, the committee would also opt for a larger proportion. However, under the concessions made in the December talks we see that in fact a number of Governments have caved in, so it looks as though it will be smaller rather than larger. Where permits are given away rather than auctioned, it is in effect a subsidy for the utilities and firms concerned. New regulations on monitoring and verification are to be introduced, and the degree to which external credits can be used to offset domestic emissions under ETS obligations will be restricted. Our report examined the proposals put forward by the Commission last summer and in general endorsed the stronger stance, particularly the notion of a tighter overall cap—a 30 per cent rather than 20 per cent reduction—provided that a broader agreement was reached in Copenhagen around climate change. If the ETS is to work, it is sensible to extend its coverage to areas such as transport and shipping. Agriculture and forestry, as the noble Viscount, Lord Ullswater, mentioned, were the subjects of an interesting teleconference with the New Zealanders on their approach to these measures. However, I do not agree that they are coping with it all, and indeed it struck me that they still have much to learn. We are also particularly keen to see auctioning extended and the free allocation of permits limited to those industries that are likely to relocate out of the EU—those that comprise the so-called carbon leakage. We are and have been much in accord with the UK Government in all this, as their response to our report implies. However, we part company on two issues. First, we have argued that where allowances are auctioned, part of the revenue should be ring-fenced for policies that promote low-carbon technologies. The noble Lord, Lord Sewel, mentioned the importance we place on promoting carbon capture and storage. The Commission asked that a proportion of these funds be put at its disposal, but we agree with the Government that that is not a good idea. However, the money should be directed as a matter of urgency into R&D in the UK. We also parted company over the use of clean development mechanisms and similar schemes for offsetting carbon. While understanding the general argument that a reduction in carbon usage is just as useful whether it derives from an advanced country such as the UK or from a developing country such as Nigeria, it nevertheless sends all the wrong messages. If we are to meet the tough carbon reduction targets necessary to prevent global warming, all countries have to make the shift towards low-carbon technologies, with the developed countries leading the way. In this respect, I think that the agreement on these issues concluded last December in Brussels was extremely disappointing, caving in as it did to much too great an extent to national and industrial interests on so many points where a tough stance was needed—the commitment to the 30 per cent target is still very tenuous; limiting the number of new industries to be brought into the fold was not clear; there was a caving in on the auctioning of allowances and allowing free allocations to a lot of the major players; and there was agreement that up to two-thirds of emissions reductions could be outsourced to third-world countries. I can only agree with a letter written to the Guardian by the Green MEP, Caroline Lucas, who was a member of the European Parliament’s team working on the package. She wrote: ""EU leaders ended up with such a dramatically weakened agreement, devoid of any serious ambition ... A 20 per cent emissions reduction target by 2020 is far too little too late and, scandalously, around two-thirds of the emissions reduction could be outsourced to developing countries. This is scientifically unsound and ethically wrong. It means the EU can cherry-pick the cheapest climate mitigation potential in developing countries in order to prolong our own unsustainable model"." I have for some time been something of a sceptic about the European Emissions Trading Scheme. I worried that it was too clever by half to work effectively, another of those schemes dreamt up by economists that get distorted in practice and never work out as planned. I confess that the probing that we undertook as a committee for the report somewhat reassured me. For all its limitations, it seemed to be beginning to get a carbon market off the ground and to provide a model that could be extended to link with others—a link that would be so important if President Obama manages to get a similar scheme off the ground in the United States. Although my scepticism is somewhat abated, it is important to put the ETS into perspective. Its record is, as we say in the final chapter of our report, unproven. In particular, the UK Government need to beware of putting too many of their eggs in that one basket. Few dispute today the gravity of the climate change agenda. All the data coming out of last week's science meeting in Copenhagen emphasise how important it is. It is important that the Government back the scheme as wholeheartedly as they can, but other policies on that agenda that promote energy efficiency and encourage the uptake of low-carbon technologies also play a part in the strategy. As I have said before, the public mood is now receptive to the climate change message and the public are looking to the Government to provide the lead. Hiding behind the seeming neutrality of market mechanisms is not necessarily the most effective way to show that leadership.