Market-Based Instruments of Environmental Policy in Practice: The European Emissions Trading Scheme - Essay Example

? Word Count 2480 Introduction The EU can be regarded as a leading force within the world on taking action on environmental sustainability, especially with regard to climate change. The European Union’s Greenhouse Gas Emissions Trading Scheme (EU ETS) was instituted under the Directive 2003/87/EC, which came into operation on 1st January 2005. The scheme works by demanding that operators of installations undertake the specified activities to hold a permit, which enables the installation to emit certain levels of CO2. The paper explores one of the market-Based Instruments of Environmental Policy - EU Emissions Trading Scheme (EU ETS) and appraises it effectiveness in controlling environmental degradation. Background The aim of EU ETS centres on meeting the obligations outlined in the Kyoto Protocol in the 20008-2012 trading period. The EU ETS sought to minimize anthropogenic emissions of certain greenhouse gases within a cost-effective and economically efficient manner. Since 2005, when the initial emission trading period (2005-2007), the total emissions of EU industry sectors covered by the scheme capped and toward the end of every compliance cycle companies needed to surrender allowances matching emissions so as to comply with the EU regulations and avert sanctions. From 2013, the EU ETS seeks to dramatically reduce CO2 emissions from 2.083 to 1.720 metric tons of CO2 by 2020. The biggest share of the emission allowances is allocated directly and free-of-charge while a lesser percentage may be auctioned, and allowances could also be gained via trading on the carbon market (Faure and Peeters 2008, p.208). In 2010, the industrial installations within the scheme accounted for close to 50% of the EU’s CO2 emissions and 40% of its total greenhouse gas emissions. Critics to the scheme cite the fact that triggered by the EU’s financial and economic crisis carbon prices, which have remained low since 2011 owing to EU’s financial and economic crisis carbon prices, which constraints the capability to incentivise the reduction of greenhouse gas emissions (Hahnel 2012, p.141). Greenhouse gas emissions from aviation activities incorporated into European Union’s Emissions Trading Scheme after, Directive 2003/87 amended to encompass greenhouse gas emissions from aviation activities (Faure and Peeters 2008, p.19). Figure 1. Annual EU ETS Cap as proposed for Phase 3 Year Billion metric tons of CO2e Annual limit for Kyoto compliance period (2008-2012) 2.083 2013 1.974 2014 1.937 2015 1.901 2016 1.865 2017 1.829 2018 1.792 2019 1.756 2020 1.720 Source: European Commission Market-Based Instruments of Environmental Policy Economies rely on natural resources as a critical input and economic growth and industrialization within the developing has significantly increased demand for resources. This has increased pressure on numerous natural resources, which raises questions centring on sustainability and availability, and high prices for some resources (EEA Technical report 2005, p.6). Majority environmentally-related market based instruments in use globally is mainly fiscal (tax) instruments. The rationale for the utilization of MBIs draws from the fact that regulatory approaches have failed to arrest the on-going environmental degradation or where the cost of traditional policy tools has proven to be prohibitive to both the government and the society at large (Kruger, Oates, and Pizer 2007, p.114). The adoption of MBIs may be grounded in the premise that MBIs avail the potential to attain efficiency gains over conventional regulatory instruments (Tunteng 2012, p.14). The EU has increasingly supported economic or market-based instruments such as indirect taxation, tradable emissions rights, or targeted subsidies for such policy purposes since they avail a flexible and cost-effective means for attaining certain policy objectives (Julien 2012, p.6). Discussion European Union Emissions Trading Scheme (EU ETS) The “phase1” that started in January, 2005 delivered a number of positives such as significantly enhancing emissions data; (2) stimulating development of the Kyoto Protocol’s project-based mechanisms; and, (3) influencing corporate behaviour to start pricing within the value of allowances within decision-making. Nevertheless, a number of issues that cropped up during the first phase were not determined as the ETS moved into Phase 2 such as allocation of schemes, new entrant reserves, and shutdown credits. It still remains unclear on to the degree that phase1 of the ETS has attained real emissions reductions. Emissions are dynamic over time and represent an outcome of a country’s population, greenhouse intensity, and economic activity. In order to capture these dynamics, the Members States of the EU establish emissions baselines from models, which project future trends within a country’s emissions based on such factors (Clo? 2011, p.14). This has raised questions on whether the level of reductions attains during phase 1 were real or mere paper artefacts. EU remains committed to attaining a 20% reduction within greenhouse emissions by 2020 from the 1990 levels. The revised ETS is the strategic component of this effort, whereby EC envisages a linear reduction within the ETS cap to match the reductions target under the overall 20% reduction program. Cap and Trade versus Baseline and credit trading schemes There are two prominent types of emissions trading scheme: cap and trade represent an overall absolute cap, target, or envelope of emissions per unit fixed, and the cap may be assigned to diverse parties who can trade. Baseline and credit, on the other hand, establishes a standard against which standards should be anchored. In the event that emissions of the party in question are lower relative to the set benchmark, then the difference can be traded. Baseline and credit may be typified as rate based in which there no absolute cap is implied (Convery and Luke 2007, p.88). There are two ways of allocating allowances: auctioning in which allowances can be auctioned in which operators pay for all the allowances they receive. Grandfathering details where allowances are given away free to operators on the grounds of past or expected future, performance. The EU cap and trade system scheme limits total emissions of CO2 from covered facilities and generates a market for emissions allowances within which participants can trade allowances (International Emissions Trading Association 2011, p.2). Other policies such as green certificate and white certificate schemes also generate tradable environmental commodities. The establishment of EU ETS faced its own challenges including over allocation of allowances or emitters owing to the absence of accurate data in advance of the program, concerns relating to program volatility, which emerged when the initially high allowances prices (propelled by high global energy costs) dropped precipitously in April 2006 after the release of accurate, confirmed emissions data. The graph below demonstrates price volatility of EU ETS as indicated by the sharp decline in September 2006 due to restriction on trading between 1st and 2nd periods. Figure 2. Price volatility The European Emissions Trading Scheme from an economics perspective EU ETS follows the concept of market-based environmentalism based on a global market in GHG emissions by means of three flexible mechanisms: emissions allowance trading between registered emitters; the clean development mechanism allowing offset trading within the mode of emissions credits between countries, and joint implementation enabling high-polluting countries to invest in mitigation projects within transition economies (Bailey and Maresh 2009, p.445). The allowances differ to mirror diverse national circumstances within industrial output in which some countries manifest surplus while other manifest a deficit. Grandfathering was favoured in the national allocation plans and represents a method of allocation grounded in installations’ historical emissions shares as per the sector. Grandfathering is perceived to supports big industrial polluters, weakening the “polluters pay” rule whilst failing to stimulate investment in clean technologies. The free market environmentalist theory stipulates that carbon trading is efficient in internalizing the costs of environmental externalities (Barrett 2008, p.211). This theory bears some validity when judged against the success of the US cap-and-trade of SO2; nevertheless, there is a huge gap between practice within the EU and environmental theory (Castree 2009, p.185). The economic rationale for utilizing market-based instruments seeks to correct market-failure within a cost-effective way. Market failures represents a situation in which markets are either deficient, or do not adequately account for the “true” or social cost of economic activity. Market based instruments implicitly acknowledge that firms vary from each other; hence, avail flexibility that can considerably minimize the costs of environments (Hansjurgens 2010, p.4). Although, MBIs are not a panacea for all problems, MBIs carry a number of strengths over regulatory instruments: allow the industry to have greater flexibility in satisfying objectives, which lower the overall compliance costs; MBIs award firms with an incentive to seek technological innovation to minimize adverse influences on the environment; and, support employment when employed in the context of environment tax or fiscal reform (Chernyavs’ka 2008, p.4; Gilbertson and Reyes 2009, p.2). An emission trading has always been advocated by economists as a cost-effective instrument to minimize emissions in comparison with direct regulation. The core idea is that a cap on total emission, coupled with free trading in emission allowances between polluters’ guarantees that pollution abatement will take place where it can be undertaken at the lowest costs. Hence, in principle emission trading will always yield to net efficiency gains and bear a positive impact on overall welfare, unless transaction costs are too high or significant market failure manifests (Ellerman and Buchner 2007, p.84). As demonstrated in Figure 2, it is more efficient to allow permits to be traded compared to specifying a uniform level of abatement across firms. Figure 3. ABD + ACD>AEF Firms abate until the MCA= P permit. In the event that the market is competitive, the firms are price takers and p is determined by the market. For a set amount of abatement, firms can comply via carbon offsets (amount outlined by individual member states) and should be limited to prevent over-supply. Some of the ETS trial period concerns centres on price volatility, windfall profits, and over allocation of permits. The emission trading may be driven by certain assumptions such as global pollutants relate to the aggregate pollution rather than discharge location (SO2, NOx, CO2); competitive market; marginal cost of abatement (MCA) is positive and rising. The free allocation of allowances within the first stages of the EU ETS has contributed in making emissions an acceptable instrument of emissions trading itself, than anticipated to adversely impact on industry’s production costs and competitiveness. There are a number of reasons that explain the evident surplus of allowances within the EU ETS market (Neuhoff et al. 2006, p.395). One of the prominent reasons explaining this is that national authorities were too lenient in awarding allowances to their national industries owing to industry pressure, and fears on loss of jobs and competitiveness. Furthermore, authorities underestimated the degree of abatement that would be forthcoming owing to the ETS. There are numerous studies and reports on the impacts of the EU ETS on costs and competitiveness, but empirical evidence has not revealed significant effects as yet (Ellerman and Buchner 2007, p.66). An emission trading scheme bears the advantage of guaranteeing that emissions are reduced, whereby such an advantage mainly increases with the increasing scope of the trading scope. An integrated approach, on the other hand, could present major drawbacks whereby in the event that the abatement cost of transportation would be significantly higher relative to those of present EU ETS sectors, the allowance price within the EU ETS will rise owing to the purchasing allowances price from industry and increasing demand (Ellerman and Joskow 2008, p.4). The incorporation of the aviation industry into the European Emissions trading scheme From the beginning of 2012, all airplanes should hold emission rights within the form of CO2 certificates for flights to and from Europe. About 82% of the certificates awarded to airlines free of charge while airlines seeking growth purchase the remaining 15% of the certificates with 3% being reserved for the new airlines. The allocations derived from average emissions registered from 2004-2006. The incorporation of airlines within the EU emissions Trading Scheme heralded additional costs that will render flying within and through Europe more expensive for passengers. Critics also asserted that the Directive would distort competition and influence the sustainability of the aviation industry (Tuinstra et al. 2005, p.3). Operators surpassing their quotas permitted to purchase idle credits from those doing better at reducing their emissions, which aids the EU to reach the EU targets as per the Kyoto Protocol. The legal objections presented before the European Court of Justice (ECJ) detailed that: EU contravene the international treaty obligation as outlined by Article 2 (2) of the Kyoto Protocol, which provides that the International Civil Aviation (ICAO) has “exclusive responsibility” for minimizing greenhouse gas emissions from the aviation sector. The inclusion of the emission from the aviation into the EU ETS also faced opposition based on assertions that, such an act contravenes the EU/US Open Skies Agreement (Hodgkinson et al. 2008, p.3). The opponents claimed that an application of the scheme in the aviation sector imposed an illegal tax on aircraft operators. However, the ECJ in the end upholds the Directive as valid. The EU’ aviation emissions policy can be situated within the wider debate on the legality of unilateral environmental measures bearing extraterritorial effect. The directive shapes the legal grounds for the incorporation of emissions from all domestic or international flights arriving and departing from the EU community aerodromes within the scheme. In 2012, the entire allocations allowances allocated to aircraft operators were equivalent to 97% of the “historical aviation emissions” and from 2013 onwards, 95%. About 15% of the total quantity of allowances is auctioned (European Environment Agency 2008, p.5). From 2013, about 3% of the allowances should be set aside within a special reserve for aircraft expanding their business while the remaining allowances (the largest share) allocated free of charge in every trading period and consequent to aircraft operators applied for them at the competent authorities of their administering member state. In order to satisfy their obligations as per the Directive, aircraft operators may also purchase emission credits from clean energy projects undertaken in third countries as outlined in the Kyoto Protocol mechanisms, or they can purchase allowances on the carbon market (Ellerman and Joskow 2008, p.4). In the event that aircraft operators fail to comply with the requirements of the Directive they risk facing sanctions including the possibility of an operation ban (Hepburn et. al. 2006, p.137). In order to avert double regulation, as well as the possibility step towards a global agreement on greenhouse gas emission reduction within the aviation sector, the Directive outlines the option of linking the scheme with emission trading schemes from other countries or regions via bilateral arrangements. Conclusion Emissions trading have overtime become acknowledged as a prominent instrument for regulating greenhouse gas emissions. The effective and efficient control of greenhouse emissions via the issuance of a limited amount of tradable permits highly viewed as an attractive approach. The adoption of directive 2003/87 has made emissions trading a key instrument of EU climate change policies. The adoption of EU ETS sought to minimize greenhouse gas (GHG) as required under the Kyoto Protocol. Based on the appreciation of their lack of knowledge and program architecture, EU covered only on gas-CO2 and a limited number of sectors. Based on the lessons learnt from the carbon trade, it is hoped that other greenhouse gases will be incorporated once necessary infrastructure was in place. References List Bailey, I. & Maresh, S. (2009). Scales and Networks of Neoliberal Climate Governance: The Regulatory and Territorial Logics of European Union Emissions Trading, Transactions of the Institute of British Geographers, 34(4), pp. 445–461 Barrett S (2008). 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