Debate 13 - Paper 1

Emissions trading - the political context

Chris Hewett, Senior Research Fellow at the Institute for Public Policy Research

Climate change as a political issue

Climate change is here to stay as a political issue. The scientific evidence will continue to mount and as the ’solution’ industries grow, such as renewable energy, the economic case against taking action will weaken.

UK/EU and Japan are committed to ratifying the Kyoto Protocol regardless of US participation in the short term. If anything, the ‘war on terrorism’ will add to the international pressure on the US to come on board.

In Britain, the Government’s central environmental manifesto commitment is to deliver 20% reduction in CO2 by 2010. There is also an appreciation of the sort of emissions reductions required after that. The current Government Energy Review is, in part, a response to the Royal Commission on Environmental Pollution’s recommendation that UK cuts CO2 by 60% by 2050.

Advantage of emissions trading as a policy instrument

There are many policy instruments that will be required to address carbon reduction: regulation, carbon taxation, voluntary and negotiated agreements, better consumer information etc. All have their merits and problems depending on the way they are implemented.

A good emissions trading system mixes the certainty of regulation with the flexibility of the market. It should be the most economically efficient way of reducing emissions across the economy as a whole. Pollution permits allow resources to be used on the most cost effective emissions reduction activities first. Emissions trading is also now a well advanced international policy tool, in a way that carbon taxes or regulation could never be.

There is a degree of consensus across the policy community that a well designed emission trading system would be the most desirable policy tool to deal with greenhouse gas reduction. The disagreements come over how permits should be allocated and the size of emissions reduction that should be imposed on the system.

Where is emissions trading happening?

At a national level there are a number of countries that have been discussing setting up an emission trading scheme.

Denmark has a small compulsory scheme for its electricity generation industry, with agreed reduction of CO2 emissions over four years.

Other countries such as France, Sweden, Norway, New Zealand and Australia, all have schemes under various stages of development. The UK will have a voluntary scheme up and running from next year.

The European Commission has recently published plans for an EU wide scheme, which could start as early as 2005, although the Council of Ministers and European Parliament have yet to discuss the plans in any detail.

All national schemes can run independently of a global system being agreed as part of the Kyoto Protocol, but will need to be compatible with the international system for when it gets up and running.

Emissions trading in the UK

The UK government is very proud it is one of the first countries in the world to have an emissions trading scheme up and running. However, it is only a voluntary scheme and does not have a defined emissions reduction target. To compensate for this, there is a financial incentive for companies to join the scheme and a bidding system so the permits are allocated to the companies offering the greatest emissions reductions. Companies involved will also be able to trade emissions internationally.

There are also other energy policy measures, like the Renewable Obligation Certificates and Energy Efficiency Commitments, applied to electricity and gas companies, which will be tradable so act as de facto emissions trading systems.

One issue being addressed in the Energy Review might well be how to merge these schemes in to a full blown emission trading market in the medium term.

What opportunities will be created as a consequence?

One psychological difference between carbon or energy taxes and emissions trading permits is that, by cutting emissions, companies can make money by selling permits rather than save money by cutting the tax bill. Some analysts have argued this creates more innovation and risk taking.

For example, energy service companies could draw up contracts with a multitude of clients to outsource energy management of company offices, in return for the property rights over emissions permits. Small energy savings in a number of different sites could net a significant number of permits to sell on the market.

The opportunity to sell surplus emission permits will be an extra selling point for low carbon buildings. If their design incorporates renewable energy, then the building fabric itself could start to generate an income stream.