Dealing in Hot Air The Pitfalls of Europe's New Emissions Trading System
Part 3: Design Flaws in the Trading System
Starting in 2013, a lot of money will be at stake, giving companies that feel unfairly treated more of an incentive to take their cases to court. And this is likely to occur often.
The potential challenges start with the question of who is even required to participate in emissions trading. Neither agriculture nor forestry is included. The real estate sector doesn't need certificates, nor do small businesses and operators of motor vehicles. On balance, about half of all emissions being pumped into the skies above Germany will not be subject to trading.
The example of the ceramics industry highlights the seemingly arbitrary nature of the decision as to who is required to be part of the system and who is not. While makers of ceramic tiles need certificates, producers of plates and cups do not.
This is because porcelain factories are consistently small businesses that fall below a production threshold of 75 tons a day. Paradoxically, it takes much more energy to fire porcelain than to produce tiles.
Another design flaw is that the amounts produced by a plant play an important role in the allocation of the free certificates. This is bad news for glass manufacturers whose plants happened to be undergoing maintenance during the reference period. Glass plants receive a general overhaul once every 10 to 15 years, which can take up to three months.
It's also bad news for airlines whose planes were grounded for days in April because of volcanic ash unleashed in Iceland. For airlines, lower sales during the reference period means fewer free certificates.
A Disincentive for Investment?
Another concern for companies is that in the future, businesses hoping to expand will only be entitled to additional certificates if they increase their capacity by at least 10 percent. In other words, those that expand to a lesser degree will have to make do with their existing allocation. In some cases, this could prompt companies to decide against the investment. As a result, emissions trading could put a damper on growth.
German companies should be bracing themselves for substantial changes, but very few are adequately prepared. Many small and mid-sized businesses are only gradually realizing what costs and risks they could face, says Ines Zenke, a Berlin expert on energy law. Many are downright shocked and some are worried that the new regulations could put them out of business, says Zenke.
Help will come in the form of consulting firms that manage the entire emissions trading process for their customers. They search for efficiency reserves in companies, they buy and sell CO2 rights and they procure certificates from climate protection projects in developing countries and emerging economies. Examples of projects for which such certificates are issued include the capture of mine gas in Chinese coal mines and the disposal of old refrigerators in Brazil.
A company can use up to 22 percent of such certificates for its DEHSt account. They cost about 12 apiece, which is more than 2 cheaper than conventional pollution rights. Critics charge that this is nothing but the sale of indulgences. Some of these arrangements were recently discredited when polluting industries were developed solely for the purpose of promptly eliminating them and then collecting certificates for doing so.
Both documents, the certificates for development projects and the classic polluting rights, are traded on special exchanges, mainly in Paris, Amsterdam and London. Leipzig has developed into the most important trading center in Germany.
A 'Lack of Imagination'
The European Energy Exchange (EEX), which offers trading in electricity, gas and CO2 certificates, is located on the 24th floor of Leipzig's Panorama Tower building. The trading room isn't much bigger than a large living room, and the trader for CO2 rights walks into the door with a cup of coffee in her hand. It's a Monday afternoon, and there isn't much going on.
Nothing at all is happening on the spot market. The market closes in an hour and a half, but sales are still zero. There is at least a little movement in the futures market, where contracts for delivery on a specific date in the future are traded. "There's a lack of imagination at the moment," says EEX Managing Director Oliver Maibaum.
Apparently companies are still well provided for with certificates, as a result of the economic crisis, which meant that they were involuntarily producing and emitting less. For this reason, Maibaum already has high hopes for the third trading period, when the market will expand several times over. "Then there'll be music," he says.
When that happens, emissions trading could also turn into a goldmine for speculators betting on the development of certificate prices. The CO2 market is still relatively small and poorly regulated. There are no position limits for traders, meaning limits on how many contracts they can buy or sell. Some fear that powerful financial jugglers could move prices at will, adversely affecting companies that depend on the certificates, because they would have to adjust to price fluctuations.
The wild rollercoaster ride on the commodities markets, for metals like nickel and copper, for example, give a manager like Saarstahl CEO Klaus Harste every reason to be concerned. If the prices of CO2 certificates start fluctuating in a similar way, says Harste, it will become extremely difficult to estimate the cost basis for a steel plant. "It will get harder and harder to put together a business plan."
'We Need the Same Rules for Everyone'
He is even more concerned about the fact that emissions trading is limited to Europe, which Harst believes puts him at a disadvantage against competitors from China and the United States. The two countries are responsible for 40 percent of all CO2 emissions. "Steel is a global market," says Harste, "and we need the same rules for everyone." He disagrees with the argument that someone has to take the first step. Being a pioneer is all very well and good, he says, "but what happens if no one else follows suit?"
In fact, there is little indication that emissions trading will take on global dimensions in the near future. But the system has to be global to function properly, or else every ton of emissions Europe carefully saves will simply be blown into the air someplace else, where emitting CO2 costs nothing.
The lime industry already fears that production will shift to the edges of the EU, namely to Russia and North Africa, to the detriment of European production sites. "We are developing into a green backyard," warns industry association head Fuchs. Lufthansa expects to be at a competitive disadvantage with its intercontinental flights through Frankfurt and Munich, compared to the competition at Emirates, for example, which uses Dubai as its hub.
However, a true global emissions trading system could also produce effects that German industry would not welcome at all. If CO2 certificates were distributed worldwide, every person would have to be granted the same right to pollute the atmosphere. This would create more leeway for the economies of heavily populated countries like China and India, while Germany and the United States would have to limit themselves considerably.
Contradictions in German Policy
Such a system of consistent climate justice once had a prominent champion. German Chancellor Angela Merkel introduced the per-capita principle at the 2007 G-20 summit at Heiligendamm, Germany. But she no longer even mentions the idea today, and emissions trading is only discussed as an aside in the energy plan the German government unveiled in the fall.
The 32-page document also steadfastly ignores the fundamental contradiction of German energy policy: The government spends billions to subsidize renewable forms of energy, like wind and solar power. As a result, the demand for CO2 pollution rights declines, and so do prices.
This automatically makes it worthwhile for energy providers to return to burning dirty coal. "The subsidization of renewable energy is incompatible with emissions trading," says environmental economist Till Requate of the northern port city of Kiel, who is critical of the failed incentive policy.
In the end, the question remains as to what will happen to the epochal project, given all of these problems. When the concept of emissions trading was first raised many years ago, an alternative was also discussed: the so-called input or upstream solution.
Under that concept, emissions trading would not affect products and consumers, but would instead be applied at the source, so to speak: where petroleum, natural gas and coal enter the economy. Then every refinery owner, every gas supplier and every coal producer would have to buy certificates, at differing prices determined by carbon content.
A ton of bituminous coal wouldn't just cost 80, but many times as much. Electricity producers would have no choice but to pass on the costs to their customers -- or invest in alternative energy. The advantage of this approach is that it would cover a large share of emitters, and the system would be more efficient and less costly and complex.
But this alternative was quickly discarded. Europe's politicians apparently feared the consequences of brutally confronting citizens and companies with the true costs of climate protection. Instead, they favored the complex version, despite all of its contradictions.
Translated from the German by Christopher Sultan
- Part 1: The Pitfalls of Europe's New Emissions Trading System
- Part 2: Transforming CO2 into a Currency
- Part 3: Design Flaws in the Trading System