The ETS is great, but not enough for the transport sector

The ETS began in January 2005 aimed at creating an economic incentive to reduce emissions. It gives large stationary installations such as power stations so-called “CO2 allowances”. If the installations emit more than their allowance, they have to buy extra emissions permits in the CO2 market; if they emit less, they can sell the difference in the form of CO2 permits. This in turn creates a carbon price that fluctuates according to supply and demand.

So far its relevance for transport has been limited, but this is just in the first phase when only the biggest power stations are affected (and any transport that takes its energy from power stations, like tram systems and most rail services, is effectively in the system). The EU’s institutions appear to be serious about putting the aviation sector into the system, possibly in the second phase starting in 2008. Once that has happened, shipping seems an obvious second candidate, and there are a few voices asking for road transport to be included.

At first sight, the idea seems ideal. The more economic sectors that enter the system, the more incentives there will be to look for low-cost CO2 abatement measures. Economists have long argued that it would be the most cost effective solution if every sector faced the same CO2 abatement costs. They argue it does not make sense to make some sectors pay more for CO2 reduction than others. But
this is where the problems start.

The root of the problem is that climate policies across the world are different. The EU has climate policies, as do the other Kyoto signatories, but certain other countries do not. This means that the EU – along with other countries that want to be ambitious on climate change – is in a constant struggle to implement climate protection policies that have the lowest impact on the European economy. If it fails in this, European industries will face competitive disadvantages compared with non-EU states and in some cases they threaten to relocate outside the EU.

There are some sectors which will seriously struggle with CO2 prices of, for example, €100 a tonne or more. These are sectors that make energy-intensive products that are traded on the international market (aluminium and cement are two examples). By contrast, other sectors can easily bear such CO2 prices without feeling the heat of unfair competition. Households are an obvious example: high energy prices or taxes do not lead to people moving out of countries in large numbers.

Another sector that can easily bear higher CO2 prices is transport. Increased costs in transport, such as fuel taxes, have not led to transport being “relocated” outside Europe. That is by definition impossible. The fuel taxes also apply to Chinese and American firms, so European firms are not put at a competitive disadvantage.

But if we are to have a single carbon price – and a single carbon price seems to be accepted as the route to cost-effectiveness – which is not going to unfairly penalise the energy-intensive industries, that price is going to be so low that, for industries not vulnerable to high carbon prices, the ETS will make little difference, certainly not enough difference to be a central part of an ambitious climate protection strategy.

This is already happening. The energy-intensive industries are heavily lobbying EU governments not to make the allocations in the second round of ETS allowances (2008-12) too strict because that would hurt them too much. Effectively, this means the most vulnerable sectors in the ETS are holding the system hostage. If this is allowed to happen, CO2 prices in the system will stay at a level that will allow the economic consequences for the most energy-intensive sectors to remain manageable.

This is why there are people in the environmental movement whose enthusiasm for the ETS is limited. The ETS is very useful for energy-intensive sectors, and it can do some good for other sectors, as it will add a certain level of financial incentive to save energy and reduce CO2 emissions. But if a single carbon price is to find its level so that the most energy-intensive industries are not unfairly penalised, and the EU’s climate protection strategy is to be based solely around emissions trading, it will put a “lowest common denominator” floor in climate policy. We would then be stuck with a relatively meaningless climate protection strategy, one that will never achieve reductions close to those needed to meet the EU’s target of limiting warming to two degrees.

Of course aviation should be in the ETS, and possibly shipping too – it makes sense for those sectors where we do not yet have any climate policy. But no-one should say that putting aviation, shipping or even road transport into the ETS will be enough. If we are to have an efficiently functioning economy, the sectors that can do most in a climate protection strategy must be made to do most – through a mixture of emissions trading, other fiscal measures and some regulation.

It is time for policy makers and the economists who advise them to realise that it is cost-effective if some sectors – such as transport – go further in their climate policies than just joining the EU ETS. It would be bad for Europe if this awareness came too late.

This news story is taken from the May 2006 edition of T&E Bulletin.