Parliamentary Update

Emissions trading vital to global warming strategy

Letting businesses trade carbon emissions will be an important part of the British and international response to global warming. That was the message from a panel of experts addressing politicians, business people, academics and NGO representatives at a recent British Energy seminar, chaired by BBC Radio 4's Sue MacGregor.

Widespread concern over the Climate Change Levy (CCL) has moved tradable emissions permits up the political agenda. The Levy has been criticised because of the costs it imposes on businesses and because it fails to concentrate on carbon dioxide gas emissions, the main cause of global warming.

Trading is about creating a financial incentive for a polluter to reduce emissions. Government sets a cap on carbon emissions at both national level and for individual companies over a certain size.

The cap will be set below present emission levels. Permits would then be allocated and companies which come out below the level would be allowed to trade the balance of their permits to companies struggling to hit their targets.

Cleaner companies would benefit from extra revenue; heavier polluters would have to incur additional costs for surplus permits or take action to cut back on emissions. Sulphur trading in the United States has proved very effective, hitting emission targets at a lower than predicted cost to both private and public sectors.

The CBI and ACBE (Advisory Committee on Business and the Environment) have recently put forward proposals for a trading scheme. Whitehall has now agreed that companies which have negotiated official energy efficiency and carbon emission reduction agreements will be able to trade between each other, within the scheme.

International responses to emissions trading

'There is an ebb and flow in policy making and I feel that emissions trading is on a flow,' said Peter Vis, from the European Commission's Climate Change Unit and one of its international negotiators.

The EU has agreed an overall target of an 8% emissions reduction from a package of greenhouse gases by 2008-2012. Britain is likely to meet its 12.5% mandatory reduction target of this package. But the mid-to-late 1990s has seen a reversal in EU-wide emissions reductions. Though the novel nature of trading means that a fully functioning EU scheme is still some years away EU policy makers are coming to realise that tax alone will notbe enough to influence behaviour. The Commission's energytax proposals of 1997 would only have reduced CO2 emissions by between 0.6-1.6% by 2010. A mix of instruments is needed.

International emissions trading will be part of the picture. Detailed rules are expected to be negotiated at this autumn's Hague Conference of the Parties with a view to starting an international scheme in 2008. The United States is hoping for an unrestricted trading scheme to help retrieve the situation, and is supported by Australia, New Zealand, Canada and Norway. Many Third World countries are hostile to this approach, as is the European Commission which believes that unrestricted trading will enable some countries to evade action on their domestic emissions. Current EU policy states that no more than 50% of Kyoto targets should be met by international emissions trading.

Many other countries are now looking at domestic trading schemes. Within the EU, Denmark has enacted a limited emissions trading scheme for its electricity generating sector, starting this year. Peter Vis said that Britain is thinking proactively but some member states have done little.

Dr Michael Grubb suspected that there was an ill-founded moral objection to trading which some saw as a 'licence to pollute.' This arose partly because discussions are led by environment rather than economics ministries.

The Commission is looking at the educational aspects of the matter and will publish a paper this year 'that will try to de-demonise emissions trading.'

Peter Vis added that he preferred the term 'cap and trade' to 'trading' because it emphasised that trading was about emissions reduction.

Making a trading system work

A domestic trading scheme would provide British business with experience which can be exploited in an international scheme, hopefully establishing the City as a centre for global emissions trading, said Ian Coates, Economic Adviser on Climate Change and Energy Efficiency, DETR. The City of London has expressed strong support for emissions trading as a source of new markets.

Ian Coates said that a priority for government would be to ensure that genuine emissions reductions are taking place. This is particularly important if the CCL or other tax reductions are being offered in return for hitting targets. A role for some kind of trading authority could be foreseen.

Allocating permits to participating companies was a major issue. Dr Michael Grubb, of the Royal Institute of International Affairs, thought that the negotiated agreements would at least help provide information for a future allocation. He added, however that 'one of my big fears is that the Government has become so CCL that it has not paid attention to these questions which are even more important.'

It was suggested that trading would create a de facto tax for new entrants to a market not applicable to existing operators. Michael Grubb answered that new firms would have a choice over whether to start business while established firms would have no option but to carry the costs involved in a trading scheme. Problems for new entrants could also be overcome by offering reductions on their CCL payments if they joined the scheme. But he accepted that deciding on how permits would be allocated was a difficult question on which work was still in hand. Several trading projects are already in operation: the EU fishing quotas, Britain’s milk quotas, the Montreal Protocol on Ozone Depleting Substances (which allows a small transferring of allowances between the parties). The most sriking example is the US sulphur trading scheme. Garth Edwards of NAT Source, a US company involved in sulphur trading, pointed out that the marginal cost of emissions reduction for companies is much less than it would have been through taxation or a regulatory command approach.

All the speakers agreed that tax had a role to play in emissions reduction. The CCL is a useful tool for influencing small businesses that would find trading transaction costs too high relative to their size. Michael Grubb argued strongly that trading should complement the CCL and the growing network of negotiated agreements. But he also said that "by the Spring of 2000 the Chancellor has to be in a position to know exactly what he will say about how to introduce and structure an emissions trading permit system in the UK." Gordon Brown would also need to explain how he intends to promote carbon, as distinct from energy use, reductions.

Why the levy isn't enough and how trading can help

Whitehall is always likely to prefer a tax because revenues would go straight to the Treasury, said Dr Michael Grubb, Energy and Environment Programme, Royal Institute of International Affairs. A trading scheme meant that companies with surplus permits - those with good emissions records - would get the revenue from their sale.

Michael Grubb pointed out that the CCL provides no incentive to cut carbon emissions as opposed to energy consumption.

Yet it is carbon, not energy use as such, that produces global warming. It is vital that any scheme concentrates on fossil fuel use by electricity generators.

'The greatest and lowest cost potential for reducing CO2 emissions over the next ten years is in the electricity sector.' Even the revised CCL fails to do this.

Ministers responded to fears from energy intensive industries by suggesting that they sign negotiated agreements, involving energy use and emissions reductions in return for discounts on CCL payments.

But Michael Grubb argued that such agreements lack transparency and their effectiveness is therefore hard to measure. Emissions trading, by contrast, concentrates on carbon and reveals the real cost of emissions reductions, and can do so more cheaply, as the United States sulphur trading scheme has demonstrated.

'Emissions trading gives the most direct and efficient incentive to emissions limitation.'

CBI/ACBE proposals and Whitehall's response

The trading scheme proposed by the Emissions Trading Group, a joint initiative between the CBI and ACBE, could be up and running by April 2001 if it receives Whitehall support, said Peter Agar, Deputy Director-General of the CBI.

The Group, supported by 25 leading companies, including BP Amoco, Blue Circle, ICI Petrochemicals, Du Pont, British Energy, National Power, ScottishPower, Nestlé UK, Cadbury Schweppes, British Steel, Ford and Vauxhall, submitted its plans to the Government on 27 October 1999.

The scheme is designed to operate within the CCL structure, despite the views of the companies concerned that it is not a good tax. Companies would sign up to binding emissions limits on energy efficiency targets and then trade with each other to ensure they are met in the most cost-effective way.

The new negotiated agreement targets could serve as a basis for trading. Companies which have not signed agreements with the Government should be offered incentives in exchange for emissions reductions. The Group believes that more firms will adopt binding targets through its trading scheme than via separate deals with the DETR.

Speaking on behalf of the DETR, DTI and Treasury, Environment Minister Michael Meacher said on 27 October 1999 that: 'Our support for this initiative reflects our clear recognition that emissions trading has a key role to play in the long term solution to reducing greenhouse gas emissions. A domestic trading scheme would complement other climate change measures in the business sector by offering cost-effective and flexible options for achieving emissions reductions.'

There is, however, thus far, no firm government commitment other than to work with business on the detailed development of the draft proposals.

The DETR did announce on 21 December that companies within the negotiated agreements regime will be able to conduct emissions trading with each other, although details remain to be worked out.

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