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Top of the iceberg
By Catrinus J. Jepma
Emissions trading as a policy instrument can be compared to an iceberg: 10% of it sticks out of the water and looks beautiful and shiny. This is the trading part, where the market matches supply and demand based on deficits and surpluses of individual market players (albeit against sometimes unpredictable prices and hopefully without speculation which could destabilize the market).
The main part of the iceberg, however, remains under water and is thus difficult to observe, or even remains obscure. This is the allocation part, where an authority must allocate the allowances. The key complexity in this context is on what rule allocation should be based. This is where the struggle starts. If the rule would be to differentiate allocations so that marginal abatement costs would become the same everywhere (assuming that the underlying cost functions are known), this would lead, at least in theory, to a limited scope for trading. If the rule would be to allocate similar portions of allowances to everyone, small entities would be worse off, as well as those entities that are high up on the marginal cost curve, for instance due to past investments in greening up production (creating perverse incentives for subsequent allocations). A rule that would allocate allowances mainly among incumbents would create a bias against new entrants. Finally, if an emissions trading scheme would focus on large enterprises first with allowances distributed via a lenient rule with banking opportunities, and would be followed by a stricter regime involving the smaller firms, the latter firms may be squeezed by the former (elements of the US SO2 trading scheme?), etc. In other words, irrespective of the rule applied, allocation criteria seem arbitrary and will always favor some entities – relatively speaking – while hurting others.
Although these aspects relate to other instruments as well, they should be kept in mind when assessing the present phenomenal effort within the EU to put the various National Allocation Plans (NAPs) together: allocation matters a lot. The issue is even more complex in the EU, because allocations are not based on an EU-wide consistent rule (such as was the case in the KP Art.4 burden sharing agreement), but are rather left to individual Member State governments via the principle of subsidiarity (obviously used to increase the scheme’s political acceptance). The interpretation of criteria, therefore, can and will differ across countries. At the same time, the EU internal market regime tries to create a level playing field within the EU, but what is the guarantee that the NAPs will not distort this condition?
It is no surprise that the time schedule, to start the system in January and issue the allowances in February 2005, looks increasingly ambitious. Neither is it a surprise that the lack of clear guidance seems to lead to different schemes in terms of structures and even in terms of scope (e.g. with France, unlike others, leaving out its entire chemical industry due to insufficient clarity about definitions).
This raises the question: what could go wrong?
To start with, some countries could simply fail to deliver their NAPs in time. However, remember that Commissioner Wallström has already indicated, on 18 May last, that she is preparing infringement procedures against EU-15 serious latecomers (at the end of June, the Commission was to declare its verdict on the first NAPs).
Next, some countries could introduce NAPs that are considered too lenient and therefore not acceptable for the European Commission. These NAPs would need revision. However, this would simply shift the burden of the impossible (designing an allocation scheme that is objectively optimal) to the European Commission that could, even worse, be tempted to introduce unfair across-the-board adjustments.
Installations covered by NAPs may start legal procedures claiming that the allocations unduly affect their competitiveness. This could frustrate the process and could easily lead to costly and time-consuming procedures, which therefore does not seem to be a very attractive or desirable option.
Finally, installations may turn out not to be prepared in time for implementation.
This last point should be taken seriously. According to a recent consultancy survey, only one third of European firms that will be affected by the ETS have set a budget for complying with GHG reduction targets for 2005, mainly because it was still considered too early for that! In addition, some consultancy firms recently found out that about 20% of top officials of 250 companies in 7 EU countries were not sure whether their firms would be sellers or buyers of allowances. Although one has to keep in mind that consultants often tend to portray a picture of worry and gloom in order to create better opportunities for additional work from the business community, it is fair to say that both for administrations and business time to prepare for the ETS is short.
Despite these concerns, I believe that much has already been achieved in terms of creating a political agreement on emissions trading within the EU, preparing the largest emissions trading scheme in the world, and linking the scheme with JI and CDM. If Europe manages to streamline the allocation process, e.g. by establishing an EU-wide allocation procedure with clear definitions of installations to be covered and clear criteria, I feel that there is enough reason to be optimistic about the future of the EU ETS.
Catrinus J. Jepma
Chief editor
Previous Notes from the Editor
March 2004
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