Cap-and-Trade Comes Of Age in Europe

photo credit: flickr/adpicasso

How industry has learned to live with (and perhaps even love) cap-and-trade in Europe.

This piece is second in a series from Visiting Senior Fellow Jill Duggan:

• The Truth About Cap-and-Trade in Europe
• Cap-and-Trade Comes of Age in Europe
• “Synchronized Swimming”: The Regional Greenhouse Gas Initiative

On a dank, dark day in February 2004, thousands of worried executives from British industries filled the halls of the UK’s National Exhibition Centre in Birmingham. The country was about to begin participating in the first multi-national cap-and-trade programme for capping greenhouse gases, the EU Emissions Trading Scheme (ETS). Industry representatives were there to question government officials on the recently published Draft National Allocation Plan that set out the rules for allocating permits. This new system, they feared, would change the very way they had to do business, and they wanted to make sure their companies were not placed at a disadvantage.

Two years later, and a year after the EU cap-and-trade system officially began, the UK government held another stakeholder event – this time for the 2nd Draft National Allocation Plan for the 2008-2012 phase of the EU ETS. This meeting could not have been more different. In place of thousands of anxious industry representatives, there were only around 200 people. The air of apprehension had dissipated.

What happened? Once trading began, industry attitudes towards cap-and-trade started to change.

Industry Lobbying: A Prisoners’ Dilemma

Industry lobbying prior to the introduction of the EU ETS was intense. While some industry associations were broadly supportive of cap-and-trade as an approach – because it was the cheapest way to cut emissions – individual industry representatives were often relentless in pursuing, quite naturally, the best possible outcome for their own companies. In this case, that meant the maximum number of free allocations, or pollution “credits.”

And while industry sought allocations, European Member States understandably were implementing the new cap-and-trade legislation with their domestic economic interests at heart. There was a lot of talk by both countries and companies on the need for simplicity and transparency, but many would plead that they should be treated as ‘special cases’ or exceptions to the rules. Of course, more special cases meant less simplicity and transparency.

The initial efforts to establish the EU ETS were characterized by a “prisoners’ dilemma,” in which complexity and lack of transparency leads to a lack of trust. Without transparency, companies and countries alike suspect others of gaining an unfair advantage. But transparency makes tougher targets more acceptable, because participants can see that their competitors face the same challenges and constraints. There is a natural tendency for countries and companies to want to favor their own, when in fact they gain more certainty and stability by collaborating.

Changing Industry Attitudes

Fortunately, this lesson was not lost. By the time of the consultation for the second phase (2008-2012), trading had started, cap-and-trade had become a known commodity, and many of their concerns had not materialized. As I mentioned in my previous article, that first phase of the EU ETS now looks like it generated significant emissions reductions at far lower costs, and pain, than anticipated. The system, after some initial bumps, was working.

Companies increasingly understood the need for transparency. While lobbying did continue, the second allocation plans were marked by greater understanding and acceptance, and greater willingness to compromise in order to achieve the higher prizes of trust and transparency.

Adapting to the System

Europe has now had nearly 5 years of successful trading, and industries have adapted to the new system. Now that they are familiar with how it works, parties have agreed to rule changes that they would have found difficult to agree to at the start. For example, electricity generators will have to buy all their permits from 2013, instead of receiving at least some of them for free.

Companies have also adapted to the carbon price. In 2006, only 15% of the companies covered by the ETS were taking the future cost of carbon into account. Point Carbon and others found that a year later, about 65% of companies in the trading system were making their future investment decisions based on having a carbon price.

Recent studies¹ show how industries have adapted to the trading system and realized that many of their initial concerns were unfounded or overstated. One found that:

The EU ETS has not resulted in significant costs to business to date, especially when compared to the impact of other facts such as energy price fluctuations and economic downturn…

So far there has been no major impact on companies’ competitiveness: they have not relocated their operations, reduced their workforce, or lost market share as a result of carbon pricing…None has cut jobs or shut down operations as a direct result of climate-related policies, and their financial performance and global market share have not changed relative to their competitors…

(An exception to this reassuring picture is the extremely energy intensive aluminum sector, which has lobbied hard to be included in the EU ETS and will now be covered from 2013. The best way for this sector to mitigate the impact of the carbon price – until such time as there is a global carbon constraint – is by some amount of free allocation, which they will get as part of the system.)

Concerns that industry would relocate to developing countries appears to be unfounded. One study finds that “the economic impact is imperceptible,” the “European economy has not been ‘wrecked’” and there has been “no evidence of carbon leakage through trade,” meaning that carbon pollution has not simply been exported elsewhere.²

In fact the Climate Group/GMF survey seems to suggest that companies adjust quickly and benefit from the new system:

Companies have improved their monitoring and reporting of emissions and realized energy efficiency gains…

and often become supportive of EU climate policy once they get their feet wet. Says one company representative:

At first, we thought the EU ETS would die quietly after 2-3 years – but it didn’t…[now] management really support the EU’s goals on climate change. Our CEO has sent a letter of support of the 20-20-20 policy ³ to the EU Commission.

A financial analyst remarked:

The main change has been in attitudes toward climate legislation. Companies aren’t saying ‘it’s a complete disaster’ anymore. We see a bit of that positioning now in the US and Australia, where similar legislation is being considered. But you don’t tend to get that response in Europe anymore. Companies see lots of opportunities to invest in new assets and create shareholder value.

Legislators in the U.S. will, I am sure, recognize the picture of that stakeholder event in Birmingham as they deal with the concerns of constituents and companies, while trying to frame legislation to tackle this most urgent issue. In Europe’s experience, however, once legislation was passed and became part of the furniture, it was easier to address issues with more objectivity and greater acceptance from industry. And while lobbying did not go away, it became less intense and industries become more willing to accept compromises that seemed impossible just a few years ago.