Completion of phase one of the European Emissions Trading System brings valuable lessons for designing an effective strategy to control global climate change.

With mounting evidence of rapid global warming, few now question the urgent need to control and reduce the world’s production of greenhouse gases. The big question is whether and by what means a rapid reduction can be achieved without major disruption to economic, social and political stability. Can emissions trading systems help?

The Greenhouse Effect

Greenhouse gases like carbon dioxide trap solar radiation within the atmosphere and play a key role in maintaining global temperatures. A stable proportion of greenhouse gases helps to stabilise average temperatures around the world. But an increase in the proportion of these gases will contribute to an increase in temperatures.

After much debate, most scientists now believe that a spiral of increasing greenhouse gases and increasing global temperatures is underway, and that greenhouse gases produced by human activity are largely responsible. A continuation of recent rates of change will have alarming consequences within the lifetime of many of us, with more extreme effects further in the future.

Measures taken so far have had little effect on slowing the changes that are occurring. Indeed, each new piece of evidence seems to show that changes in the natural world are happening faster than previously thought. If the scientific consensus is correct, the need for significant changes in our approach to controlling emissions is becoming increasingly urgent.

Cap and Trade

Emissions trading is an essential component of the Kyoto Protocol, an almost complete global agreement on tackling climate change to which 175 countries are now committed.

The idea of “cap and trade” emissions trading is to put a limit, or cap, on the emissions allowed by each individual emitter within the system; to reduce that cap each year; to monitor each individual’s actual emissions; and to allow emitters to trade their emissions allocations, buying more if they need them, and selling their right to emit if they can adopt technologies and work practices to reduce their emissions below their allowance.

A Price for Emissions

Trading, therefore, creates a price for emissions, measured for example in euros per ton of carbon dioxide. Reducing the overall cap each year applies upward pressure to the price, creating a greater financial pressure to emit less.

The effect of the system is to allow the market to play a key role in allocating among all emitters a steadily decreasing total right to emit greenhouse gases. Supporters believe that harnessing market forces is both fairer and more effective than allowing politicians and bureaucrats to decide how the burden of reducing emissions should be shared.

The EU Emissions Trading System

Of several examples around the world, the European Emissions Trading System is the largest for CO2 emissions. In its first phase from 2005 to 2007, it covered 11,000 installations in 25 countries, responsible for 30 per cent of Europe’s greenhouse gases. Its experience during this trial period provides valuable lessons.

In some respects, the system has worked as intended. It contributes to a growing international carbon emissions market that Oslo-based consultancy Point Carbon estimates will be worth $92 billion in 2008. Early in 2008, an independent Ecofys study concluded that the system has reduced emissions in Europe by about seven percent compared to what they would have been without the system.

But even if this estimated reduction is correct it is far from enough to reduce emissions by 21 percent below 2005 levels by 2020, the EU target which may itself be too modest to meet nature’s challenge.

Setting Emissions Allowances

Among many criticisms, during its first phase, the European ETS was crippled by the over the generous allocation of emissions limits, resulting from fierce lobbying by industries and nations. Therefore the system has not yet created a carbon price that is high and stable enough to influence companies’ investment decisions. After peaking at almost €30 per tonne in 2005 carbon prices collapsed late in 2007, temporarily neutralising the intended pressures to cut emissions.

In its forthcoming second phase, from 2008 to 2012, the European ETS will broaden its scope within Europe, taking in the aviation industry by 2010; set national caps centrally rather than trusting each country to set its own limit; auction emission permits rather than issuing them free of charge; include other greenhouse gases as well as CO2; and open itself to emissions trading with non-EU countries within the framework of the Kyoto Protocol.

Thus the potential effectiveness of the European ETS should increase significantly. But if this potential is to be realised the first requirement is to resist demands for emissions caps above the levels dictated by science. Doing so will go a long way towards determining whether Europe and the world will reduce greenhouse gas emissions enough, and in time. The stakes could hardly be higher.