Do you consider that emissions trading provides a viable means of achieving reductions in greenhouse gases?

1. Introduction

Directive 2003/87/EC established a scheme for greenhouse gas (GHG) emission allowance trading within the Community which is in compliance with the overall commitment entered into by the European Community and its Member States under the Kyoto Protocol. It aims at reducing total emissions of GHG by at least 5% of the level of emissions in 1990, during the period 2008-12. The EU Emissions Trading Scheme (EU ETS) is based on the recognition that creating a price for carbon emissions is the most cost-effective way to achieve the deep reductions in global GHG emissions that are needed to prevent climate change from reaching dangerous levels. The first section of the present essay outlines the problem of climate change and how the international legal framework addresses it. In the second section, the cap-and-trade system is discussed as a flexible mechanism for climate protection. The next section identifies three theoretic models of the ETS: Economic Efficiency, Private Property Rights and Command-and-Control models. The fifth section outlines the EU ETS and discusses its main components. Finally, in the last section a critical analysis of the EU ETS is presented in terms of three main criticisms: target achievement, perverse incentives and economization of an ecological roblem.

2. The international legal framework to combat climate change

Climate change is a dominant concern across all areas of law and policy. In particular, concerns are raised about the increasing quantity of GHG emissions in the atmosphere, which contribute to ozone depletion. Air pollutants may come in many forms. The range of problems to atmospheric pollution stretches across the full range of human activities, from highly toxic fumes emitted from industrial processes, to such seemingly mundane activities as lighting a fire, driving a car, or using spray-on deodorant.^[1] The production of various GHG has increased in the past century with progressive industrialisation. Air is a common resource – it is intangible and not capable of being owned. Emissions can diffuse quickly and the immediate impact can be transferred away from the direct point of discharge. As a result, it has often been difficult to identify causal links between particular sources and effects of pollutants. Thus, air pollution problems are complex in their causes and solutions.

The United Nations Framework Convention on Climate Change and its Kyoto Protocol created a framework within which the international community can work towards climate change prevention. The Climate Change Convention was adopted on 9 May 1992 and entered into force on 21 March 1994. The ratification of the Kyoto Protocol allowed for the establishment of supranational emissions trading schemes. Under the Kyoto Protocol of 1997, a number of industrialised countries made a commitment to reduce the annual average of GHG emissions within the first commitment period from 2008 to 2012. The target set was 95 per cent of the base year 1990. The 95 per cent signifies the average of the quotas of all individual states. For example, the EU quota is 92 per cent. The Convention established a range of obligations for developed states noted in Annex I (Annex I States) as well as developing countries to achieve GHG emissions reductions. Under the Climate Change Convention, countries that emit less than their quota will be able to sell Assigned Amount Units (AAUs) to nations that exceed their quota. The Kyoto Protocol endorses a degree of flexibility in the way in which emission reductions could be met in terms of flexible mechanisms. There are three flexible mechanisms: emissions trading, Joint Implementation (JI) and Clean Development Mechanism (CDM). It is possible for Annex I countries to sponsor carbon projects that reduce greenhouse gas emissions in other countries. These projects generate tradable carbon credits that can be used by Annex I countries in meeting their caps. These mechanisms ensure that Annex I States would not restrict themselves to actions directed only towards domestic obligations.

The Kyoto Protocol permits emissions trading among states as well as between companies and among states and companies. The most advanced emissions trading system is the one developed by the EU, which is discussed in detail in the fourth section of the present essay.

3. The Cap-and-trade system

Cap-and-trade is the core of the flexible mechanisms for climate protection where the maximum use of a resource is determined. ETS is predominantly suited to the emissions of GHG, the gases responsible for global warming, which have the same effect wherever they are emitted. A cap-and-trade system is defined as: 'a system which constrains the aggregate emissions of regulated sources by creating a limited number of tradable emission allowances, which emission sources must secure and surrender in number equal to their emissions'^[2]. The rationale behind emissions trading is to ensure that the emission reductions, required to achieve a pre-determined environmental outcome take place where the cost of the reduction is the lowest. The cap is an enforceable limit on emissions that is usually lowered over time. Nationally, an overall cap of allowances covering all participating installations is set and divided between installation allowances, where each allowance representing a tonne of the relevant emission. At the end of the compliance period, participants must hold sufficient allowances to cover all of their emissions. Installations with comparatively high abatement costs (the cost of reducing emissions) can be expected to have higher emissions and attain fulfillment by buying allowances from other participants. Installations with relatively low abatement costs will undertake more abatement activity and can be expected to benefit from the sale of any surplus allowances.^[3] In contrast to regulation which imposes strict emissions limits on particular installations, emissions trading gives companies the flexibility to meet emission reduction targets according to their own strategy; for example by reducing emissions on site or by buying allowances from the market. The environmental outcome is not affected because the overall amount of allowances allocated is set. This allows governments to regulate the amount of emissions produced in aggregate by setting the overall cap for the scheme but gives companies the flexibility of determining how and where the emissions reductions will be achieved. By allowing participants the flexibility to trade allowances the overall emissions reductions are achieved in the most cost-effective way possible.^[4] Additionally, by putting a price on each tonne of carbon emitted, the EU ETS is driving investment in low-carbon technologies.

4. The Theoretic Rationale behind ETS

ETS involve complex legal dilemmas such as how and to which actors to allocate regulatory power in regard to common resources. Emissions trading literature is significantly interdisciplinary and discourses on this topic include studies from a wide range of academic disciplines. However, the idea of emissions trading schemes originated in the science of economics. The general principles underlying emissions trading schemes are based on ideas put forward by academics primarily in the USA in the 1960s. Coase developed the view that pollution is simply a factor of production, and that by transforming it into well-defined, transferable legal rights, the market, as opposed to the government, could play a crucial role in the way in which pollution is regulated. ^[5]

The general theories behind ETS are based on the problem of the over-exploitation of commons. However, scholars present different views as to what the underlying principle of emissions trading is. Bogojević argue that three different perspectives of ETS can be distinguished: Economic Efficiency, Private Property Rights and Command-and-Control models.^[6]

Firstly, under the Economic Efficiency Model, ETS are understood to solve the problem of externalities and to have the role of a ‘profit-centre’. Externalities, such as air pollution, are created due to lack of incentives to protect the commons. This represents a risk as certain externalities, such as GHG are allowed to increase to levels that threat to cause climate change. Externalities are defined as the problem that emissions trading as a regulatory framework should seek to remedy. Externalities are seen as costs which are not reflected in free market prices, but they result in over-exploitation of common resources. Emissions trading is recognised as being able to circumvent this over-exploitation of commons by turning externalities into 'transferable rights that are cost-effectively allocated, via the market, to their highest bidder'^[7]. Thus, externalities can be resolved by creating a market in which these are traded. Therefore, ETS is defined as a profit-centre, which does not reduce emissions in itself but which gives incentives to polluters as it makes it profitable to do so.

Secondly, according to the Private Property Rights Model the problem lies in the government control of the commons. State officials are seen to over-exploit the commons for their own benefit in terms of pleasing industries, securing jobs, and ultimately, guaranteeing re-election. This theoretical approach argues that by creating tradable private property rights government control in this regard is abolished, and that property owners are able to manage the commons on their own terms via the free market. The creation of property rights of common resources is seen as a form of 'protection' from government control and bureaucratic management of the commons.

Thirdly, according to the Command-and-Control Model, the problem causing the over-exploitation of the atmosphere is defined to be ineffective regulation. The classical ‘command-and-control’ type of regulation is regarded as ill-suited to tackling emissions stemming from mobile and diffuse sources. The rationale behind emissions trading is to establish a revised regulatory framework, which deals with specific types of air pollution in a more flexible way. In the Command-and-Control Model, traditional regulation is portrayed as ineffective in dealing with air pollution control. The aim of emissions trading is simply to 're-regulate' by making this regulatory approach more flexible in controlling emissions, without substituting traditional performance standards or government control of common resources. Hence, a less imposing regulatory mechanism is created.

In summary, the Economic Efficiency Model the role of the regulator is determined according to its impact on the cost-effectiveness of the emissions market. In the Private Property Rights Model the role of the state is limited to the legislator defining private property rights and the legislator enforcing these. In contrast, in the Command-and-Control Model, the government is continuously present in emissions trading in terms of 'determining the quantity of emissions, the form of allocation, the recognition of entitlements and enforcement'.^[8] In contrast to the Economic Efficiency and Private Property Rights models, the Command-and-Control Model is far more sceptic of the role of the market in emissions trading. In the first two models, the market is depicted as free, meaning that no room is left for governmental intervention. In the Command-and-Control Model, markets are not understood to exist in this kind of legal vacuum, but in the presence of the regulator.

5. The design of EU ETS

5.1. Background of EU ETS

Reducing greenhouse gas emissions from human activities that are threatening to cause dangerous changes in the world’s climate is a cornerstone of the European Union's policy to combat climate change. To meet its obligations to reduce GHG concentrations under the Kyoto Protocol, the EU established the first cap-and-trade system for carbon dioxide emissions in the world. Under the provisions of Directive 2003/87/EC (the ‘Emissions Trading Directive’), the EU has developed the EU Emission Trading Scheme as a key tool for reducing industrial greenhouse gas emissions cost-effectively. Launched at the beginning of 2005, the EU ETS is the world’s first international company-level ‘cap-and-trade’ system of allowances for emitting CO2 and other greenhouse gases. Around 5,000 operators with approximately 12,000 installations participate in this multijurisdictional attempt to reduce CO2 emissions from four broad sectors: energy (electric power, oil refineries, etc.), the production and processing of ferrous metals (iron and steel), minerals (cement, glass, ceramics), pulp and paper.^[9] From 2012 it will be expanded to include emissions from air flights to and from European airports. These energy and industrial sectors are collectively responsible for half of the EU’s CO2 emissions and 40 per cent of its total greenhouse gas emissions.^[10] As of 1 January 2008, EU ETS applies not only to the EU 27 Member States, but also to the other three members of the European Economic Area- Norway, Iceland and Lichtenstein.^[11]

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^[1] S. Bell and D. McGillivray, Environmental Law (OUP 7th Edition, 2008) 512.

^[2] Judson Jaffe, Matthew Ranson and Robert N. Stavins, Linking Tradable Permit Systems: A Key Element of Emerging International Climate Policy Architecture (Ecology Law Quarterly, 36, 2009) 789.

^[3] E. West, Draft Implementing Regulation of the European Union Emission Trading Scheme (Journal of Planning and Environmental Law, 161, 2004)3.

^[4] Ibid.

^[5] RH Coase, The Problem of Social Cost (3 JL Econ 1, 1960)

^[6] Sanja Bogojevic, Ending the Honeymoon: Deconstructing emissions trading discourses (Journal of Environmental Law, 2009) 4.

^[7] Ibid.

^[8] Ibid p.7

^[9] C. Hepburn, Regulating by prices, quantities or both: an update and an overview (Oxford Review of Economic Policy 22 (2): 226–247, 2006)232.

^[10] Peter Davies, Trading in greenhouse gas emissions: the European Community's Endorsement of emissions trading (International Energy Law & Taxation Review, 2006)

^[11] http://ec.europa.eu/clima/faq/ets/index_en.htm