Emissions Trading in the European Union

Table of Contents

1 Introduction
1.1 Emissions Trading
1.2 Emissions Trading in the European Union

2 State of Research

3 Opportunities and Risks of EU Emissions Trading

4 Criticism of Emissions Trading
4.1 Climate Becomes a Commodity
4.2 Overallocation of Certificates
4.3 Market Stability Reserve
4.4 Criticism of Ineffective Target-Setting
4.5 Windfall Profits
4.6 CO2 Tax - A Reasonable Measure?

5 Reform of EU Emissions Trading for the 4th Trading Period
5.1 The Strengthening of the EU ETS
5.2 Maintaining the Competitiveness of Industry
5.3 Promotion of Innovation and Solidarity Measures

6 CO2 Tax as an alternative Climate Protection Mechanism

7 Conclusion: What Opportunities and Risks arise for Germany as a Result of EU Emissions Trading?

8 Bibliography

1 Introduction

Climate change is a global problem. According to the majority opinion of renowned experts, humans are to blame for this development (Doran & Zimmermann, 2011). In recent years, industrialization has caused the levels of greenhouse gases in the earth's atmosphere to rise rapidly. The consequences are clearly noticeable in our daily lives, such as rising average temperatures or more frequent extreme weather events.

Recent events, such as the diesel scandal, have fueled discussions about the CO2 tax as a more effective measure to deal with climate change. In addition, the diesel scandal showed how the environment is being negligently treated in favor of profit. This has led me to critically analyze emissions trading as one of the current environmental policy measures to reduce greenhouse gases. This is because it is seen in the EU as a particularly powerful tool for achieving climate targets. However, it often also serves as a basis for argumentation against further measures for the environment by companies. The question that occurs to me is what opportunities and risks could arise for Germany from emissions trading.

In order to be able to answer this question, it is first necessary to give an initial overview of the topic. It will be explained which functions emissions trading should fulfil and what differences there are between global emissions trading and that in the EU. I then present the scientific findings on emissions and emissions trading to date. Based on the research and the knowledge gained from it, I am able to answer the key question.

Finally, my conclusion follows.

1.1 Emissions Trading

The United Nations set the starting point for international climate protection in Rio de Janeiro in 1992 with the “Framework Convention on Climate Change”. Its aim was to mitigate climate change and achieve an acceptable level of greenhouse gases in the air (Coenen, 1997). It quickly became clear, however, that the decisions of this agreement were too much based on voluntariness. Thus, countries from all over the world came together at several climate conferences to work together on a binding protocol that would guarantee global climate protection.

The Climate Conferences in Berlin in 1995 and Geneva in 1996 were the first to draw up plans for the implementation of such a protocol, which were finally adopted in December 1997 at the third UN climate conference in Kyoto, Japan, with the so-called “Kyoto Protocol” (Barrett, 1998). By ratifying the protocol, the negotiating states committed themselves to global climate protection and for the first time international, binding targets for the reduction of greenhouse gases were set. The precondition for the Protocol to enter into force was that at least 55 states, which together account for at least 55% of all emissions, would sign the protocol. This was only achieved in 2005 with the signature of Russia (Neuhoff, et al., 2017). The Kyoto Protocol laid down important basic building blocks for the further development of climate change mitigation. For the first time, industrial nations were given a defined target: by 2012 they had to reduce their 1990 greenhouse gas levels by 5% (Neuhoff, et al., 2017).

To realize this, the so-called “Kyoto mechanisms” were developed in the Kyoto Protocol (Neuhoff, et al., 2017). The best-known mechanism is emissions trading. Additionally, there are two more, which focus on intergovernmental climate protection projects.

For example, Joint Implementation (JI) stimulates cooperation between two industrialized countries. In this cooperation, the "investor country" that implements or promotes climate protection projects in another industrialized country is rewarded with emission certificates. This means that these greenhouse gas savings are credited to the country's own greenhouse gas targets in the form of emission rights. The "host country" in turn commits itself to providing the same amount of emission reductions (Lucht & Spangardt, 2005).

The other environmental policy instrument is the comparable Clean Development Mechanism (CDM). This differs from "Joint Implementation" in that the participating countries can promote and finance climate protection projects in developing countries. As a result, developing countries are also involved in climate protection (Lucht & Spangardt, 2005).

In 2007, the project-based Kyoto mechanisms (JI & CDM) were expanded and measures such as “Programmes of Activities” were included in the Kyoto Protocol. They enable the implementation of smaller environmental projects that are subordinated to a larger project because they would not be economically viable individually as CDM projects. In this way, the emission-reducing potential of smaller measures can be additionally exploited (Lucht & Spangardt, 2005).

Emissions trading is an economic instrument that entitles all industrialized countries that have signed the Kyoto Protocol to trade in emissions certificates. In accordance with the cap & trade principle, an emissions cap is first set, which indicates how many emissions may be emitted in one trading period. This emission cap is distributed among the industrialized countries in the form of emission certificates. Depending on which emission target the respective country is to achieve in the Kyoto Protocol, the allocated quantity of emission rights is adjusted (Deutsche Emissionshandelsstelle im Umweltbundesamt, 2020). In order to ensure that the reduction in emissions is steadily progressing, the upper limit is periodically lowered. If an industrialized country reduces its greenhouse gas emissions more than specified in the Kyoto Protocol, it can sell the surplus emission certificates to other countries. These certificates can then be purchased by those industrialized countries that do not achieve their prescribed greenhouse gas reductions. In addition, penalties are imposed on those industrialized countries that emit greenhouse gases without emission rights. Based on supply and demand for emission certificates, a market is created that forms a self-regulating price for CO2 (Brill, 2015).

1.2 Emissions Trading in the European Union

In the Kyoto Protocol, the EU committed itself to an 8% reduction in emissions. In order to be able to implement this goal, emissions trading was introduced in the European Union in 2005 (Lucht & Spangardt, 2005). The Emissions Trading Directives of the European Parliament and the Council of the EU set the legal basis for emissions trading in the EU (Neuhoff, et al., 2017). They determine which emission-intensive industries or companies are subject to emissions trading. As with international emissions trading, a cap is set, which does not affect countries but individual companies. Companies that have not been assigned emission rights must purchase them on the market. The most energy-intensive industries such as incinerators, oil refineries, iron, steel, glass, cement, lime, brick, ceramics and paper are covered by the EU emissions trading directives (Amt für Veröffentlichungen, 2018). Other sectors are not covered by the European emissions trading system and are to be regulated independently by the respective member states. Although all countries that are parties to the EU emissions trading scheme are still allowed to use the Kyoto mechanisms, this has been limited since 2013. Some climate protection projects are no longer permitted in the EU and emission certificates may for the most part only be permitted from low developed countries (Lucht & Spangardt, 2005).

2 State of Research

The state of research, including current facts and results of past years, is a decisive factor in creating an up-to-date picture of the situation. For example, the achievement of a set goal can be tracked and checked step by step. In addition, the current situation forms the basis for future prognoses, which are important for future adjustments, especially in the field of emissions trading. Thus, the primary elaboration of the information provided by the German Federal Environment Agency serves primarily as a basis for the following analysis, interpretation and conclusion of the scientific work.

According to the German Federal Environment Agency, the total greenhouse gas emissions of the European Union in 2017 amounted to 4,325 million tons of CO2 equivalents, an increase of almost 0.5% compared to the previous year. In 2017, the top emitters were the two most populous countries in Europe: Germany with 906.6 million tons and Great Britain well behind with 470.5 million tons of CO2. Compared to the previous year, Great Britain saved 12.8 million tons, which corresponds to a reduction of 2.6%, whereas Germany only saved 0.5%. Finland and Denmark are positively striking with 4.7% saved emissions compared to the previous year and 4.5% respectively (Umweltbundesamt, 2019). These effects could be attributed to the lower population density, and/or to the growing environmental awareness and investments in more environmentally friendly technologies. If one also looks at the period before the turn of the millennium and compares current measured values with those from 1990, it becomes clear that emissions have fallen sharply in percentage terms. Europeans are emitting 23.5% fewer emissions than 27 years earlier, in 1990 EU emissions amounted to 5,653 million tons. This achievement could be due to modernization in the field of technologies such as the emergence of electromobility or the application and expansion of renewable energy sources (Umweltbundesamt, 2019).

Furthermore, many Europeans are becoming increasingly aware of environmental issues, which is reflected in the change of lifestyle of many people and in modern trends, for example in the area of nutrition (veganism, vegetarianism), waste separation, or even the increasing appreciation of "Ecolabels".

The resulting emissions can be divided fundamentally into four broad segments. Industry, agriculture, waste management and the energy sector, which together are responsible for over 94% of total emissions (4,067 million tons) in Europe in 2017 (Umweltbundesamt, 2019). The share of the various air-polluting gases was also measured, with carbon dioxide (CO2) accounting for the largest share at 81.3% (Umweltbundesamt, 2019). It is mainly emitted by high mobility and the combustion of fossil fuels. Almost every vehicle, whether on the road, on the water or in the air, contributes to this. Further annual fluctuations can be attributed above all to extremely changing weather conditions, such as particularly cold winters, as these led to increased consumption of solid fuels in 1996, 2001, 2010, 2013 and 2018, boosting energy consumption (Ruhnau, 2020). The energy sector, for example, accounts for 3,368 million tons (78%) of total emissions but has recorded savings of 23% since 1990. The agricultural sector, which also includes livestock farming, contributed only 10% of Europe-wide emissions in 2017. It is also important to note the recessionary trend, which has been largely caused by the exponential increase in the vegetarian and vegan lifestyles of many Europeans. Due to the efficient reduction of livestock, emissions attributable to agriculture have declined by 19% since 1990. This means that, in percentage terms, agriculture has realized the smallest savings. Industry has achieved a 27% reduction since 1990, with a share of total emissions of 8.7% in the latest figures. In 2017 waste management contributed just 3.2% to total emissions with 139 million tons of CO2 but has recorded a decline of over 42% since 1990 (Umweltbundesamt, 2019).

The Kyoto Protocol, launched by the European Union in 2002, initially envisaged an 8% reduction in EU greenhouse gases. A measurement from the year 1990 was taken as the base value. Since the original target was met by 2012, this was followed by a 12% increase in the percentage for the second period, as well as enlargement by the so-called climate and energy package. Among other things, this provides for an increase in energy efficiency and the introduction or use of renewable energy sources. The next update took place at the end of 2014, in which the European Council also took part and set an exorbitantly high reduction in EU emissions of 40% by 2030 and up to 95% by 2050. Forecasts by the European Environment Agency show that a significant increase in effort is needed to meet this target by 2050, or even only a 40% reduction by 2030. With the current approach these agreements cannot be achieved (Sniter, et al., 2019).

The German Emissions Trading Authority (DEHSt) is the most important German institution with regard to emissions trading and the implementation of the targets set out in the Kyoto Protocol. The range of tasks of this organization, which operates on a national level, essentially consists of the administration and processing of entities subject to emissions trading. Among the entities are mainly parts of the German energy sector and industry. DEHSt is also responsible for monitoring the achievement of the Kyoto Protocol targets, for providing the EU Commission with forecasts and progressive ideas, and for the distribution and auctioning of emission rights in Germany (Takramah, 2017).

Due to the excessively high caps, i.e. the emission ceilings and the reduction of production, the emission rights, also known as "carbon credits", have been accumulating since 2008. This surplus must in turn stabilize the market, with the market stability reserve (MSR) initially reducing the remaining surplus in the short term. The MSR came into force at the beginning of 2019. In accordance with the MSR mechanism, the total volume to be traded was reduced by 400 million certificates throughout Europe (Deutsche Emissionshandelsstelle im Umweltbundesamt, 2020).

3 Opportunities and Risks of EU Emissions Trading

Through the emissions trading system it is possible to achieve burden-sharing through an adequate distribution of emission rights. EU emissions trading primarily creates an incentive for the expansion of renewable energy, which results in changes in production methods. In this context, the introduction of innovative technologies plays an important role. The most efficient measures that industry can use to achieve the emission targets are non-fossil energy sources. This involves replacing harmful processes, such as burning fossil fuels, with the use of renewable energies such as biomass or wind and solar energy.

The reduction in the greenhouse effect caused by CO2 is just one example of the positive effect on the environment. The greenhouse effect is a consequence of the combustion of fossil fuels (Europäische Kommission, n.d.). Human activity accelerates the greenhouse effect and causes extreme changes in the climate. One example of this is the increasing number of natural catastrophes in Germany, such as the extreme weather in summers of recent years, which will probably not be the last of this magnitude (Ruhnau, 2020).

The most important measure to decelerate the greenhouse effect is therefore the massive reduction of CO2 emissions, the approach to this is the EU emissions trading. Since some industries are already actively participating in EU emissions trading, an expansion into other industries or sectors such as transport could take place. In this case the expansion would enhance climate protection and reduce the burden on industry. It is therefore important to extend emissions trading to different levels and through this involve several actors, since in the opposite case greenhouse gases cannot be reduced efficiently.

From an economic point of view, too, EU emissions trading is associated with a number of opportunities and risks. On the one hand, EU emissions trading offers market- and incentive-based approaches. For example, the reduction or avoidance of emissions is associated with subsidies or tax concessions. In addition, companies can flexibly decide for themselves whether and to what extent they invest in reduction measures or purchase certificates for them.

On the other hand, EU emissions trading is an opportunity for companies to improve their standing in society by introducing environmentally friendly production methods. Both society and companies are increasingly addressing the issue of sustainability, also known as corporate social responsibility. CSR deals with the responsibility of companies towards the environment and society. All three parties benefit from this: Society benefits from the protection of the environment, the company increases its social acceptance, as more and more consumers pay attention to sustainability, and the environment can only benefit (Boote & Hartmann, 2019).

Another point is that sustainably produced products lead to higher prices, which in turn environmentally conscious customers are increasingly willing to pay. Emissions trading is classified as an economically efficient and also ecologically effective instrument for achieving climate protection goals. However, it is only an effective instrument if the cap, i.e. the upper limit on emissions, is reduced sequentially and the number of certificates issued is continuously reduced accordingly.

Turning now to the negative aspect of emissions trading. A major problem in the trading system is the oversupply of certificates. As a result of the global financial and economic crisis, demand has fallen, resulting in less production and fewer emissions, with the result that more certificates than needed were in circulation. These lost values accordingly (Donner & Stratmann, 2006). The problem that arises here is that the companies are tempted to buy certificates at low prices instead of investing in sustainable technologies. This problem of the EU emissions trading system is a risk factor from both an economic and an ecological point of view.

4 Criticism of Emissions Trading

4.1 Climate Becomes a Commodity

The EU Emissions Trading Scheme (EU ETS) is regarded as the EU's key policy instrument for achieving the climate goals of its members. However, this policy instrument is often criticized. Trading in greenhouse gases means that environmental issues are to be solved by the market and that the economy therefore determines what is done for the environment. The question is therefore rightly raised as to whether politicians are trying to abdicate responsibility here. After all, taxpayers' money should be used for a sensible environmental policy; instead, set targets and expectations repeatedly remain unfulfilled.

The market-based approach turns the climate into a "commodity" or a private good, which, like other goods, is distributed and used unevenly. Financially strong companies can pollute the environment more, although they, like everyone else, would have to protect the environment in the same way (Lucht & Spangardt, 2005).

Another aspect is the criticism of limiting emissions trading to only a few greenhouse gases. Annex 1 of the original version of the Emissions Trading Directive only mentions CO2 emissions, but not the other greenhouse gases listed in the Kyoto Protocol, such as methane, nitrous oxide, hydrofluorocarbons, perchloro carbons and sulphur hexafluorides (Europäisches Parlament, 2003).

Annex 1 of the Emissions Trading Directive only included certain emission sources, such as entities in the energy sector and high-emitting industrial installations (Europäisches Parlament, 2003), since together they are responsible for around 86% of greenhouse gases in Europe (Umweltbundesamt, 2019). Thus, the legislator extended the list to include larger entities for the production of metals, primary aluminum and certain chemical products. Since 2010, aviation has also been monitored and in 2012 it was also included in emissions trading, as it was a strong and noticeably growing source of emissions (Lucht & Spangardt, 2005).

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