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The Thin End of the Wedge?

Alice Kenny

The one-year old European Emissions Trading Scheme received its first annual report card on May 15, 2006. The Ecosystem Marketplace asks the experts to weigh in on the market's successes and failures in the wake of the report.

The one-year old European Emissions Trading Scheme received its first annual report card on May 15, 2006. The Ecosystem Marketplace asks the experts to weigh in on the market's successes and failures in the wake of the report. Scientists, economists, presidents and parliamentarians from 21 Western European nations launched the European Union Emissions Trading Scheme (EU ETS) in February 2005 as an ambitious free-market attack on global climate change. The market has been hailed as a financially lucrative and environmentally effective mechanism to spur polluters to cut carbon monoxide emissions, but the Scheme's first annual results released on May 15 unleashed aftershocks that are still shaking exchanges around the world. Crafted in response to the Kyoto protocol, the ETS allocated carbon-emission credits (intended to be 1 percent below baseline emissions) to each participating nation. The nations then divvied up these belt-tightening credits between 12,000 major polluters, including power, iron, steel, cement and paper plants. The plants could offset excess emissions by purchasing credits from more efficient plants or by building carbon-absorbing projects in less expensive developing countries. The market was to be the world's most ambitious environmental market yet and a harbinger of things to come. The first annual report on the market's progress, however, reveals that only Britain and a handful of other countries set their credit allocations low enough to require polluters to cut emissions. The remaining nations have leftover credits, indicating that their credit levels were set too high, enriching power plant owners by allowing them to sell their excess credits, but doing little to stem the carbon dioxide emitted into the atmosphere. Credits that had been trading at 31 euros per metric ton before the report data was leaked suddenly plunged to less than one-third that price. The market tumble set off a band of critics who say they are frustrated by the Scheme's design and uncertain of its ability to drive real environmental gain. Defenders, meanwhile, emphasize that this first year was intended only as a trial run to work out the kinks of a carbon-trading program slated to go into effect in 2008. Many also point to the innovative and effective projects built in third-world countries as a result of the trading scheme. Still, with $10 billion in carbon credits traded during the past year according to World Bank figures, it seems reasonable to ask what benefit the environment reaped from this massive effort. Has the Herculean effort behind the EU ETS been worth it?

Training Wheels

Speaking from his London office as rain pounded the windowpanes, physicist Alex Rau, co-founder of Climate Wedge, a firm focused on expanding the voluntary market for carbon offsets, pointed out, "no one thought this first year would make a meaningful dent in the climate problem. This is training wheels for all of us. You run into things and fall over once or twice on training wheels. This is just a road test." Failures, others add, can offer valuable lessons in finding the right balance for using market forces to fight global warming. Economist John Reilly, associate director and author of "An Analysis of the European Emission Trading Scheme" for MIT's Joint Program on the Science and Policy of Global Change, said he was relieved when the cost of carbon credits collapsed. Carbon credits, he observed, would be expected to trade for a high price if there was a high demand for them, but since carbon-emissions reduction had been slated to be only one percent this first year, the credits' earlier price tag seemed to indicate that either "the market was screwed up or that it was incredibly costly to reduce carbon emissions." The broadest lesson learned during the Scheme's inaugural run, most economists and environmentalists agree, is that emissions targets must be accurately set at a level that drives investment. The Scheme could learn from the California model; instead of allowing polluters to fiddle with emissions data, California requires companies to submit current emission numbers so that the market has a solid baseline. The market must also be transparent, releasing emissions figures quarterly instead of annually. And instead of leaking results to stakeholders erratically (as happened this month), results should be released in a systematic, professional manner. Ironically, the price drop could be considered a victory for the environment, Reilly said. It provides reassurance to Scheme members as well as other large carbon-emission producers such as the United States that emissions can be cut at a reasonable cost.

Knocking at the Door

Paging through data documenting the rapid accumulation of greenhouse gases in the atmosphere, Steve Pacala of Princeton University's Carbon Mitigation Initiative says that the world has little time to waste when it comes to combating climate change. A glimpse at the data reveals that even if the ETS realizes its promise to cut emissions from Western European nations by 8 percent below 1990 levels, it would not significantly dent the greenhouse gases causing climate change. Instead, a massive effort involving most countries and fossil-fuel emitters is urgently required. As is, the amount of CO2 trapped in the atmosphere will double within the next 50 years and quadruple by the turn of the century. That, Pacala said during a break between proctoring final exams, would "bring out the monsters behind the door"—melting the Greenland ice cap, washing away coastal cities, spreading famine, and intermixing hurricanes with prolonged droughts. Scientific ability to predict climate change, Pacala says, is not yet sophisticated enough to say how many gigatons of CO2 emitted into the atmosphere will produce how many degrees of warming. It can, however, extrapolate that seven billion tons—seven gigatons—of carbon emissions must be prevented from entering the atmosphere during the next 50 years if we are to level off at 500 parts per million (ppm)—a point less than double the current atmospheric concentration of 380 ppm, but roughly double where the carbon level stood at 280 parts per million for thousands of pre-industrial years. Pacala uses the simple example of bakery-pie slices to explain how to achieve this seven-gigaton cut. He slices the pie into seven wedges that are 1 gigaton high and 50 years long. Western Europe's emissions comprise about 1 wedge of the pie. If the ETS successfully cuts emissions by 8 % by 2012—a serious challenge considering its limited success this past year—and continues with similar emission cuts for the next 40 years, it would be on track towards cutting out one wedge of the emissions pie. Still, six of the seven wedges remain—1 ½ representing United States emissions, another 1 ½ slices from Eastern Europe and three wedges from China, India and other developing nations. Had the Scheme's first trial year succeeded in cutting emissions by 1 percent, its portion of the 7-gigaton emissions pie would have been approximately one-fiftieth of a single slice in Pacala's seven-slice pie. Even a completely successful ETS carried out for nearly five decades, would not circumvent the cataclysmic events associated with increased global warming. That is, of course, unless the ETS were part of a larger worldwide effort to cut emissions. The European Trading Scheme's trial year, then, should also be evaluated for its ability to inspire copycats. And here, at last, we stumble upon some awe-inspiring success.

The Ripple Effect

Within the United States, California and at least eight northeastern states are developing cap and trade schemes. Venture capitalists are pouring money into green technology. General Electric just announced better-than-expected revenues thanks to its investments in renewable technologies. And a slew of funds have been set up to look at the carbon market, such as Rau's Climate Wedge, the world's first voluntary carbon-offset fund for large-scale institutional buyers. European energy plants, meanwhile, have been taking advantage of the Scheme's link to the Clean Development Mechanism (CDM) of the Kyoto Protocol, which allows industrialized countries to fund emissions reductions projects in the developing world in exchange for emissions reduction credits. European utilities with excess emissions have built innovative zero-emissions-energy projects such as wind farms, landfill-gas-recovery projects and high-efficiency boilers. Karan Capoor, a senior financial specialist at the World Bank, says this demonstrates that the market has been effective at going wherever it can to find low-cost-compliance solutions. Meanwhile, a surprising offshoot of the program is that it turns what had been an aid-model for third-world countries into a trade model. "When companies found it too costly to reduce their own emissions, they came up with a flood of projects in developing countries," Capoor said. "That's a clear success story."

Hunting for Lemons

All this talk of market lessons and new investments still does not address the original question; how will the world measure the environmental impact of the EU ETS to determine if it is an efficient approach to combating climate change? Most environmentalists, cognizant of the up-hill-battle they are fighting just to convince governments protective of their industries' bottom line that global warming is a scientific reality, have joined their economist colleagues in acknowledging that a market approach holds the most promise for reducing greenhouse gas emissions. "I'm a big believer of trading systems as a way to deal with large-scale-energy-intensive installations," says Eileen Claussen, president of the Pew Center on Global Climate Change. Annie Petsonk, international counsel for Environmental Defense's Global and Regional Air Program adds that she is particularly pleased with some of the innovations triggered by the CDM. "You can't predict whose lemons will make lemonade because people only thought of them as lemons before," she explains. "The Scheme triggered a big hunt for these lemons." One of her favorite "lemons" is a new technology that turns manure into methane that can be purified and used as natural gas. Inspired by the active market in Europe, people continue jumping on the bandwagon in the hopes of capitalizing on a perceived first-mover advantage in new emission-free, energy-producing industries. Since the Scheme and similar markets add a cost to emitting carbon, they will make zero-emission-emitting facilities financially viable. If these innovations become widely used, there could be a true global effort to address climate change, allowing Pacala's pie to be sliced by industries instead of geography. Of the seven wedges or gigatons of carbon emissions that must be prevented from entering the atmosphere, two could be saved by inducing industries to build better cars and other small but popular emitters. Increasing the size of carbon sinks such as forests, which naturally absorb carbon, and switching to conservation tillage on agricultural land, which keeps carbon locked up in the soil, could save another wedge. And four could come from transferring large-scale power plants into zero-emissions emitters. According to Pacala, the technology is already available. He is working with BP to build zero-emission power plants that capture CO2 before it is emitted, converting it into a solvent that can then be injected into the ground to allow oil pumps to extract more oil from already active drilling fields. Only a global attack on fossil fuel emissions, Pacala concludes, can sidestep otherwise imminent but nightmarish scenarios of populated cities washing away, towns swallowed into the Earth's faults and nations suffering through droughts and famine. "The market could be the most efficient way of solving global warming," Pacala reasons, before adding: "One way or another, we have to solve this." Alice Kenny is a prize-winning science writer and a regular contributor to the Ecosystem Marketplace. She may be reached at alkenny@aim.com. First published: May 31, 2006 Please see our Reprint Guidelines for details on republishing our articles.

Please see our Reprint Guidelines for details on republishing our articles.