Carbon trading schemes have their fair share of detractors, and certainly they are no silver bullet for global warming, but they are being adopted by a growing collection of countries

Climate change policies are always divisive, and emissions trading is no exception. They are attacked by large corporations for imposing costs, consumer groups for increasing electricity prices and charities for legitimising pollution.

The EU ETS is the largest of its kind, covering more than 12,000 individual installations across 30 countries (the 27 EU member states plus Norway, Iceland and Liechtenstein).

It works by imposing a collective limit, or cap, on emissions from a defined group of participants, allocating allowances, and then letting participants trade allowances between themselves.

The scheme is dominated by heavy industry. Facilities covered by the EU ETS include power stations, combustion plants, iron and steel works, oil refineries and factories making cement, pulp and paper, glass, lime, bricks and ceramics. Together these account for more than half of Europe’s emissions.

From 2012, aviation is also included. There are plans to extend the scheme to petrochemicals, ammonia and aluminium from 2013, which marks the start of the third trading period of the EU ETS.

So, why the big push for emissions trading? The theory is that emissions trading delivers a known level of emission reductions for the cheapest possible cost. In an emissions trading scheme, organisations that can reduce their emissions cheaply will reduce as far as possible, in order to sell their excess carbon allowances to organisations that would find it more expensive to make reductions.

Compare this with the two main alternatives, “command and control” and carbon taxes, and you can see why both sides prefer emissions trading.

With command and control, the desired emissions reductions are fixed on a per-industry or per-installation level. Each organisation has to make reductions, even if it is very difficult or expensive. Under this approach the government can be sure of meeting its emissions reduction targets, although the cost will be higher.

Carbon taxes are very effective if set at the right level. But the difficulty for the government is determining that level. It is hard to predict how a tax will affect carbon emissions, because it depends on how much organisations value the ability to pollute – they might just pay the tax and carry on polluting.

Reduction certainty

So emissions trading is comparatively efficient, while allowing government to be certain of meeting its reduction target.

Dr Matthew Brown, head of energy and climate change at the UK business group CBI, points out other ways in which industry can benefit. “To grab the jobs, investment and growth opportunities of going low-carbon we need economy-wide carbon pricing, and we need to give the private sector freedom to innovate and create solutions. Emissions trading provides both of these ingredients.”

Based on these benefits, there is growing support for emissions trading worldwide. This is reflected in the increasing prevalence of emissions trading schemes, with more than a dozen active or planned schemes globally.

New Zealand kicked off its national ETS in 2008. Due to the make-up of New Zealand’s economy, the scheme covers different sectors to the EU ETS, with forestry and landfill included, and agriculture due to enter in 2015.

Politicians in neighbouring Australia had more of a struggle getting the legislation through parliament, with Kevin Rudd losing his premiership on the back of anti-emissions-trading sentiment from industry and the public.

Rudd’s successor, Julia Gillard, had an equally tough time drumming up support for the policy, which was demanded by her coalition partners the Greens. She finally achieved success late in 2011, with the Australian house of representatives narrowly passing a carbon tax that will turn into an ETS after three years.

Despite Australian businesses now calling for certainty over the legislation, it is unlikely they will get it. Opposition leader Tony Abbott claims that the scheme will be disastrous for Australia’s economy, which is heavily reliant on resource extraction and has made a “pledge in blood” that if his Liberal Party wins the next election, it will repeal the ruling.

US president Barack Obama has not had it easy either. All looked promising for America to launch an ETS of its own – since 2008, regional schemes covering 27 US states (and four Canadian provinces) have been launched.

The American Clean Energy and Security Act, otherwise known as the Waxman-Markey bill (after its authors), set out a plan for a national ETS that was to cover 85% of US emissions by 2016. The bill was narrowly approved by the House of Representatives in 2009, but failed to pass through the Senate.

Since then, emissions trading (like most other US environmental policies) has barely moved an inch at the federal level. Derik Broekhoff is vice-president of policy at Climate Action Reserve, an organisation set up to promote market-based climate change policies such as emissions trading in the US. He says: “It’s not likely we’ll see a federal ETS in the US in the near future.”

California’s not dreaming

US states are continuing to make progress, however, and in December 2010 the state administration in California approved an ETS that will reduce emissions to 1990 levels by 2020. Broekhoff thinks that may make the US more open to implementing a federal ETS further down the line. “California’s cap-and-trade programme will be the first economy-wide programme in the US and the second largest market in the world. Its success will demonstrate the environmental and economic importance, as well as viability, of cap-and-trade as a policy tool to address climate change.”

After countless legal battles, the Californian ETS is now due to launch in 2013 for the power sector and large industrials, and will extend to include transportation fuels and gas in 2015. Like the aborted US federal scheme, it is ultimately due to include 85% of emissions within the territory.

Political challenges abound elsewhere. Japan announced the future launch of an ETS in 2010, but despite the fact that a couple of regional schemes are up and running, the introduction of a national scheme has now been deferred indefinitely.

In South Korea, a report stating that the cost to the economy of a planned ETS would average 1.5% of GDP annually until 2020, combined with negative press coverage and low public support, led lawmakers to postpone their scheme for two years until 2015.

While delays hit schemes in developed countries, a new World Bank initiative, Partnership for Market Readiness (PMR), could see some less economically developed countries launch market-based controls for greenhouse gas emissions sooner than expected.

Last year, the World Bank awarded eight countries PMR grants of $350,000 to help them to develop emissions trading schemes. Support focuses on capacity building to enable countries to establish baselines, targets and allocations, and to prepare legal frameworks and pilot schemes. This initial tranche of funding has gone to China, Chile, Colombia, Costa Rica, Indonesia, Mexico, Thailand and Turkey, and more is to follow.

Currently countries’ plans are at different stages of development, with China the most advanced. Six pilots are in place in the cities of Beijing, Chongqing, Shanghai and Tianjin and the provinces of Hubei and Guangdong, with plans to expand these into a national scheme by 2015.

Hotspots of dissent

Not everyone is happy that emissions trading is being entertained as a key policy by so many countries.

Mike Childs, head of policy, research and science at Friends of the Earth, brands the World Bank grants “a waste of money”. He says: “The biggest significant challenge to emissions trading is that it sets a single price of carbon when in reality different sectors and industries need different price signals … The money would be much better spent on helping these countries develop a portfolio of economic and regulatory policies tailored to their specific needs.”

Friends of the Earth’s main objection to emissions trading is that the mechanism delays structural change: a focus on cost-effective mitigation postpones the costly and dramatic structural changes economies require to decarbonise.

Critics also cite the potential for emissions trading schemes to “leak” emissions overseas, saying the impact of the policy is to drive business, and therefore emissions, abroad rather than reduce emissions outright.

In a report on the potential for carbon leakage caused by the EU ETS, the European Commission noted that 164 of the 258 manufacturing sectors in the EU are at risk.

The Greens-European Free Alliance parliamentary group disagrees, believing that the potential for leakage has been vastly overstated by industries keen to get their hands on more freely allocated (“grandfathered”) allowances. According to the Greens, as few as 13 of the 258 sectors are really at risk.

Competitive issues

Sandbag, an NGO that works to improve emissions trading schemes, highlighted in its Carbon Fat Cats 2011 report that some of the business voices most vocal about their potential loss of competitiveness are in fact funding competitors’ carbon abatement activity, something that would be unlikely to happen if international competitiveness were really an issue.

Bryony Worthington, founding director of Sandbag, says: “Current fears about carbon leakage in the EU ETS are overblown. In fact, some companies are finding themselves sending money to their international competitors via offsetting projects.”

Worthington says EU steel plants have bought carbon offset credits originating from steel plants in developing countries, a revelation that she says has undermined their lobbying position.

Any significant policy intervention, environmental or otherwise, will create divisions. But emissions trading appears to be here to stay. If developing countries decide to opt for emissions trading over other policies, schemes may start to link together, moving us closer to a global carbon price.

Analysts have reservations about the speed at which this might happen. “While the linking of carbon markets is seen as desirable by many policymakers, there are complications that will make the process of linking longer and slower than people might initially imagine,” says Matthew Cowie, carbon market research manager at Bloomberg New Energy Finance. He adds: “The most significant impediment to linkage is the differing levels of ambition of different schemes and their focus.”

The path to a global carbon market will no doubt be a difficult one. But it seems to be one which policymakers across the globe have chosen to walk. Ten years ago the UK’s fledging ETS had just begun. In five years’ time, emissions trading schemes will be up and running in many of the world’s major economies. By 2020, a global carbon market could be a very real prospect.

Jane Burston leads the UK National Physical Laboratory’s work in climate science and low carbon technology.

Carbon trading timeline

• 2002    UK ETS launches.
• 2005    EU ETS launches (Phase 1).
• 2008    EU ETS Phase 2 starts. Cap starts to bite.
  NZ ETS launched.
  Regional Greenhouse Gas Initiative starts in the north-western US.
• 2009    Waxman-Markey bill fails to pass through US Senate.
• 2010    Japan announces, then postpones, ETS plans.
• 2011    World Bank allocates eight grants for the ETS pilots in developing countries.
  Australian parliament narrowly approves ETS for 2015.
• 2012    Aviation to enter the EU ETS.
• 2013    Californian ETS to launch. 
  EU ETS Phase 3 to start. Scheme to be extended to additional industries and gases.
• 2015    ETSs to begin in Australia, China and South Korea.