Fifteen years ago, the Kyoto Protocol presented a blueprint for preventing the increase of carbon dioxide in the atmosphere. A key measure, put forward by the administration of US President Bill Clinton at the time, was a tempting extension of the free-market argument: establishing emissions quotas to limit pollution, and trading them internationally. Let the market find the lowest cost path to accomplish the goal.
One of the two ways of putting a price on pollution is cap and trade – taxation is the other. And emissions trading was successfully implemented through the US Clean Air Act of 1990 to limit sulfur dioxide caused by acid rain.
The United States incorporated a global cap-and-trade model into the Kyoto Protocol, allowing industrialized countries to meet their commitments with maximum flexibility, such as by purchasing emissions credits from projects in developing countries. The model was instrumental in agreeing a national emissions limit for Kyoto’s first ‘commitment period’ from 2008-12.
That time has proved long enough to uncover the grand scheme of a globally negotiated, integrated cap-and-trade system. The United States never ratified the protocol. Europe’s flagship Emissions Trading Scheme (ETS) is in trouble. Nevertheless, something unexpected is happening. Smaller carbon-pricing schemes are emerging around the world (see ‘Carbon merchants’). This renewed momentum can still give an effective response.
Rocky road
Even though the idea of cap-and-trade originated in the United States, it fell to the European Union (EU), when US President George W. Bush rejected the Kyoto Protocol in 2001, then it was applied to CO2. The European Union swiftly instituted a carbon cap. And covering CO2 emissions from electricity generation and industry in 27 countries (as well as some neighbours) was an astonishing achievement.
The EU ETS evolved in phases. Its first three years (2005–07) ended with the carbon price crashing to zero as the industry – fearing a lack of emissions allowances – instead gained a surplus by being more compliant with emissions cuts.
The second phase coincided with the first commitment period of Kyoto. The European Commission won a historic legal and political battle to force EU member states to set emissions limits in line with their national Kyoto commitments. To avoid another pricing roller coaster, surpluses were allowed to be ‘banked’ for later use. In its first four years, ETS estimates that it has cut CO2 emissions by an average of 40 million to 80 million tonnes per year, or 2–4% of the total capped1.
Flush with apparent success, the European Union advocated a global carbon market of similar schemes operating in Organization for Economic Co-operation and Development (OECD) member states by 2015 and expanding to include all major emitters by 2020. With the US presidency of Barack Obama, who advocated for cap-and-trade in his 2008 campaign, such a vision seemed to be back on track. The US Congress begins work on the Waxman-Markey energy bill, with emissions trading at its center.
But events intervened and the appetite for carbon trading waned. The credit crunch discredited complex trading instruments. EU ETS has seen scams such as theft of allowances from registries and fraud involving complex tax treatment across borders.
In July 2010, the Waxman-Markey bill crashed in the Senate. Consensus became that the United States would not stomach carbon pricing—the public would never accept taxation, and the Senate rejected the only option. Meanwhile, it became clear that the slowdown and progress on energy efficiency and renewable energy would lead the EU to achieve its second phase of the Kyoto goals.
To give industry more time to plan, the third phase of the EU ETS was extended to 2020. It turned out to be a poisonous cup. The surplus of emissions permits from phase two is now so large that it covers all the cutbacks agreed to by 2020 – making the phase-three cap almost irrelevant. The price of ETS carbon has fallen to around €7 (US$9) a tonne, less than a third of what was estimated before Europe’s recession.
This low price may not encourage investment in low-carbon technology, and it devastated revenues that were expected to fund innovations such as carbon capture and storage. Instead, old plans for new and upgraded coal-fired power plants have been dusted off, based on the belief that ETS surpluses will sustain low carbon prices through 2020. Without changes, the future of EU ETS – and its role in driving emissions. Cut – looks bleak.
Many pundits rushed to declare emissions trading dead. Academics break down goals and boundaries as a ‘top-down’ political process in sync with the real world. Intellectuals offered an alternative ‘bottom-up’ approach to localized mitigation efforts that would not rely on emissions caps, pricing or international negotiations.
