Sunday, 1 February 2015

How is the EU going to meet carbon targets?

The EU has set itself an interim target of 40% cut in carbon emissions by 2030 (from a 1990 baseline) [1]. How will this be achieved? By which I mean (a) what technology and lifestyle changes are we going to make and (b) what government policies will prompt us to make these changes? The reason I ask this question is that the EU emissions trading system (ETS) only covers about 45% of carbon emissions - basically power supply and other large industry [2]. If we only cut in these areas, we would need an 80% cut to hit the target. Obviously that isn't going to happen and there are lots of other policies for other areas, like minimum efficiency standards for lighting and other appliances, and new cars. But are these measures enough? As of 2012 we had already achieved an 19% cut which is good news [3]. The next 21% may not be so easy.

This topic really ought to interest everyone because it affects everyone. If you live in Cambridge, come to the Friends Meeting House on 2nd March to hear Prof. Michael Grubb explain some of the issues. Michael Grubb is author of Planetary Economics - I read it last year and have been raving about it to my friends every since. But it is 700 pages so you might find Grubb's talk a gentler introduction to the topic. The rest of this post is a little taster for you, based on my own understanding.

There are two 'orthodox' economic instruments for carbon emissions: cap and trade - like the ETS - and carbon taxes. Taxes are politically unpopular, but potentially very effective. The Citizens Climate Lobby in the US proposes a carbon fee and dividend system which is effectively a tax with a twist: the revenue from the fee is distributed as a dividend to citizens. Cap and trade has variations too. Under the ETS system allowances are auctioned off, so revenue is raised. (Industries which are subject to international competition get some free allowances). However, there is another variant called Tradable Energy Quotas (TEQs) where allowances are initially shared out equally to citizens for free. Any you don't use you can trade into a pool from which businesses and industry have to buy what they need. Then there are non-economic instruments, such as efficiency regulations.

Carbon Fee and Dividend treats everyone equally and directly benefits low emitters.
I think the carbon fee and dividend system has a lot going for it (see Carbon taxes can be good for jobs). It treats everyone equally. It penalises high carbon emitters - who tend to be wealthy - whereas for an average person the losses and gains balance out and low emitters get a boost. Economic models suggest it leads to an increase in jobs and GDP. However, I can't see it being implemented here in the EU. We have the ETS already and it was hard enough to agree that.

Cap and trade limits carbon directly.

Many people think that a trading system like the ETS is better for several reasons. Firstly, it affects carbon emissions directly. If you want to reduce emissions by 50% you set a cap at 50%. In contrast it is hard to know what level of tax or fee to set in a fixed price system to achieve the desired effect. In practice, however, given that we ultimately want to cut our carbon emissions to nothing (see What do IPCC emissions budgets mean), it doesn't really matter what the price is as long as everyone knows it is going to keep going up. Whatever the cost of reducing emissions, an infinite tax will cover it.

Cap and trade is supposed to be efficient but it doesn't really achieve minimum cost.
Secondly, with a trading system the market is supposed to ensure that carbon reductions are achieved at minimum cost. However this is also a fallacy. There are two issues. Firstly it assumes that markets behave rationally, whereas we know perfectly well that they don't. Secondly, the tendency is to take low hanging fruit first but this isn't always the most cost efficient approach in the end. For example, with home heating, after loft and cavity wall insulation the next single most effective measure is usually a new boiler. This could easily save you 20%. However, if you then reduce your heat loss by 20% by adding insulation, your nice new boiler isn't making so much difference. In the extreme case, if you cut your heat loss to nothing the new boiler has nothing to do. You would be better off not having bought it in the first place. Of course, in the real world you will still need a boiler, but probably only half the size of the one you bought.

Under cap and trade, economic cycles bring price uncertainty and discourage investment.

Finally, cap and trade, at least as implemented in the ETS doesn't work well because of economic cycles. During an economic boom, production increases and the cap bites harder. During a recession production decreases and the cap has little effect - which is why the current carbon price under the ETS is currently a joke. Some would argue this is beneficial because the low carbon price in recession reduces barriers to growth. The trouble is, though that the cycles introduce massive uncertainty in future prices and this is a disincentive to long term investment in reducing emissions. This problem can be reduced by mechanisms to control the price such as adjusting the cap. Adding a price floor and a price ceiling reduces uncertainty - arguably evolving the system to be more like a tax.

You need a mechanism for imports and exports.
By the way, I mentioned that under the ETS some industries get free allowances because of international competition. This is a fudge and it probably only works now because the price is low anyway. Whichever way you do it, cap and trade or tax, you need some way to sort out imports and exports. See How we can stop carbon exporting emissions and lead the way to real savings.

Should we treat all sectors the same? Sometimes pricing is neither fair nor effective.
One important feature of the CCL proposal is that it covers all sectors, and the TEQ proposal is similar. In contrast the ETS currently leaves out important sectors including transport and heating. However, economic instruments such as taxes and quotas may not be the best way to promote change in all areas. For example, even with the high gas prices we have seen recently, the payback time on insulation for many homes is more than 15 years [4], and most people don't have that kind of cash available. Putting a price on carbon penalises people who live in hard to heat homes without making it possible to get them fixed. This isn't fair and isn't effective either.

Grants are an alternative, but they need to be fair.
An alternative approach is to give people grants. However, the money for those grants still has to come from somewhere. Currently our main source of grants is still the Energy Companies Obligation (ECO) which is paid for through our electricity bills. This penalises everyone, but only a few people - who get the grants - get the benefit. Unfortunately, the way the ECO works the people who need it most - whose homes are very 'hard to treat' seem to have most trouble getting it. As of Nov. 2014 72,000 people received ECO grants for solid wall insulation - a sixth of the number getting cavity wall insulation [5]. Three quarters of homes with cavity walls are now insulated, but only 5% of homes with solid walls [6].

Grants stimulate the economy offsetting some of their costs.
Arguably, grants should come from central government, from our taxes. Grants 'cost' a lot less than their face value because spending the grants stimulates the economy and raises more revenues (see The cost to the taxpayer of Green Deal subsidies is less than you think).

Efficiency measures are hard to enforce and suffer from the rebound effect.
The EU is keen on efficiency regulation such as the Ecodesign directive that has taken incandescent light bulbs off the market, amongst other things. There are regulations about new cars too. However, regulations can be hard to get right. For example we know that the new car fuel efficiency figures vastly underestimate real fuel use, because the efficiency test doesn't fully reflect real world driving and cars are 'built to the test' (see Why your car does not achieve the fuel efficiency it is supposed to). The other problem is that there is always some level of rebound effect. Do we leave our low energy light bulbs on longer compared to how we used to use incandescents? Having bought a more efficient car do we drive it further or more often? Some of the savings from more efficient things tend to be offset by using them more. There is also an indirect rebound effect which comes from the carbon emissions from things we do with the money we saved from the more efficient things (see Does saving energy reduce our carbon emissions?).

Don't ask how much it costs, what matters is who benefits.
The appeal of CCL's carbon fee and dividend is that everyone pays according to how much carbon they generate but they are all get the same dividend. That means low emitters have a net benefit. This is fair on the face of it, except where people don't have low carbon options to choose. If you live in a leaky old rented house and can't afford anything better you either turn up the heating and pay the fee or freeze. Under the ETS there are revenues from allowances that are auctioned: EU policy is to use at least half the proceeds for 'climate and energy related purposes such as energy efficiency, renewables, research and sustainable transport' [7]. This could work very well but isn't so transparent as the CCL policy.

These policies affect us directly.
The issues are complex but that doesn't mean they aren't important. Carbon management policy affects all our lives directly. Will ETS revenues be spent on improving public transport or grants for electric cars? Will we find ourselves busy calculating energy costs every time we buy a new TV or freezer - or will we not have to worry because all but the most efficient ones have been taken off the market? How will we afford to insulate our homes?

I think you can see from this post that I have quite strong opinions but I don't have all the answers. You probably disagree with me and maybe have a lot of questions. So come along on 2nd March and find out more.

[1] EU Action on Climate
[2] The EU Emissions Trading System
[3] Annual European Union greenhouse gas inventory 1990–2012 and inventory report 2014
[4] Solid wall insulation (
[5] Green Deal and Energy Company Obligation (ECO): monthly statistics (January 2015)
[6] Green Deal, Energy Company Obligation (ECO) and Insulation Levels in Great Britain, Quarterly report: to September 2014
[7] Climate Action: Auctioning

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