What will emissions trading deliver for the environment?

We are at the threshold of determining how much environmental added value the European Union’s Emissions Trading Scheme is going to deliver.

Emissions trading is a market instrument. One of the preconditions for there to be a market in anything is scarcity. Without sufficient scarcity, there would be an insufficient

Margot Wallström, Commissioner for the Environment

price signal to bring about the changes in behaviour that are needed to address climate change. Emissions reductions would have a low value, energy-efficient companies would have no comparative advantage and early actors would have no reward.

The time when the quantity of carbon dioxide emissions was unimportant to a company is over, and the price of allowances in the market will reflect this.

It has been said many times before that it is not the instrument of emissions trading that creates the scarcity of allowances that is needed for the development of a market instrument. It is actually the collective allocations of 25 national allocation plans that member states prepare. I would like to emphasise this.

As the allocation plans are being drawn up by member states and submitted to the Commission, it is crucial that the allocations proposed actually create a sufficient degree of scarcity. Over-supply will depress the price of allowances in the market, but it will also send the wrong message to the EU’s largest emitters: that the effort being asked of them is going to be very modest, and the obligations of the Kyoto Protocol will be fulfilled by other sectors, such as transport, households or the tertiary sectors. It is unrealistic to think that the other sectors of the economy can deliver the Kyoto obligations alone. And it would also be an unwise economic choice.Yet this is precisely what the implications of a ‘business-as-usual’ allocation to the emissions trading sectors, advocated by some, would amount to.

Once the emissions trading system has begun, there is no opportunity for tightening allocations made to industry that, with hindsight, were considered too generous. Over-generosity by governments now will mean that they are virtually postponing action on climate change.

Member states are now collectively fixing the level of scarcity that is to prevail in the emissions trading system for the years 2005–07. The resulting scarcity will reflect the contribution asked from energy-intensive industry.

If a particular member state is relatively generous in its allocations, then, ironically, companies across the EU – not just those in its own country – will benefit from that relative generosity, as there will be a greater abundance of allowances and a lower market price in the EU emissions trading system as a whole. Conversely, if a member state allocates ambitiously, this perceived hardship will influence the EU market, resulting in a greater degree of collective scarcity and a higher allowance price. The image of connecting jars of water finding a common level is an appropriate one: the levels of water cannot be kept higher or lower in any single jar.

I want the allocation process to result in a reasonable degree of scarcity at EU level to secure three things. First, to ensure that emissions trading will help to bring our economies in line with our Kyoto commitments. Second, to stimulate the development of new low-carbon technologies.Third, to demonstrate to the rest of the world that the merits of emissions trading do not only exist on paper but play out in real life.

Margot Wallström
Commissioner for the Environment
European Commission