Europe's cap & trade system is faltering

Europe's Emissions Plan Hits Turbulence

Crisis Hampers Program Aimed at Fighting Global Warming, as Economic Recovery Efforts and Environmental Goals Clash

By SEAN CARNEY

WSJ.COM 2/20/13: Europe's flagship effort to fight global warming is faltering, despite an effort Tuesday by European parliamentarians to bolster the regional emissions-trading system, as the Continent's governments struggle to balance environmental priorities and pressing economic concerns.

Prices for polluting have plummeted, the result of an oversupply of emissions permits in the European carbon-trading market and slackening demand for electricity amid the Continent's economic woes—a development that is calling into question the effectiveness of similar programs world-wide.

With the cost of emitting carbon dioxide at around €5 ($6.68) a ton, a third of what it was 18 months ago, utilities in the Czech Republic, Germany and Poland have largely lost the incentive to pollute less, and are reconsidering plans to phase out coal-fired plants.

On Tuesday, a committee of the European Parliament moved ahead with a plan aimed at shoring up the market, known as the European Union Emissions Trading System, or ETS, and keeping prices from falling further. The committee delayed the release of 900 million new emissions allowances by up to five years. One permit, or one allowance, equals the right to emit one ton of carbon dioxide.

But despite the committee's action, permit prices slipped further, ending the day Tuesday at €4.58 after closing Monday at €5.12.

Making it more expensive to pollute by requiring companies to buy emissions permits is central to the EU's goal of reducing emissions by 20% in 2020 from 1990 levels. But it would also be an unwelcome drag on a struggling economy.

That has turned decision-making on the permit plan into a tug of war between those more concerned with sparking growth and those arguing that the EU shouldn't lose sight of longer-term environmental goals as part of the international effort to stem global warming.

"There is a disparity between the economic priorities and challenges that Europe is facing and reaching more aggressive emissions reductions," said Divya Reddy, a Washington-based analyst for Eurasia Group who follows climate change.

In Tuesday's vote, EU politicians mustered enough votes for the ETS lifeline plan to move forward, but were unable to agree on much more than that.

The committee delayed a decision on whether to send the plan directly to the Council of Ministers, which would start negotiations among EU member governments, or to first put it before the whole European Parliament, which could drag out the discussions, potentially for months.

Among those arguing most loudly for the primacy of economic concerns is Poland. Polish Environment Minister Marcin Korolec said his government opposes any effort to increase the price of permits. Higher permit prices would make electricity more expensive and threaten his country's economy, which is experiencing a sharp slowdown in growth and rising unemployment, he said. "The ETS was designed as a market mechanism. I believe that it should continue to be operated based on market rules," Mr. Korolec said.

Günther Oettinger, the European energy commissioner, on Monday voiced concerns that EU governments wouldn't be able to agree on the proposed changes.

The longer the process drags on, the further permit prices could slip, some traders said.

EU member states auction off about 60 million allowances a month, according to Milan Hudak, a carbon trader at Virtuse Group Suisse.

Over the past five years, the price of permits has dropped from a high of €28.70 a ton before the global financial crisis started in 2008 to below €3 a ton last month when the European Parliament's industrial committee rejected the plan to delay allowances.

Jan Pravda, director of Pravda Capital Partners, a trader of the allowances, said the problem is that if allowance prices rise, European manufacturers could move operations to countries that lack nationwide emissions-trading systems, such as China or the U.S.

The question is: How deep will the cuts in the number of allowances have to be to get the market functioning effectively again?

"Temporarily taking 900 million tons off the market is too little too late," Mr. Pravda said. "The real oversupply is several billion tons and this 'backloading' isn't taking supply off market but shifting it in time."

Environmental activist groups Climate Action Network and Greenpeace argue that 1.4 billion planned allowances need to be withheld and an additional 2.2 billion outstanding permits should be canceled.

One possibility is for the EU to set minimum prices for permits, an approach taken by California, which held its first auction for emission allowances in November. The average auction price was $10.09 per ton, just above the $10 minimum price. The minimum price will rise 5% each year and be adjusted for inflation. In 2013, for example, the minimum price for a ton of emissions is $10.71.

A minimum price could prevent another crash, Ms. Reddy of Eurasia Group said. "But from a political perspective it looks unlikely," she added.

What happens could well come down to a decision by Germany, which has roughly half the votes needed for a blocking minority that could prevent any changes to the ETS. But German leaders appear split among themselves.

Peter Altmaier, Germany's environment minister, supports the reduction of carbon allowances, while Economics Minister Philipp Rösler is against any plans that would lift power prices.

Mr. Rösler's main argument against the plan is that it would threaten competitiveness and jobs, an Economics Ministry spokeswoman said.