Joan MacNaughton, Alstom, UK
Carbon trading is falling out of favour in some circles as the worldwide recession bites and the European Union Emissions Trading Scheme (EU ETS) carbon price slumps. The price of carbon traded in the EU ETS has, over recent weeks, dipped below the €10 ($13) per tonne mark.
The environmental imperative of decarbonizing power generation is not helped by a low carbon price: €10 a tonne will not spark green investment decisions in the boardrooms of European utilities. Without the commercial imperative to decarbonize, the electricity industry will obviously focus on supplying electricity cheaply and efficiently to its customers, leaving the expensive switch to decarbonized power for as long as legitimately possible.
With the EU ETS not delivering the price needed to stimulate new carbon-light technologies, many are arguing that direct intervention, such as a carbon tax, is needed to kick-start development in renewables and carbon capture and storage (CCS). At a time when financial markets are no longer seen as a panacea, and financial traders are more likely to be reviled than revered, the whole concept of carbon trading is under question.
There is clearly a case to answer: if the market cannot stimulate the investment needed, then something needs to be done. But do we turn away from the market completely and bring in a carbon tax, as some have argued? Or do we build on what has already been done in the EU ETS and improve it?
EU ETS a viable global trading model
I advocate sticking with the EU ETS. While it is far from perfect, a start has been made and a foundation laid on which an effective global system for reducing carbon dioxide (CO2) emissions can be built.
The key point here is timing. Climate change is taking on a frightening urgency, so we need to look towards the quickest solutions. While a global system of greenhouse gas reduction based on national taxes is possible, it is a longer route. Even after it has been agreed in principle, a tax-based system is likely to be bogged down in protracted negotiations among governments about suitable levels of taxation.
Take the example of Europe. There we have a trading scheme already agreed, among 27 sovereign nations. For each one to design and implement a tax system, and for the negotiations to be completed on how they will be linked is bound to take years, not months years that we simply do not have. Granted, to step up from a regional to a global trading scheme will take time, but not as long as a global tax system would.
A market system, once established within set parameters as in the EU, allows the carbon price to find its own value, and sends price signals that determine the level and direction of investment in low-carbon technologies. These can quickly target money towards those technologies that are low-carbon, taking advantage of the ability of business to make speedy resource allocation decisions.
CARBON TAX AND RESOURCE ALLOCATION
A carbon tax would be less effective in optimizing resource allocation. And one of its biggest drawbacks is that tax policy in general has many drivers, not least of which is to balance the books. Volatility in the CO2 price under the EU ETS is definitely an issue though a price that is responsive to general economic conditions is not in itself a bad thing. What would help to reduce volatility is a deeper and more liquid market which should ensue from linking the EU with the proposed US, Australian and other schemes. But here, again, timing is key.
Concern is mounting about the global lack of urgency in the policy response. Much is resting on the United Nations Framework Convention on Climate Change (UNFCCC) Conference of Parties (COP) 15 meeting in Copenhagen, Denmark. There is a need to build on what has been started at Kyoto, Japan
Countries ratifying the Kyoto Protocol are committed to national binding greenhouse gas reduction targets, with three market mechanisms available to aid carbon reduction over and above national measures: emissions trading; Joint Implementation (JI) and the Clean Development Mechanism (CDM).
JI allows industrialized countries to offset carbon emissions by carrying out joint implementation projects with other developed countries, while the CDM allows carbon emissions to be offset by investing in sustainable development projects, which reduce emissions in developing countries.
By setting up the CDM, the protocol facilitates the transfer of money, technology and projects to developing countries, hence allowing them to move directly to best available technologies and to leapfrog less successful low-carbon technologies.
Addressing market shortcomings
The shortcomings of the current CDM are widely acknowledged, and include insufficient monitoring, inspection and control of projects submitted. Reform of CDM will no doubt be high on the COP15 agenda.
While these market mechanisms are essential steps on the road to a flourishing world system for carbon reduction, it is fair to say that no amount of tweaking will make a market system think long-term. As Lord Stern’s report1 pointed out, a market mechanism on its own will promote only the cheapest technologies, and not foster those that are at a pre-commercial stage, but with important long-term potential. Yet, if we are to keep global temperature rises below 2 ºC, a target which in all probability still entails damaging impacts from climate change, we need to act quickly and decisively to bring new low-carbon technologies to commercial viability.
Many new technologies will be able to compete effectively against today’s power technologies in the decades to come, but need help now to become competitive. Until such technologies are ready, a market mechanism alone will push utilities simply to switch from coal to gas, a risky option for Europe in terms both of energy security and likely price volatility. And gas, while cleaner than coal, is still a big emitter: as well as being unattractive to those nations with abundant cheap coal, such as India and China.
That is why CO2 capture and storage needs to be widely deployed. Alstom recently commissioned the Brattle report on EU Climate and Energy Policy to 20302 to examine the prospects for CCS in Europe in the light of current and forecast carbon prices.
Additional support essential
The report sets out why CCS is central to key European energy policy goals and that without it the EU will struggle to meet its current targets for reduction in greenhouse gas emissions. Early CCS demonstration projects which take this proven technology to industrial scale is the essential next step.
The report also looks at EU ETS allowance prices and argues that, with the unlimited banking of allowances between phases II and III of the EU ETS, prices today ought to be a good indicator of the market’s view of prices at the end of 2020. Consequently, the report concludes that the market alone will be unlikely to bring forth investment in CCS before 2020.
This is compounded by the “significant uncertainty” surrounding future carbon prices. The report points out that, among other factors, the price and use of gas versus coal will significantly affect the carbon price. If coal becomes more expensive in relation to gas, increased generation with gas will ensue, leading to a fall in the price of carbon in the ETS, as gas generation produces less CO2. This price uncertainty is a further disincentive for investing in CCS.
Public support for nascent technologies is nothing new. Nuclear power was heavily supported, and more recently German feed-in tariffs for small-scale wind farmers paved the way for this important renewable energy source to become viable. And such a route to viability is what is required here. Support could take the form of using the revenues from the auctioning of emissions allowances to support CCS demonstration schemes, or issuing emissions allowances for CO2 stored.
Support for pre-commercial technologies is a necessary adjunct to an emissions trading scheme. It needs, though, to be carefully targeted and time-limited. All such support should contain sunset provisions triggered, for example, by reaching a certain level of deployment. Then the market should play its part.
For the foreseeable future, though and perhaps permanently a mixture of market and government-backed intervention mechanisms will be needed to tackle what Lord Stern called “the biggest market failure” climate change.
1. The Stern Review on the Economics of Climate Change, July 2006, HM Treasury, UK
2. Climate and Energy Policy to 2030 and the Implications for Carbon Capture and Storage, March 2009, Brattle Group, www.brattle.com/_documents/UploadLibrary/Upload755.pdf
Joan MacNaughton has been Senior Vice President, Power and Environmental Policies for Alstom Power since 2007. Previously, she was a senior UK civil servant, including being Principal Private Secretary to the Deputy Prime Minister, and from 20022006 she was the Director General, Energy, UK Department of Trade and Industry.