House of Commons Environmental Audit Committee The role of carbon markets in preventing dangerous climate change Fourth Report of Session 2009–10 Report, together with formal minutes, oral and written evidence Ordered by the House of Commons to be printed 26 January 2010 HC 290 Incorporating HC 393-i to -v, Session 2008–09 Published on 8 February 2010 by authority of the House of Commons London: The Stationery Office Limited £24.50 The Environmental Audit Committee The Environmental Audit Committee is appointed by the House of Commons to consider to what extent the policies and programmes of government departments and non-departmental public bodies contribute to environmental protection and sustainable development; to audit their performance against such targets as may be set for them by Her Majesty’s Ministers; and to report thereon to the House. Current membership Mr Tim Yeo MP (Conservative, South Suffolk) (Chairman) Gregory Barker MP (Conservative, Bexhill and Battle) Mr Martin Caton MP (Labour, Gower) Colin Challen MP (Labour, Morley and Rothwell) Mr David Chaytor MP (Labour, Bury North) Martin Horwood MP (Liberal Democrat, Cheltenham) Mr Nick Hurd MP (Conservative, Ruislip Northwood) Rt Hon Jane Kennedy MP (Labour, Liverpool Wavertree) Mark Lazarowicz MP (Labour/Co-operative, Edinburgh North and Leith) Mr Ian Liddell-Grainger MP (Conservative, Bridgewater) Mr Shahid Malik MP (Labour, Dewsbury) Mrs Linda Riordan MP (Labour, Halifax) Mr Graham Stuart MP (Conservative, Beverley & Holderness) Jo Swinson MP (Liberal Democrat, East Dunbartonshire) Dr Desmond Turner MP (Labour, Brighton, Kempton) Joan Walley MP (Labour, Stoke-on-Trent North) Powers The constitution and powers are set out in House of Commons Standing Orders, principally Standing Order No. 152A. These are available on the Internet via www.parliament.uk Publication The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including substantive press notices) are on the Internet at: www.parliament.uk/eacom/ A list of Reports of the Committee from the current Parliament is at the back of this volume. Committee staff The current staff of the Committee are: Gordon Clarke (Clerk), Simon Fiander (Second Clerk), Tim Bryant (Committee Specialist), Edward White (Committee Specialist), James Bowman (Senior Committee Assistant), Susan Ramsay (Committee Assistant) and Steven Everett (Sandwich Student) Contacts All correspondence should be addressed to The Clerk, Environmental Audit Committee, Committee Office, 7 Millbank, London SW1P 3JA. The telephone number for general inquiries is: 020 7219 6150; the Committee’s e-mail address is: [email protected] The role of carbon markets in preventing dangerous climate change 1 Contents Report Page Summary 3 1 Introduction 5 2 Background 7 What is emissions trading? 7 The Government’s twin policy aims 8 3 The impact of the EU Emissions Trading System 9 Assessing the impacts of the EU ETS 9 The extent of emissions reductions within the EU 9 Capping emissions 11 The design of Phases II and III (2008–2020) 13 Intervening to lower the cap 14 Cancelling New Entrant Reserves 15 Use of offset credits 15 Auctioning allowances 18 Conclusions on Phases II and III 19 4 Setting a price for carbon 21 The impact of the EU ETS 21 Encouraging low-carbon investment 21 Intervening to affect the carbon price 26 A price floor 26 Subsidies and regulation 31 5 Global carbon markets 35 Latest international developments 35 Linking cap and trade systems 36 6 Conclusions 39 Conclusions and recommendations 40 Annex 43 Environmental Audit Committee Visit to the USA, 18–22 May 2009 43 Formal Minutes 45 Witnesses 46 List of written evidence 47 List of Reports from the Committee during the current Parliament 49 The role of carbon markets in preventing dangerous climate change 3 Summary Emissions trading is central to the Government’s efforts to reduce greenhouse gas emissions in the UK. This is our third report on UK policy on emissions trading. We undertook this latest inquiry to examine the prospects for a global carbon market and the implications of this for further development of the European Union Emissions Trading System (EU ETS). In doing so, we have reviewed the impact and future prospects for the EU ETS in meeting the Government’s twin objectives of reducing emissions at lowest cost and setting a carbon price that delivers investment in low-carbon technologies. Carbon allowances were clearly over-allocated in Phase I of the EU ETS, which ran between 2005 and 2007, and emissions as a whole went up over that period. In due course, the declining emissions cap in Phase III (2013–2020) could drive genuine emissions cuts, but in the meantime there is a risk, if economic recession leads to a prolonged reduction in emissions, that Phase II (2008–2012) will also turn out to be significantly over-allocated. The EU ETS could also be significantly weakened because surplus allowances may be banked and carried-over into Phase III, because industrial sectors have again been allocated allowances in Phase II in line with business-as-usual projections of their emissions, and because in Phase III they may again have access to free allowances. The Copenhagen conference in December failed to set binding global emissions reduction targets. Whatever the progress of continuing international negotiations following the conference, the Government should push for the EU to adopt an emissions reduction target which more closely reflects the climate science, and to adopt a revised cap for the EU ETS which might act as a real lever to achieve those targets. Mechanisms for reducing the EU ETS cap—whether in response to recession-driven reductions in demand for allowances, the success of complementary policies in cutting emissions, or the efforts of the public in reducing their carbon footprint—are urgently needed. The Government should press the EU to consider periodically whether to tighten the EU ETS cap. Emissions trading can help promote action to tackle climate change. However, the EU ETS has emissions caps set too high to force emitters to make the often costly investment decisions which would reduce emissions. The recession has only served to loosen what little constraint the cap provided. The carbon price, because of the lack of tautness in the EU ETS, has been too low to encourage the necessary investment in low-carbon processes and infrastructure. The cap mechanism therefore needs to be significantly tightened. This should be supported by cancelling ‘new entrant reserve’ allowances and auctioning as many allowances as possible, rather than giving them away for free (with the revenues possibly hypothecated to climate change measures). The Government should explore the possible use of a carbon tax. It should also encourage more use of allowance auctions with reserve prices, more use of incentives for low-carbon power generation and emissions performance standards for electricity generation. If necessary, the UK should be prepared to act in these areas unilaterally, to demonstrate a continuing leadership role on tackling climate change. 4 The role of carbon markets in preventing dangerous climate change The emphasis, nevertheless, should be on harmonising the approach internationally, and on extending effective emissions trading systems. There will be a need for emissions trading for decades to come, however optimistic we might wish to be on the rate of global progress on emissions reductions. There are other trading schemes in prospect elsewhere in the world, and the Government should urge the EU to link the EU ETS with other schemes. Differences in the parameters of the schemes, for example in terms of the use permitted of offset credits, could make that difficult, so the EU ETS should take care that linking schemes does not undermine the environmental effectiveness of the EU ETS or weaken the carbon price. Some variation in different schemes would not be an insurmountable hurdle in linking them together. If the EU ETS is merged with other emissions trading systems with a more generous allocation of allowances and greater access to offset credits from other countries, or more generous subsidies for low-carbon emitters, then terms of trade—some sort of carbon ‘exchange rate’—could ensure a level playing field. The Government, with its European partners, should however ensure that schemes are not merged without such an ‘exchange rate’ being carefully calibrated. The role of carbon markets in preventing dangerous climate change 5 1 Introduction 1. Emissions trading is central to the Government’s efforts to reduce greenhouse gas emissions in the UK. This is our third report on UK policy on emissions trading. In a report on the European Union Emissions Trading System (EU ETS) published in March 2007,1 we found that, while Phase I of the System (2005–2007) had been an administrative success, its record in reducing carbon emissions was questionable. At the time we were encouraged to believe that Phase II (2008–2012) would be more effective. We commended the Government for showing leadership in developing the EU ETS, but cautioned against relying solely on emissions trading to save us from dangerous climate change. 2. In October 2007 we published our second report on emissions trading.2 That report highlighted our concerns about the transparency with which the Government was reporting the impacts of carbon trading in UK national emissions figures—an issue we return to in this report.3 3. Since our earlier inquiries, in December 2008 the EU agreed emissions caps, in line with Europe-wide emissions reductions targets of 20% by 2020 (relative to 1990 levels), subject to revision if there were an agreement at the UN climate change conference in Copenhagen. That target represented a 10% cut in emissions (relative to 2005 levels) in the ‘non-traded’ sectors of the economy (which account for about 60% of total emissions), and a 21% cut for the emissions-traded sectors.