Monday, November 2, 2009

What works in the West might not work in the East: ensuring the integrity of the ETS

Why some EU Member States need to restrict carbon trading

EU member states cannot avoid taking different approaches to the implementation of the EU emissions trading scheme (ETS) if the integrity of the system is to be sustained. What works in the West might not work in the East.

There are questions whether new measures by the Lithuanian government to restrict the use of cash gained through the carbon sales in the second phase of the scheme are in line with the spirit of the EU ETS to provide a flexible mechanism and cash incentive for the companies for the reduction of carbon dioxide across the block.

The idea of emissions trading was to provide a flexible mechanism to stimulate environmental progress in our most polluting industrial sectors. Lithuania takes the view that in order to preserve the integrity of the ETS in fighting climate change, governments must implement legislation that would underpin and reinforce the rules on carbon trading, but also lay a foundation for sustainable development of a country, particularly in the face of economic downturn. Every country has a specific economic and social background that requires differentiated approaches in steering a state towards a sustainable economy. It means that EU regulation will have to be adjusted to the requirements of individual members.

Voluntary investments towards pollution reduction can be expected among the EU ETS operators in developed member states, such as Netherlands, in part because of the exposure to international competition, caring for the company brand as well as public checks and balances ensure operators investing in ‘cleaning up’. But other countries without these ‘drivers’ cannot engineer a laissez-faire move towards carbon reductions and a greener economy. In these cases regulation can and must fill in the void to surge financing of economy greening.

Lithuania is facing closure of the Ignalina Nuclear Power plant in 2009 and subsequently moving towards dirtier and more carbon intensive fuels in the coming years. Still, Lithuanian companies are able to sell allowances they didn’t need - in turn making profits but passing CO2 costs on to consumers. It happened at a grand scale during the ETS phase 1, when companies were making up to €35 million in profits and no investments towards pollution reduction, transforming industry or cleaning up production processes, which could have eased the need for additional allowances in the future.

The existing surplus of permits if not managed properly is failing the “polluter-pays principle” as it represents “hot air” in the system. To avoid permits being bought and used without any effort towards emissions reductions having taken place, some governments especially amongst the new member states will have to take a more active role.

Thus article 5 of the Climate Change Financial Mechanisms Act, which sets a duty upon the operators to use the proceeds from the permits trade exclusively for the environmental projects, has been introduced in Lithuania. Under the new law, companies sustain a level of discretion which projects to spend the carbon revenue on: from implementing best available practices to environmental programmes that can be rolled out on a wide scale. The new regulation applies only until 2013, when centralized allocation of emissions allowances is proposed by EU authority and the auctioning share as opposed to free allocation is envisaged to be bigger. But in response to dialogue with the European Commission over the contested national allocation plan and the need for the government to promote the transformation of industry to minimise the impact of ever decreasing free allowances, the Lithuanian government felt such regulation is necessary.

It will help to sustain the integrity of EU ETS, promote sustainable development, and to protect the public from hefty energy prices that will be inflated by the need of extra EUAs in the face of changing energy sources in Lithuania and cut of free allocations.Indeed such legislation is being considered by other new member states in the Czech Republic and Poland, which are both reported to be considering placing restrictions on how revenue raised from selling EUAs is spent in the third phase of the scheme.

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