In a few months time, the EU Emissions Trading System must finalize the sectors that will receive exemptions meant to avoid carbon leakage for Phase III of the EU ETS.
European industry has been lobbying hard to increase the number of free, sectoral allocations. But a new report by the NGO Sandbag shows that despite the political pressure to grant "sweeping exemptions" to steel, aluminum, cement, iron and energy industries, in Germany and France in particular, almost no new allowances will actually be needed.
"The Carbon Fat Cats List, dominated by steel and cement companies, could share a surplus of pollution permits worth €3.2 billion by 2012. This is more than double the EU investment of €1.5 billion in renewable energy and clean technology as part of the economic recovery," the report states.
Anna Pearson, head of policy at Sandbag says, "We're not saying that carbon leakage is completely bogus. I think what we're trying to say is that at the moment it's overstated — quite a lot."
Carbon "leakage" is the term used to describe industry relocation for competitive purposes. European industries claim that without free allowances they will be forced to sacrifice jobs in manufacturing and generation facilities located in the EU or ultimately relocate to other regions because they will not be able to compete with cheaper manufacturing sources in emerging market countries.
Pearson says the claim that industries will be forced overseas is an exaggeration, noting that goods produced for consumption within the EU would have to be shipped farther if production moved overseas, adding cost and making the process more carbon intensive anyway.
There's also the issue of companies receiving free allowances, deciding to cut European jobs anyway, and pocketing the value of those allowances.
"Politicians continue to give generous numbers of free permits to industrial sectors that face international competition in order to prevent job losses," Pearson explains, "But using an environmental scheme to do this has proved poor policy making since many of the same companies are cutting swathes of jobs despite being able to make windfall profits from carbon."
In December, for example, the UK steel maker Corus closed a plant in Teesside, putting 1,700 employees out of work, but the company retained the plant's carbon permits. Corus, according to Sandbag's report, now has €377,520,882 worth of surplus carbon permits that it can resell.
An inquiry on behalf of the UK's Environmental Audit Committee found that, as it stands, allowance surpluses from the previous phases of the EU ETS could be used to offset 50 percent of EU required emissions cuts in Phase III. The committee noted that "in some cases, companies could meet all of their required cuts for Phase II without making any actual emissions cuts themselves."
New numbers released Thursday on the EU ETS bear that out. Amid last year's economic downturn, ETS-covered CO2 emissions dropped by 11 percent, but the cap didn't change, meaning the number of surplus permits in circulation rose from 62 million to 142 million. Those are permits that companies can sell or use in the future rather than cut their emissions.
Under an EU plan, 164 sectors — comprising 77% of total EU emissions — would be eligible for free allowances in the long term to avoid carbon leakage, with the details to be determined this year. The EU is also considering allowing carbon offsets to be purchased from other regional or national schemes, which would increase the overall supply of offsets available, and drive the price of offsets further down, which would be counter productive.
While Sandbag found that some companies may have legitimate complaints about carbon leakage, they are small in number.
The report explains that so many permits held in surplus means that some companies stand to make windfall profits in the future from companies that have too few permits. A small number of companies in the iron, steel, and energy sectors will be required to bear responsibility for overall EU emissions cuts for the sector because others that are flush with credits won't have to change how they operate. If the costs are substantial, the result could be a competitive disadvantage.
Christopher Wright, a researcher at the University of Oslo elaborates, "The additional cost of paying for pollution permits is likely to be a very small part of overall production costs. ... Academic literature has not provided significant evidence in support of the pollution haven hypothesis, that companies move production to countries with the weakest environmental regulations, fueling a 'race to the bottom'."
Pearson suggests that the EU find some way to claw back the surplus permits before going forward with Phase III.
"What we'd recommended is that the EU consult on that. It might be to offer tax incentives so companies actually cancel these permits," Pearson said.
The best solution, though, is to tighten the overall caps and auction the permits rather than give them out as free allowances, she said. The distinction to be made is behavioral, according to Pearson, because benchmarking is still guessing, which caused a large market surplus in Phase I, and there's always the risk of an unforseeable economic shock like in Phase II, when global economic recession meant companies were producing less and their carbon emissions decreased anyway.
The only way to fully eliminate leakage, according to both Wright and Pearson, is a global carbon trading system, and that is a long way off. It would have to include emerging markets, and trading would have to be completely integrated and sufficiently regulated. While the Japanese and South Koreans will have trading systems shortly, the U.S. seems to have stalled, and India and China aren't anywhere near setting up schemes of their own.