Environmental Law

30/06/2021

The Challenge of Meaningful Comparisons of ETS Systems: How Canada and the EU Price Emissions

By Michael Leach

Introduction

Scholars and policymakers have been considering emissions trading systems ever since at least the 1960s when Ronald Coase imagined pollution and emissions as factors of production that could be converted into transferable legal rights.^[1] Although it took a number of decades yet before the first markets for emissions trading took off, there are now a relatively limited pool of functional examples of emissions trading systems (ETS) around the world that provide some grounds for comparison and lesson learning as these systems continue to evolve and future ones are imagined. There is tendency among scholars to treat the puzzle of emissions trading as a kind of multi-case engineering design process that searches for optimally efficient mechanisms, system architectures, forms of regulatory market oversight. From such a perspective, the few examples of ETSs around the world can be mined for evidence about what models and practices work best, and then plugging them into existing systems in processes of technical refinement. What is less discussed, however, are the boundaries of what can be learned from such inter-system comparisons, something that becomes evident once ETSs are appreciated more as regulatory systems in and of themselves rather than as a specific kind of markets that are subject to regulatory oversight. This blogpost will draw attention to these limits through a very focused and cursory comparison of the EU ETS and the Canadian emissions reduction scheme under the Pan-Canadian Framework on Clean Growth and Climate Change along the narrow comparator of how the two are structured to produce prices on emissions.

ETS Comparisons

Comparative studies of ETSs are relatively few and far between, largely because the number of actual functioning ETS in the world is quite limited.^[2] Of those that exist, ETS comparisons have largely been done to evaluate the effectiveness of different ETSs in creating a functioning market and achieving actual emissions reductions goals.^[3] Other types of comparative studies have compared the experiences of different industrial sectors within single ETS systems to evaluate how well or poorly a given ETS incentivizes them to reduce their emissions and innovate cleaner technologies.^[4] Still others have compared different specific features of ETS systems,^[5] or have compared the relative effectiveness of ETS systems versus across-the-board carbon taxation to induce emissions reduction behavioural changes.^[6] In almost all cases, the metric of comparison is the same, namely how effectively a given ETS achieves its respective goals.

By framing ETSs as forms of regulatory technology, however, much is missed about how contingent the designs of such systems are on the socio-political and legal environments in which they are created. By focusing on the technical pursuit of optimal models for ETS system designs, scholars sometimes forget to ask why it is that those few ETS systems that exist currently in the world differ from one another in the ways that they do. In 2013 Sanja Bogojevic argued that the EU ETS system was sui generis and unique because of the EU’s unique supranational legal environment. In so doing, Bogojevic challenged the notion that transferring ETS design and technologies from one jurisdiction to another is technical and straightforward.^[7]

In the brief EU-Canada comparison offered below, the argument follows Bogojevic’s line of thought, not only to point out that the two achieve emissions prices differently, but also to argue that the reason for this difference is that both ETS frameworks are products of their respective idiosyncratic political contexts and constitutional legal regimes.

Comparing Europe and Canada

Both the EU ETS and the Pan Canadian Framework are based on a logic that markets can achieve prices for emissions in ways that will produce incentives for affected industries to reduce their emissions. Despite the similarity of their goals, the two systems achieve those prices in quite different ways, however. The reasons for these differences are not simply a matter of better or worse technical choice-making, but rather are intimately connected to the natures of the political and legal orders within which they are created. Indeed, any accounting for the differences between the Canadian and European ETS systems will always circle back to the constitutional natures of Canada and the EU as political unions, one being a national federation, the other a supranational federation.^[8]

The EU ETS is structured to achieve prices by centrally determining and limiting permissible levels of emissions throughout the EU though establishing a cap on a restricted number of emissions allowances. Regulated industries are permitted to emit provided within the limits of the allowances that they own. By creating increasing scarcity of allowances as the cap is lowered annually, the ETS achieve prices on emissions as increasingly scarce allowances are traded among affected industries. Emission caps are determined centrally by the EU Commission and allocated by a combination of an open auction as well as some given freely to Member States to allocate as they feel is important. How many emissions allowances should be produced and auctioned or distributed is calculated according to both environmental considerations as well as the relative economic development of the different Member States, where some poorer countries are receive relatively more allocations to emit than richer ones). Over the course of its existence, the ETS has produced considerable fluctuations in emissions prices, but generally has been criticized for prices ending up too low, creating insufficient incentives on industries to reduce emissions accordingly.^[9]

The Canadian system achieves emissions prices quite differently. The method for achieving emissions pricing proposed in the Pan Canadian Framework and promulgated with the 2016 Greenhouse Gas Pollution Pricing Act (GGPPA)^[10] sets a basement benchmark price for all of its subnational provinces and territories to either match or surpass, using whatever means they choose, whether through a straight carbon taxes or by using market-based trading systems. In contrast to the EU ETS, the structural logic employed here is to rely on market forces (in those provinces that choose to establish a price through a trading system) to achieve an efficient sub-national emissions reductions within a framework that is centrally constrained by a basement emissions price setting. The Canadian federal system does not centrally determine emissions caps like the EU does because the point is not to intervene by controlling scarcity, but rather to set an outer framework for achieving at least a minimal price and then relying on the cost of emissions as the mechanism to structure how emissions are efficiently allocated throughout the economy. While sub-national provinces and territories that choose to set up their own ETSs are entitled to set their own cap and allowance allocation mechanisms to provide sufficient scarcity in order to achieve that price (or higher), unlike the EU Commission, it is not the Federal Government in Ottawa that does this.

Now, one can spend time wondering whether the European or Canadian ETS as they are structured will better achieve behavioural and emissions reduction goals. There is considerable debate in Europe, for instance, about whether or not to include a basement price equivalent (often referred to as an ‘auction reserve price’), while discussions in Canada have debated the value of a single national trading market instead of a sub-nationally variable one. To date, such a study has not been done, but its utility would be limited because the differences between the two systems are quite significant. The question of interest here, however, is not which system works better, but rather why it is that they are different to begin with. The choice of how a given political order will design its ETS to achieve prices is as much a political and structural question as it is a technical and economic one.

The fact that emissions prices in Canada and the EU are achieved through different forms of state intervention to manipulate prices, as well as the different roles and purposes that each system gives to the market to allocate resources and costs reminds us that both are fundamentally market-based regulatory systems, rather than merely emissions markets that are subjected to regulation. This framing nuance is important because whereas the latter suggests that achieving optimal prices should be possible through tinkering with forms of regulatory oversight to get the right fit, the former appreciates how the systems that produce prices are contextually sensitive and structurally determined by the political and legal frameworks in which they are created.^[11]

Although Canada and the EU are both forms of federations, the manner by and purposes for which power and legal authority is distributed within each is critically important for understanding why the ETS systems that each designed look the ways they do. The most obvious difference between the two is that the EU ETS is a single system for the whole union, while the Pan Canadian Framework holds together a patchwork of different provincial approaches to pricing emissions, united by a common benchmark price floor. While the EU ETS was originally designed specifically to avoid the prospect of a balkanization of different national emissions trading markets within the union,^[12] under the principle of subsidiarity that trading was more effectively done on a union-wide basis,^[13] the legal and political logic of Canadian federalism precludes the possibility for the central federal government to construct a single carbon market for the entire country in the same way.

The Canadian form of federalism is based on a series of historical agreements that united British colonial provinces under a single federal government on the condition that provincial autonomy was protected from interference by the centre within certain designated areas of governance, including economic activity.^[14] Section 92 of the Constitution Act of 1867 confers jurisdiction to provinces over much of the trade, industry, and resource extraction that are responsible for GHG emissions.^[15] It is because of this that it would constitutionally difficult, if not impossible, for the Federal Government in Ottawa to play the same regulatory role that the EU Commission does when it determines emissions quota for Member States. Similarly, because the EU is historically a federal project to create a supranational, liberal, internal market among sovereign Member States, it would face a different constitutional legal challenge if the Commission were to impose a single price floor or benchmark (in EU ETS literature this is often referred to as an ‘auction reserve price’)^[16] on the internal market in the way that the GGPPA does in Canada. While some scholars have argued that EU law would be permissive of such an action, they have also reported hesitancy on the part of economists in the Commission to consider it, concerned that if it were interpreted as a fiscal measure then passing it would be politically difficult, requiring a unanimous vote within the European Council.^[17]  In the absence of a centrally mandated basement price for emissions, however, the early phases of trading in the ETS is generally considered a failure for not producing high enough prices to sufficiently incentivize affected industries to reduce their emissions, helped in large part by giving too much discretion to Member States to freely allocate allowances through their National Allocation Plans (NAP) in ways that created competitive distortions and undesirably large windfall gains for some industries.^[18]

Conclusion

The point here is not to argue that comparing ETS systems is not possible, nor that regulatory tinkering with ETS systems cannot be inspired by other examples around the world. Rather, the aim is only to emphasize the challenges that are involved in making comparisons between ETS systems. Indeed, in order for comparisons to be meaningful requires going well beyond technical considerations of economic and regulatory cause and effect. Just because a particular mechanism successfully structures a market in ways that do induce emissions reductions in one place does not necessarily mean that it will be feasible elsewhere.

Understanding the socio-legal embededness of ETS systems is important because if we assume that all of them (both those that currently exist and any future ones) differ in how they are politically, legally, and economically embedded, or, alternatively how the legal, political and economic contexts of each delimit the range of technical options available to their designers to a bounded set of technical options, then this poses certain difficulties when imagining the transplantation of ETS technologies from one place to another.

Furthermore, by viewing ETS systems as sui generis and embedded regulatory systems, rather than as differently regulated markets, one can also appreciate how difficult it will be to achieve any future integration of ETS markets globally, as some have called for.^[19] Again, this is not to say that cross jurisdictional integration is impossible, and the case of the Western Climate Initiative that links the ETS markets of the state of California and Quebec proves its feasibility. At the same time, however, any such cross-border integration will require creating new sui generis ETS frameworks, as the EU did in 2003, but which will likely not be possible within Canada on a national scale.

This research is made possible through funding from the Netherlands Research Council NWO under grant number 406.18.RB.004.

18/05/2021

Towards EU carbon farming legislation: what is the role of the ETS?

This is the first in a series of blogposts on a new project which we, at Tilburg Law School, have embarked on.[1] The projects starts from the recognition that the Paris Climate Agreement goals can only be achieved when greenhouse gas emissions from agriculture and land use are reduced and the sequestration capacity of these sectors is fully utilized. In most countries around the world, including in the EU, the heart of climate change mitigation policy consists of some form of carbon pricing mechanism. It seems inevitable that agricultural activities have to be included in carbon pricing mechanisms, such as the EU Emissions Trading Scheme (ETS). So far, however, policy makers have been reluctant to do so, partly because of the lack of political will, and partly because of the difficulty of measuring emissions and emission reductions at farm level.  With the improvement of measuring technologies and carbon accounting methods, however, the possibility to also regulate agriculture under the EU emissions trading scheme has become within reach.

This project aims to develop a regulatory framework that allows agricultural greenhouse gas emissions to be included in the EU ETS and to be aligned with the Common Agricultural Policy (CAP). This will be achieved through an ex post assessment of novel regulatory approaches in Alberta, California, China, and Australia and through an ex-ante assessment of inclusion of agricultural emissions under the EU ETS, either indirectly, through allowing on farm offsets, or directly, through requiring farmers to surrender allowances. Various models of inclusion of agriculture in the EU ETS will be developed and tested under a traditional ex-ante assessment methodology consisting of focus groups and stakeholder interviews.

The project runs from 2020 until 2023, so our proposals can be included in the first discussions for the post 2030 trading phase. An earlier adoption is not very likely, since inclusion of the agricultural sector in the EU ETS will have a big impact on the system. Changing the rules of the game in the middle of the current trading phase, which runs from 2020 until 2030, is not entirely impossible, but also not advisable due to the disruption of the carbon market it may cause. The European Commission, however, is stepping up its efforts to reduce agricultural GHG emissions through its European Green Deal Policy, which includes a proposal for a European Climate Law and a Farm to Fork Strategy.

The 2020 proposal for a European Climate Law introduces an ambitious overall target for the EU’s mitigation policy as it requires the Member States to have emissions and removals of greenhouse gases balanced at the level of the EU at the latest by 2050, and to pursue a new 2030 target of 50 to 55% emission reductions compared to 1990. Although the AFOLU sector is not specifically mentioned in the European Climate Law, it is impossible to achieve such targets without a drastic reduction of emissions from this sector. It comes as no surprise, therefore, that the EU 2030 Climate Target Plan, presented in September 2020, does pay ample attention both to agriculture and to land use, land use change and forestry (LULUCF). The 2030 Climate Target Plan states that new measures are being considered for the 2030-2050 period, including an expansion of the LULUCF Regulation to also cover non-CO₂ emissions from agriculture. The European Commission does not mention the option to integrate agricultural emissions into the EU ETS. Instead,

‘(o)vertime, the Commission clearly sees merit in the creation of an Agriculture, Forestry and Land Use sector with its own specific policy framework covering all emissions and removals of these sectors and to become the first sector to deliver net zero greenhouse gas emissions. Subsequently, this sector would generate carbon removals to balance remaining emissions in other sectors induced by a robust carbon removal certification system.’ ^[2]

Similarly, in the 2020 Farm to Fork Strategy, the European Commission is hinting at a new EU carbon farming initiative:

‘An example of a new green business model is carbon sequestration by farmers and foresters. Farming practices that remove CO₂ from the atmosphere contribute to the climate neutrality objective and should be rewarded, either via the common agricultural policy (CAP) or other public or private initiatives (carbon market). A new EU carbon farming initiative under the Climate Pact will promote this new business model, which provides farmers with a new source of income and helps other sectors to decarbonise the food chain. As announced in the Circular Economy Action Plan (CEAP), the Commission will develop a regulatory framework for certifying carbon removals based on robust and transparent carbon accounting to monitor and verify the authenticity of carbon removals.’^[3]

So far, most attention is focused on using the CAP to promote carbon farming. In April 2021, the European Commission published a Technical Guidance Handbook on this. There are, however, a couple of disadvantages connected to the CAP, most of which are caused by the fact that the CAP has not been designed as a climate change instrument. I discussed this in an earlier blogpost. It is important, therefore, to also look into climate change instruments to see whether these can be used to promote carbon farming.

One of the “other public initiatives” for a carbon market mentioned in the Farm to Fork Strategy might very well be integration of agricultural emissions in the EU ETS. In the remainder of this blogpost, I will have a first brief look at what carbon farming as part of the EU ETS might look like.

Two models of integration: direct inclusion in the ETS or through offsets

In the EU, the ETS has gradually expanded to require GHG emitting activities to surrender allowances for the amount of GHGs emitted. Directly requiring farmers to surrender allowances for their emissions under an ETS has not been proposed much and is not a requirement in any of the emissions trading systems around the world. The direct inclusion of farming in an ETS is considered problematic because of the difficulty of measuring emissions and emission reductions at the farm level because of the variety of factors involved (such as the diet of individual animals, tillage intensity, soil composition, weather systems of individual regions, the way in which fertilizer is applied, etc.). In addition, most farms also remove CO₂ through sequestration in soils and vegetation. For a small number of farming activities, however, direct inclusion in the ETS seems possible, especially for large scale livestock keeping within closed buildings, such as piggeries. Methane emissions can easily be monitored here, technologies to capture the methane and convert it into biogas exist, thus allowing farmers to choose between  buying allowances or investing in such technologies. With the improvement of measuring technologies and carbon accounting methods, however, the possibility to also regulate more forms of agriculture with high GHG emissions may become within grasp.

Most countries that have an ETS, have included agricultural emissions as offsets. This is true for most newly created emissions trading schemes, for example Alberta (2012), California (2014), and China (2018) (Ontario had it, but there, the ETS was revoked in 2018). All of these schemes allow regulated industries to acquire allowances from offsets in agriculture, either avoided emissions or increased sequestration. The latter incentivizes farmers to farm carbon in addition to crops as was also suggested as a policy option for the EU by the Agricultural Markets Task Force. The Canadian province of Alberta, for example, allows farmers to register and implement such projects as conservation  cropping, agriculture nitrous oxide emission reduction, changed beef  feed, methane reducing dairy production and biogas production from manure. The offsets generated under these projects can then be sold by the farmers to Alberta’s industrial emitters that have not met their provincially mandated reduction obligation.

The country with the longest experience in financing farmers for their avoided emissions and increased sequestration is Australia with its Carbon Farming Initiative (2011). Although this formally is not part of an emissions trading system as here the government acquires the offsets rather than regulated industries, the legal rules governing the Australian system are very similar to those in an ETS and can be used as a source of inspiration for a modified EU ETS that includes agricultural emissions. A positive evaluation of the Australian scheme shows that the EU, indeed, can rely on the Australian experiences with its extensive methodologies on a range of carbon farming methods. See our earlier blogpost here and here. These include for example soil carbon sequestration, beef cattle herd management, and beef cattle feed methods. The evaluation does show, though, that the drafting of many rules and regulations is needed, such as rules that require farmers to establish a baseline level of soil carbon, and to monitor, report and verify the amount of CO₂ sequestered in the projects allowed under the ETS offsets regime, as well as rules on commitment periods.

Relationship to other policy instruments

In the EU, as of 2021, agricultural GHG emissions will be regulated under Regulation 2018/841/EU on Emissions from Land Use and Forestry (LULUCF Regulation). It requires emissions and removals in land use and forestry sectors, including agricultural land use for arable crops and grassland, to be balanced. This will require some sequestration efforts due to losses occurring under conventional agricultural practices, but this can also be achieved in for instance the forestry sector. Furthermore, emissions from livestock are not included. Integration of agricultural emissions into the EU ETS, either directly or through offsets, will have to be aligned with the LULUCF Regulation.

Alignment with the EU’s Common Agriculture Policy (CAP) will also be necessary. The CAP currently  encourages farmers to apply climate-friendly practices and techniques. Both the cross-compliance mechanism, the direct payments and the subsidies for rural development relate partly to taking climate measures. It has generally been accepted in literature, however, that current EU climate and agriculture policies are largely insufficient. A much stronger focus of the CAP on climate change is advocated, for instance in this recent study published by the European Commission.

Several individual countries have introduced or are considering the introduction of domestic carbon taxes or even a meat tax aimed at further reducing GHG emissions, beyond the requirements of current EU instruments.  These domestic instruments should also be taken into account when designing a new pricing mechanism for agricultural emissions.

Impact on food security

Research by the World Bank shows that mitigation policies using a global carbon price which does not account for food production implications, will hurt crop and livestock production. To avoid such negative impacts, carbon pricing policies should be developed thoughtfully, and aim for adaptation and food production co-benefits. As discussed in an earlier blogpost, increased resilience and reduced emissions can sometimes go hand-in-hand. It is evident, however, that changes in consumption will be necessary as well. The difficulty of reducing emissions from free roaming cattle and the sheer amount of land needed to grow animal fodder for a world population of around 10 billion in 2050 necessitate dietary changes with households moving away from meat and towards plant based food and seasonal produce, reduced overconsumption of food and reduced food waste. In a great recent article in the new journal Nature Food, Rockström et al. argue that recent modelling analysis suggests ‘that it is biophysically possible to feed 10 billion people a healthy diet within planetary boundaries, and in ways that leave at least 50% of natural ecosystems intact’ as long as there is a global shifting towards healthy diets, increased productivity while transitioning to regenerative production practices, and reduced food waste and loss by 50%. Any regulatory approach towards reducing GHG emissions from agriculture has to contribute to this bigger aim to achieve a global food transition.

These are some of the legal and governance issues that need to be dealt with in the development of a regulatory framework to address greenhouse gas emissions from agriculture. For a full overview of all issues that need to be considered by law and policy makers, the FAO just published this comprehensive legislative study ‘Agriculture and climate change. Law and governance in support of climate smart agriculture and international climate change goals’. In our project, we will be focusing on the EU ETS as a vehicle for reducing agricultural GHG emissions. We will keep you updated here!

26/08/2019

Taxing and Managing Meat: An Integrated Approach to Tackle Climate Change

By Maria Alejandra Serra Barney, Nathalia Cortez Gomez, Lorena Perez Roa and Melanie Auvray (Alumni Tilburg Law School)

A few months ago, a team of four master students from Tilburg University participated in the Geneva Challenge 2018 on Climate Change. Our proposal aimed to tackle greenhouse gas emissions of the livestock industry, by creating a Global Tax Meat Scheme, that would allow countries from all over the world to have a profound transition to a cleaner industry while achieving a change on consumer’s behavior.

Climate Change is one of the biggest challenges of our generation. Action and cooperation from every country is needed, as well as from every sector and industry. While several actions to mitigate Climate Change have been developed in the most acknowledged pollutant industries, such as transportation, mining, or product manufacturing, the severe environmental impacts of the livestock industry have managed to remain in the shadows. Livestock industry alone is responsible for 14.5% of the annual worldwide Greenhouse Gas (GHG) emissions of Carbon Dioxide (CO₂), Methane (CH₄) and Nitrogen Dioxide (N₂O), exceeding the emissions produced by the entire global transportation sector^[1]. Nevertheless, a survey developed by Chatham House along with the Glasgow University in 2014^[2], revealed that livestock sector is not recognized by people as a contributor to climate change^[3]. As a matter of fact, one-quarter of people considered that ‘meat and dairy production contributes either little or nothing to climate change’^[4].

Accordingly, and contrary to popular belief, the livestock industry is responsible for a large amount of the global Greenhouse Gas (GHG) emissions, which are generated through animal physiology (enteric fermentation, respiration and excretions), animal housing, feed crops, manure handling, processing of livestock products and bi-products, transportation and land use for livestock production (deforestation, desertification)^[5]. This should not come as a surprise, considering its strong place in the economies of both developed and developing countries, as the main supplier of global calories, proteins, and essential micronutrients^[6]. Likewise, livestock production is a good alternative in some developing countries that have difficulty growing crops and need to ensure the nutrition of their population^[7], however relying almost exclusively in livestock products entails risks for human health and food security itself. The consumption of meat in developed countries is five times higher than in the developing countries^[8], which increases the risk of colorectal cancer, pancreatic cancer and prostate cancer^[9]. According to the World Health Organization (WHO), red meat (beef, veal, pork, lamb, mutton, horse and goat) has been classified as Group 2A: “probably carcinogenic to humans”; and processed meat (‘hot dogs’, ham, sausages, corned beef, beef jerky, canned meat and meat-based preparations and sauces) as Group 1: “carcinogenic to humans”^[10], just as tobacco smoking and asbestos. This is why the WHO stresses the importance of the reduction on consumption of processed meat^[11], which makes the leading role that meat products have in food security nowadays questionable.

In addition, the increase in the global temperature will have a direct impact on the health and life of livestock animals^[12]. According to experts, the rise in the temperature will enable the acceleration in the growth of pathogens and parasites^[13], which might generate shifts in disease spreading, outbreaks of severe diseases or even introduce new ones^[14], increasing the risk of morbidity and death of livestock. Therefore, relying on livestock products to guarantee the food security in the world might lead to a food crisis in the future.

For environmental, health and food security reasons, livestock production should be limited and regulated. However, when it comes to international environmental treaties and agreements, even though there is a commitment and a mandate for countries to reduce GHG emissions, livestock industry is not really targeted, even though the projections indicate that animal product consumption will continue to increase^[15]. Indeed, UNFCCC and Kyoto Protocol only formulate a fragmented set of rules’^[16] and the Paris Agreement gives general recommendations that prioritize food security rather than targeting livestock industry. Regarding the health and food security issues related to the livestock industry, some countries are already using taxation to encourage healthy eating habits on its population, for instance by raising the prices of sugary soft drinks or sweets. Nevertheless, this approach has never been used on livestock products that, as it was explained before, are known to cause several health issues when consumed in excess.

In this sense, a study on the results on taxing beef, pork and chicken^[17] in Denmark, succeeded to prove that a possible tax on meat would reduce GHG emissions between 10.4% and 19.4% for an average household^[18]. However, we believe that these figures are not enough. Our proposal for the Geneva Challenge 2018 consisted in the establishment of a Global Meat Tax Scheme, which would consider the application of taxes in developed countries and levied on the consumers in order to directly induce changes in meat consumption. It should be collected by national authorities which must ensure that tax revenues are given back to specific actors so they can invest in the development of eco-efficient technologies to support technological improvements of the livestock industry management, or to invest in high protein food alternatives^[19]. Likewise, governments shall cooperate with international organizations in order to promote and support the transition into cleaner technology and farming processes in developing countries .

To make sure that tax revenue funds are safe and utilized solely for the intended purposes, we suggest the utilization of blockchain technology, which would enhance the security of the scheme, guaranteeing the transparency of all transactions being made, and as a consequence promoting trust among governmental entities and individuals. Likewise, States would be under the monitoring and supervision of an international authority, which would assess the compliance of the States and the adequate utilization of the funds.

We invite you to read our full project report for further explanations on this “Global Meat Tax Scheme” and its complementary adaptation and mitigation measures which would allow countries from all over the world to have a profound transition of the industry to cleaner livestock management while achieving a change on consumer’s behavior.

26/05/2015

Enforcement of the EU ETS in the Member States: Further improvements needed

Although the EU Emissions Trading Scheme (EU ETS) has been operating now in three trading phases for ten years and has been extensively covered by legal research, there has been remarkably little attention for the enforcement of the ETS. Although, generally, we have seen an increasing centralization of the EU ETS, monitoring and enforcement still are largely in the hands of the emissions authorities in the states in which the EU ETS operates: 28 EU Member States plus Norway, Liechtenstein and Iceland. As part of the EU funded FP7-project ENTRACTE (Economic iNsTRuments to Achieve Climate Targets in Europe), we did an ex-post evaluation of the legal implementation of the EU ETS at Member State level with a focus on compliance. We wanted to know whether the effectiveness of the compliance mechanism of the EU ETS has been improved over the years and what further improvements (if any) are necessary. We reviewed the relevant EU law in each of the three phases, reviewed previous evaluations and relevant research projects, and evaluated the implementation of the EU ETS in selected Member States, both through existing sources and through interviews with key players in the compliance mechanism at Member State level. The Member States that we studied were Germany, the Netherlands, Hungary, Greece, Poland and the UK.

The EU ETS is the largest trading program in the world designed to combat global climate change.  The theory behind emissions trading is that a market mechanism is established in order to mitigate greenhouse gasses. After a cap is set and potential polluting firms have obtained allowances to emit, they can either (1) reduce their emissions and sell their allowances by for example investing in technological innovation; (2) use their allowances in order to cover their emissions; or, (3) increase their emissions by buying additional allowances on the market. The crucial importance of a well-developed and operationalized compliance chain has been neglected in the original design. In fact, a striking paradox of the EU ETS is that while the idea is that the market should be the place to regulate greenhouse gas (hereafter: GHG) emissions, the system only functions if it operates in a highly regulated context. Market participants must have the confidence that the system is transparent and consistent, and that it guarantees a level playing field for all actors in the 31 participating States because every firm complies with the rules. Effective enforcement of the rules is, therefore, crucial.

The EU ETS legislation originally left a considerable amount of discretion to Member States. This particularly included operational elements of emission trading, such as registration, monitoring, verification, reporting and enforcement issues. Only after European law enforcement agencies signalled that in some European countries carbon trading fraudsters may have accounted for up to 90% of all market activity, with criminals pocketing billions, the compliance issue received increased attention. Moreover, different strategies for ensuring compliance among Member States give rise to distortions of the market for greenhouse gas allowances. The effectiveness and reliability of the ETS, therefore, to a significant extent depends on the effort of each of the Member States. Lack of compliance of only a few or even a single Member State can harm the functioning of the ETS in the entire EU.

We, as well as other researchers in the consortium (see the London School of Economic’ report on compliance), found that compliance with the EU ETS is high.  Most infringements are caused by genuine mistakes and lack of knowledge, not by deliberate actions to evade obligations. The majority of offences concerns the operation of an installation without holding the required permit, exceeding the deadline for submitting the emission report or not monitoring in accordance with the monitoring plan. It is also believed that the verification process pays off: many mistakes are discovered by private verifiers and subsequently rectified. Since prices of allowances have been very low, the majority of allowances are surrendered and not traded. Hence, the EU ETS has not been tested to the full yet, and it remains to be seen whether compliance will be as high in a market under stress (with high prices due to limited availability of allowances).

There are many indications that current enforcement activities will not suffice in a market under stress, although there a big variations among countries. The number of staff employed in the national emissions authorities, for example, differs enormously, ranging from 4 to 5 in Greece and Hungary to 150 in Germany, 40-50 of whom are devoted to inspecting compliance by installations, i.e., checking emission reports, monitoring reports etc. No need to explain what this means for effective enforcement. The biggest loophole that we found in our evaluation is the absence of site visits. Site visits are not yet part of the standard enforcement strategy of most Member States we studied. Only the UK and the Netherlands have a well-developed blueprint for conducting regular site visits on the basis of a risk assessment. There is a considerable risk that non-compliant behaviour will remain undetected when inspectors rely on data provided by the “paper work” that goes with the EU ETS in its  automated system. In the UK, the competent authority regularly conducts site visits as part of its enforcement strategy; 5% of the operators are audited each year. Operators receive notice of these audits since their purpose is more to check than to inspect, although formally the regulator could use its power of entry to perform an unannounced inspection. Regulators in England and Wales have developed a common format for reporting the results of site visits, which are entered into an electronic database. The details include a summary of the visit, any instances of non-compliance detected follow-up actions that have been agreed with the operator.  The findings of the site visit may also be shared with other government bodies. Non-compliance is explicitly recorded to create a database of historical performance for future reference. Follow-up varies from a phone call or a visit to slightly more invasive forms such as a warning. By comparison, in Germany inspection was until 2013 mainly an administrative process done behind the desk at the emissions authority.  This is true for most of the EU Member States. Germany has very recently changed its policy and now officers of the ETS authority do joint inspections together with officers responsible for the enforcement of regular environmental permits, thus benefiting from the experience and knowledge on past performance of the individual company that the latter usually has.

There is not enough space here to cover all the elements of the enforcement system in the Member States that can be improved. Overall, we concluded that Member States can learn a lot from each other’s attempts to close loopholes and fix weak spots in the compliance mechanism. Overall, more efforts should be undertaken to harmonize enforcement practices of the national competent authorities responsible for the enforcement of the EU ETS. This is not easily achieved. Our research clearly shows that compliance assistance is regarded as the most important element of the compliance cycle of the EU ETS: helping companies to apply with this complex regulatory instrument. Such compliance assistance is best offered at the national level in the national context. In addition, we think that the EU, with the extensive legislative framework for the EU ETS that was developed over the years, has exhausted its legislative powers in this area. Therefore, other forms of harmonization (e.g., network based peer review) need to be explored.