Basics of the E.U. Carbon Trading Scheme

How it Came About

The EU carbon trading scheme was a result of the Kyoto Protocol – a treaty of the United Nations Framework Convention on Climate Change, which was ratified by 182 parties and went into effect in 2005.

The Kyoto Protocol calls for over thirty parties or countries involved to either drastically cut their emissions of greenhouse gases or monitor those changes through carbon trading programmes if they plan to increase emissions (such as in the case of developing countries who are only starting to expand into certain high-polluting industries).

Did the E.U. Plan Work?

Being first has its problems, and that’s been evident with the E.U. emissions trading scheme. The first phase of the scheme (from 2005 – 2007) shed light on a major issue:

Because governments involved didn’t have precise and accurate measurements of greenhouse gas emissions from various industries before setting caps, those caps were set much too high. This undermined the whole system.

With industries and firms all having more carbon credits than they actually needed, they had no financial incentive to reduce emissions. This was because everyone else also already had enough permits, so they weren’t interested in buying them. Prices plummeted.

In addition to companies not having any financial incentive to cut emissions, they also had no financial penalty that a carbon trading scheme relies on if they were to emit high levels of pollutants. This was because they had enough credits or permits to cover those emissions, so they weren’t forced to expend resources to purchase more from the market.

By incorrectly setting caps and taking away the incentives and penalties, E.U. countries found themselves in a position where they weren’t reducing emissions after all.

Improvements to the Plan

Despite its problems, all wasn’t lost with the ETS. During this two-year period, governments were finally able to start getting accurate data regarding carbon and other greenhouse gas emissions within their countries and industries. Because of this, the cap on permits has been lowered a great deal for the second phase of the programme (which runs until 2012).

The changes are already being realised, as carbon credit prices are fluctuating in a more traditional supply and demand fashion, demonstrating that some industries and companies are finally finding it to be more cost-effective to cut emissions while others are finding it more cost-effective to purchase additional credits – just as the system was designed.

Last updated 22 September 2008