Polluters' windfall: Carbon into gold

By James Kanter
Wednesday, December 10, 2008
BRUSSELS: The European Union started with the most high-minded of ecological goals: to create a market that would encourage companies to reduce greenhouse gases by making them pay for each ton emitted into the atmosphere.
Four years later, the carbon trading system has created a multibillion-euro windfall for some of the Continent's biggest polluters, with little or no noticeable benefit to the environment so far.
The lessons learned are coming under fresh scrutiny now, both in Europe and abroad. EU leaders will meet Thursday and Friday to work on the next phase of their system, seeking, they say, both to extend its scope and correct its flaws. And in the United States, President-elect Barack Obama has pledged to move quickly on a similar program.
As originally envisioned in Europe, companies would buy most if not all of the permits needed to cover their projected carbon dioxide emissions for a year, one permit good for each metric ton of CO2, the main greenhouse gas. If they produced more gases than expected, they would have to buy more permits; if they came in below target, they would be able to profit by selling their extra permits to companies that were polluting over their limit.
The initiative also included another, quieter goal: to raise the price of electricity by letting utilities pass along permit costs, thereby encouraging energy efficiency and innovation among customers as well.
But the system that emerged was far from that model.
After heavy lobbying by giant utilities and smokestack industries, which argued that their competitiveness could be impaired, the EU all but scrapped the idea of selling permits. It gave them out for free, in such quantities that the market came close to collapsing because of a glut.
But in line with the original strategy, utilities in countries from Spain to Britain to Poland still put a "market value" on their books for the permits and added some of that putative cost to the prices they charged industrial customers for electricity. And they did not stop there. In one particularly contentious case, regulators in Germany accused utilities of charging customers for far more permits than they were entitled to.
Nowhere was this behavior more evident than at RWE, a major German power company, which has acknowledged that it is the biggest carbon dioxide emitter in Europe. Bank analysts and environmental advocates estimate RWE had received a windfall of roughly €5 billion, or $6.5 billion at current exchange rates, in the first three years of the system, ending in 2007 - more than any other company in Europe.
In a confidential summary of its findings, obtained by the International Herald Tribune, the German cartel office in late 2006 accused RWE of engaging in "abusive pricing," piling on costs for industrial clients that were "completely out of proportion" with its own costs. It called for cuts of up to 75 percent.
RWE settled the case last year while denying any wrongdoing. It says price increases from 2005 to 2007 predominantly reflected higher costs for hard coal and natural gas.
Europe's overall experience with carbon trading has been a sobering one.
Its implementation has been marked by maneuvers and adjustments to the original framework that have yielded significant cost benefits to many of the Continent's biggest polluting industries. Meanwhile, the amount of CO2 emitted by plants and factories participating in the system rose 0.4 percent in 2006 and an additional 0.7 percent in 2007.
The United States is now considering a system of its own, with Obama proposing to make industries buy all of their permits. He has said he would devote $150 billion from the sale of those permits over 10 years to energy efficiency and alternative energy projects.
Many of the framers of the European plan, meanwhile, have thought hard about the way the legislation evolved as they prepare to take up the next phase. But they face the prospect of trying to close numerous lucrative loopholes while confronting the same tug of war between lofty environmental goals and their immediate economic costs - a challenge made even more difficult by the onset of recession.
During long negotiations on the landmark Kyoto climate treaty more than a decade ago, the United States, through the administration of Bill Clinton, was the loudest in insisting on including a reference to "emissions trading" in the treaty. Americans had pioneered such markets in the 1970s and used them on a broader scale during the 1990s to reduce emissions from power plants blamed for acid rain.
U.S. officials argued that markets were the most effective way of encouraging innovative, emission-reducing technologies.
The European Union initially opposed emissions trading in favor of direct taxes on polluting industries, but later agreed to trading as the price for ratification.
The United States, however, ended up failing to either ratify Kyoto or to require U.S. companies to enter a carbon trading market outside of the Kyoto accord. But the European Commission, the EU executive body, began working on plans to start such a system in Europe.
"We ourselves had invested so much in the Kyoto Protocol in choosing a global deal," Margot Wallstrom, who was the EU environment commissioner at the time, said during a recent interview. "I was eager to put it in place as soon as possible."
Today, the EU system represents about 75 percent of global carbon trading - a market worth about €60 billion in 2008, according to Andreas Arvanitakis, an analyst with Point Carbon, a research company.
Yet from the start, Wallstrom, who is now a vice president of the European Commission, said she was lobbied heavily by governments and by companies, seeking to limit the financial burden. She would not comment on any specific contacts. But Eurelectric, the main electricity industry lobby group, and its German affiliate met often with EU environment officials to discuss the shape of the emissions trading system.
A decision was made to limit the initial scope to some of the most energy-intensive sectors of the economy: electricity, glass, steel, cement, and pulp and paper. They were chosen primarily because their stationary factories were easier to regulate quickly than moving targets like transport or aviation.
The original idea of charging for all or even most of the permits never gained traction.
Many politicians said they feared that burdening European industries would undercut their global competitiveness, since rivals in Asia or the United States would not have such extra costs imposed on them.
In addition, Europe's energy market for industrial customers was opening to cross-border competition almost simultaneously.
Wallstrom and others at the commission describe the decision to give away the vast majority of permits as having been a necessary concession to get all the players in Europe on board - especially at a time when the Kyoto climate treaty was under attack from the administration of President George W. Bush.
Still, lawmakers at the European Parliament initially sought to require industry to pay for at least 30 percent of its permits, then 15 percent. (The actual trading price on the futures market at the time ranged from €5 to €13.)
But after long negotiations with EU governments, the Parliament enacted a law on July 2, 2003, allowing up to 100 percent of permits to be given away until 2013. Governments could sell some of the permits, up to 5 percent, but only Denmark, Ireland, Lithuania and Hungary did.
Denmark sold the full 5 percent, earning 226 million Danish kroner, or more than €30 million at current exchange rates. Had all the Danish permits been sold at the same price, the government could have reaped more than €600 million for the national budget.
The EU system is highly decentralized, reflecting the political reality of a bloc that now numbers 27 countries. Thus, the lobbying did not stop in Brussels, but moved on to national capitals, where governments were left in charge of setting emissions levels and distributing the permits to companies within their borders, often with deep political connections.
The EU system already is having an effect on business opportunities in parts of Asia, where companies from rich, developed parts of the world can invest in carbon-reducing projects in countries like India to earn additional permits.
Because companies like RWE are obliged to buy larger numbers of permits to meet stricter EU pollution targets, they are increasingly attracted by these so-called CO2 offset projects, which are regulated by United Nations officials in Bonn.
Through these projects, RWE could obtain a substantial number of its required permits and do so at substantially less cost than buying permits on carbon markets in Europe.
As part of these efforts, RWE has said it is distributing low-energy light bulbs in India in exchange for UN-approved permits India and has said it bought similar permits that were generated by a composting project in China.
These carbon offsets are quickly becoming a major plank of European Union climate policy.
Proponents of these projects say they have succeeded in channeling billions of euros toward low-carbon investments in developing countries.
But the trade has also has raised questions about whether it represents genuine emissions cuts and about whether it is holding back a transition to greener power within Europe.
So far there are few signs that the carbon-trading system is cutting emissions. The amount of CO2 emitted by plants and factories participating in the system rose marginally in 2006 and 2007, according to the European Environment Agency. (Neither it nor the European Commission made any forecast before the system started about how it would perform.)
Even so, the EU environment commissioner, Stavros Dimas, said in May that emissions would "most likely have been significantly higher" without the carbon trading system.
He called the 2005 to 2007 period a "learning by doing" phase, and noted that limits on emissions have been tightened for the 2008 to 2012 trading period and the glut of free permits lessened, meaning the price should rise.
But negotiations on how to meet even more ambitious targets after 2012 are in danger of coming undone as the economy worsens.
Prime Minister Silvio Berlusconi of Italy has led the assault on the package, saying that he was not in office last year when it was agreed on.
"We don't think this is the moment to push forward on our own like Don Quixote," he said at a summit meeting in October. "We have time."
Poland - which depends on coal-fired plants for 95 percent of its electricity - has threatened to block the package at another summit meeting Thursday and Friday if a compromise is not found to lessen the burden on its energy sector.
RWE, meanwhile, insists that having to pay for all its permits, starting in 2013, with no phase-in period, would distort competition across Europe, which has recently opened up to cross-border energy sales.
"Companies such as ours that are giving coal a future and rely on coal-powered generation will find themselves at a distinct disadvantage vis-à-vis companies like Électricité de France, which rely solely on nuclear and have virtually no CO2 to deal with," said Jürgen Frech, chief spokesman for RWE.
Industrial customers in Germany are issuing dire warnings of ballooning electricity prices they say are sure to come if utilities try to maintain their profit margins while complying with costly new rules.
The French president, Nicolas Sarkozy, who is leading the political horse trading, continues to push for an agreement. "Europe must be an example for others," he was quoted as saying Saturday in Poznan, Poland.
Nicholas Stern, one of the world's foremost authorities on the economics of climate change since presenting a report for the British government in 2006, said during a recent interview that the United States should draw lessons from Europe's example. He recommended that Obama move quickly toward charging industry for the permits, to avoid such repeated, drawn-out battles.
"Everybody will fight their own corner," he said. "That's why it's so important to have a clear conception from the start."
Paul Geitner contributed reporting from Paris.