Government defends carbon trading strategy

The government has today underlined its commitment to carbon trading as one of its primary mechanisms for curbing global greenhouse gas emissions, despite the release of a new report from lobby group Sandbag arguing that the world's largest cap-and-trade scheme is in urgent need of reform.

The report calculates that the impact of the recession on the carbon emissions of those companies covered by the EU emissions trading scheme (ETS) has resulted in a huge surplus of up to 1.6bn EU emissions allowances (EUAs) that firms can either sell to generate windfall profits or use during the next phase of the scheme from 2012 onwards to keep the price of carbon credits lower than expected.

According to Sandbag's analysis, falling industrial output has left firms with nearly 400m surplus EUAs, European governments hold a further 300m pollution permits, while firms have access to an estimated 915m offset credits that they can buy from developing countries under the UN's Clean Development Mechanism (CDM) and use to help cover their emissions.

The lobby group claims these surplus carbon credits, which it dubs as "Hot Air" permits", mean that it could be 2015 before firms covered by the ETS have a clear financial incentive to invest in cutting their own carbon emissions.

Sandbag founder Bryony Worthington said the EU should act now to lower the scheme's cap to ensure firms cut emissions 30 per cent by 2020, arguing that with emissions lower than expected meeting this new tougher target will only cost as much as it would have cost to reach the original goal of a 21 per cent cut.

"Weak targets and the effect of the recession have set the EU ETS on the rocks," she warned. "With too many rights to pollute in circulation the scheme is in danger of being rendered irrelevant. At a time when other countries are looking to set up their own trading schemes and the world is set to debate a global deal on how to tackle climate change the EU's flagship policy urgently needs rescuing – starting with much tougher caps."

Henrik Hasselknippe of analyst firm Point Carbon agreed the current phase of the ETS was facing a significant surplus of EUAs and that the roll over of those permits into the next phase would have a "dampening effect" on carbon prices after 2013.

However, he predicted that a tightening of emission caps was possible if UN-backed climate change talks in Copenhagen later this year deliver a meaningful global deal. "Everything depends on Copenhagen and whether the US can pass its cap-and-trade bill," he explained. "If we get a deal then the cap will be lowered to 30 per cent and the fact you can carry over the current surplus of permits will make it easier for firms to meet the new tougher caps."

Responding to Sandbag's report, energy and climate change secretary Ed Miliband said the UK was calling for ETS caps to be lowered if a global agreement to curb carbon emissions is agreed. "The UK has been successful in arguing for big improvements to the EU ETS and making sure it’s far more effective in tackling climate change. The changes mean tighter caps on emissions across the EU, fewer free allocation of permits to industry and much lower access to international project credits – meaning more cuts taking place here in Europe," he said. "As part of a global climate deal we want Europe to up its targets and that will mean a greater contribution from the EU ETS."

Sandbag's call for reform of the ETS comes on the same day as the government released a major new report arguing that carbon trading remains one of the most cost effective mechanisms for tackling climate change.

The report from the Prime Minister's Special Representative on Carbon Trading, Mark Lazarowicz MP, was commissioned by the prime minister and argues that while reforms to current systems are necessary the basic concept of a global carbon market based on interconnected regional cap-and-trade scheme remains one of the most effective ways of cutting emissions.

He said that the evidence suggests a global carbon market combined with tough carbon regulations, green taxes and incentives, and public investment in clean technologies will help deliver substantial cuts in greenhouse gases "rapidly and cost-effectively", while providing "financial flows to the developing world".

The report endorses the government's view that international carbon trading offers the most cost effective means of delivering global cuts in emissions, predicting that the way in which it allows developed nations to fund cheaper emission reduction projects in poorer nations reduces the cost of cutting emissions by up to 70 per cent. It concludes that "this could allow the world to cut global emissions by an additional 40-50% at the same cost compared to domestic action alone".

The findings were welcomed by Gordon Brown who said that the highlighted how carbon markets can support his recent proposals for developed countries to provide up to £100bn in clean tech funding each year to poorer nations.

"Developing the global carbon market is vital if we're to succeed in helping the world avoid dangerous climate change," he said. "The carbon market can deliver a substantial part of the $100 billion a year needed by 2020 to help developing countries reduce their emissions, tackle deforestation and adapt to the climate change already being experienced."

However, the report also raises tough questions about a number of existing carbon trading mechanisms, including the UN's CDM.

Echoing criticism from green groups who have repeatedly accused the CDM of failing to deliver real emission reductions, the report states that "scaled-up mechanisms for supporting developing countries to cut emissions are needed that are more efficient and equitable than the current Clean Development Mechanism".

It recommends that development of sectoral trading as an alternative to the CDM that would see the most polluting industries in the developing world incorporated into global cap-and-trade schemes.

It also argues that integration between the EU ETS and the proposed US cap-and-trade scheme should be delivered as early as 2015 and that developed nations should provide $5bn in funding over the next decade to help emerging economies develop the skills and infrastructure necessary for them to access finance through the carbon markets. In return, it recommends that large emerging economies such as China and Brazil should integrate some parts of their economy into sectoral cap-and-trade schemes.