I worked in the EU’s cap-and-trade mechanism, the Emissions Trading System (EU ETS), for almost seven years.  It probably got me to the conclusion that the EU cannot work, and got me into UKIP.  While I have written pieces that have touched upon the EU ETS in the past, I thought that it would benefit from a dedicated article.  After all, every single power bill that we receive has this cost attached.

The EU ETS was borne out of the Kyoto Protocol in order to manage the world’s output of Greenhouse Gases (GHG) that they believed to be causing Climate Change (I will not discuss whether or not man’s activities are affecting the climate, that is not the point of the article).

Kyoto cut the world into 2 blocs, Annex One and non-Annex One lists of countries.  Annex One countries were considered to be developed, and non-Annex One ones were considered to be developing.  Annex One countries included the USA, Japan, the EU, Canada, Australia, New Zealand, and Russia, the Ukraine and Belarus.    Non Annex One countries included China, India, and Brazil amongst many others.

Annex One countries were given mandatory caps top their GHG emissions expressed as a percentage of their 1990 levels, and to be achieved by 2012, with a full ‘truing-up’ due in 2015.  Non Annex One countries were not set caps or targets.  The rationale was that these countries had still to fully industrialise and develop, and so should not be burdened.  The richer countries were thereby being handed the bill.

Annex One countries were awarded Assigned Amount Units (AAUs) to trade amongst themselves to hit their targets, and based this ‘currency’ in Carbon Dioxide units of equivalence.

Kyoto declared that there were two GHG types, Perfluorocarbons (PFC), Hydro Fluorocarbons HFC), and four GHGs, Carbon Dioxide (CO2), Methane (CH4), Nitrous Oxide (N2O), and Sulphur Hexafluoride (SF6).  Each gas was allocated a carbon equivalent, as follows:

  • CO2 1
  • CH4 25
  • N2O 298
  • SF6 22,800

PFCs and HFCs, being gas groups, have a series of ranges for the different versions of them, PFCs typically being around 8,000-9,000, and HFCs 11,000-12,000.

This means that if you abate/destroy/store one unit of Methane that is the equivalent of destroying 25 units of Carbon Dioxide, destroying one unit of Nitrous Oxide gets you 298 Carbon Dioxide points, and so on.

If Annex One countries were unable to source AAUs to cover their shortfall, they could in a project in another country and generate credits that way.  These are called Flexible Mechanisms.  A Flexible Mechanism based in an Annex One Country was titled a Joint Implementation (JI) and generated an Emission Reduction Unit (ERU), and one in a Non Annex One country was a Clean Development Mechanism (CDM) and generate a Carbon Emission Reduction (CER).  The ERUs counted against the store of AAUs, and thus were subject to overall caps, while the CERs were a potentially an indefinite supply of carbon credits.

The European Union aggregated the member states Kyoto obligations, and passed the responsibility of compliance onto individual installations.  They created the National Allocation Plans (NAPs), which covered around 12,000 installations all with thermic capacity of 20 MW/h or more.  The NAPs includes the power sector, oil and gas refineries, cement works, iron and steel works, ceramics plants, pulp and glassware.  Agriculture and transport were exempted.

Each member state awarded carbon credits to the NAPs based upon audits conducted from 1997-2001 of the installations’ emissions.  These credits are called European Union Allowances (EUAs).  The EU’s aggregated emissions amounted to over 5 billion tonnes of CO2.

The ETS was launched in 2005 with its Phase One, which was designed to be experimental, and did not involve any fines for non-compliance.  All the NAPs were given a full allocation.  Free.  In order to be able to trade the credits, sell surplus ones and buy ones required, the NAPs had to have a functioning National Registry and connection to the International Transaction Log (ITL).

Inevitably, there were delays, and when the market launched hardly anyone was connected to the ITL, and several companies found themselves unable to access a route to market, and the delays were tortuous.  But this chaos was nothing.

Once the first Verified Emissions Report (VER) was issued in 2006, it appeared that there had been a mass allocation of EUAs, and the value of the market plummeted from around €10 billion to zero, as 12,000 installations fled to sell excess credits, and even countries like the UK got in on the act and began to sell credits held back for any new companies (the New Entrant Reserve).  By the end of Phase One in Spring 2008 the value of the credits stood at €0.00 when it had peaked at €32 per metric tonne.

Despite handing a multi-billion subsidy to the power and industrial sectors, the European Commission said that it was always meant to be a trial period, and these were just teething troubles.

Yet this was nothing compared to Phase Two which ran from 2008 to 2012, and is often referred to as the Kyoto Period.

During Phase Two old EUAs were scrapped and new ones issued.  These new credits could now be held indefinitely for compliance purposes.  Critically, in this period the NAPs could use ERUs and CERs for part of their compliance (roughly 15%).  Here the problems really started.

HFC23 has a CO2 equivalent of 11,700.  It is a by-product of HCFC-21, a refrigeration gas which is controlled by the Montreal Protocol.  HCFC is regulated because it is believed that it is blasting a hole in the ozone layer.  The Protocol allowed for the continued new build for HCFC-21 in the developing world (basically the same places as our Non-Annex One) until 2015, when they would have to begin to ramp down production.  HFC-23 destruction is incredibly simple and dirt cheap (less than €0.01 per tonne).  The ‘guide price’ of the EUA was always intended to be around €15-€20 pmt, so to destroy mass numbers of CERs from HFC-23 destruction was a golden opportunity.  The process was so profitable that it actually paid for developers to build new HCFC-21 facilities just to get the HFC-23 by-product and flare it off and take the CERs.  N2O abatement programmes offered similar opportunities, and in particular one French firm Rhodia developed its own carbon unit to take care of the distribution and sales of its CERs from just 4 ‘projects’.  The lack of any caps in China and India made this an absolute goldmine.  It is estimated that this created a €30 billion windfall for the two main host countries.  And the power consumer paid.

There came next the problem of Russia and Ukraine.  Emission levels there had collapsed with the fall of Communism, leaving them with billions of tonnes of AAUs.  This is mostly referred to as “Russian Hot Air”.  Getting the AAUs to market was always going to be problematic.  They had enough to crash the system, but Putin was unwilling to really exercise this right, and they were both very slow to connect to the ITL.  But when they did, it still paid them around €9 billion.  The system allowed for two types of ERU, Track One and Track Two.  Track Two credits were subject to third party verification via the UN run Joint Implementation Supervisory Committee (JISC) which would make sure the credits had actually resulted in GHG abatement.  Track One ERUs, however, could become compliance instruments in the EU as long as the host country validated them.  Amazingly, all credits were generated according to the Emission Reduction Purchase Agreements contracts, and some generated even more than forecast.  Yet again, the EU was fooled, but it was the consumer who paid.

In 2010 a new scandal hit the carbon market.  Organised crime got involved and conducted a VAT carousel fraud that is estimated to have cost the member states in excess of €10 billion, the best guess at the UK’s losses is €2 billion.

Later that year, criminals became involved again, and credits were stolen from members of the NAPs and dumped into the market costing millions to customers.

I was told, also, that money launderers were looking at the market as a means to wash their dirty money.

The questionable behaviour did not stop there.  The European Commission wanted to raise €3 billion for itself, so it instructed the European Investment Bank to sell three hundred million Phase Three credits (2013-2020) that formed the next round of NER, and supposedly ring-fenced for latecomers to the market.  The problem was that due to the recession industrial production had shrunk massively and creating another over-allocation of credits.  The EIB was not going to be able to get the intended for €3 billion.  So the European Commission intervened again.  It amended the Emissions Trading Directive, and withdrew 900 million credits to boost prices.  It deliberately tried to raise prices to aid its sale by taking credits out of circulation.  The problem was, though, that it could not permanently remove the credits without opening up the Directive, and that might fail.  So it awarded itself the right to intervene in Phase Four (2020-2030) if it thinks that prices are too low.  Price rises that will all be passed onto the consumer.

I think that the final straw for me was that all of this gross incompetence and market manipulation has bled the consumers dry by granting billions of Euros to the power companies in windfall profits during the first Phase, gifted billions of Euros to China, India and Russia etc., and opened that whole market up to criminality, and yet the EU considers this dysfunctional racket its ‘flagship’.  Due to the recession, the effects of the Energy Efficiency Directive, the Large Combustive Plant Directive, and the enormous growth in solar and wind energy subsidies the EU has hit its Kyoto target, it has hit its own 2020 target, and will not get stretched until 2027.  But it wants, despite this mass reduction in emissions – the stated goal of the ETS – it wants to squeeze you all again and again, and expose itself to corruption, crime and being used.

Oh, and as a final note.  In 2012 aviation was included into the ETS, shipping to follow in 2018, with plans for agriculture and house building post 2020.

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