The European emission trading scheme: lessons for Ontario

The EU emission trading scheme (ETS) offers valuable lessons for other jurisdictions looking to get into carbon cap-and-trade. Phase 2 of the ETS became effective three days ago. Will it correct the central deficiency of Phase 1, which was over-allocation of carbon permits?

You will recall that in Phase 1, certain EU national governments were over generous—some would argue deliberately over generous—with carbon permit allocations (see article). The more allocations granted, the cheaper carbon permits became, and the less incentive coal-fired power companies had to deviate from business-as-usual and actually reduce emissions.

Early indications are that the ETS is at least moving in a direction that could bring about significant carbon prices. The European Commission (EC), which administers the scheme, chopped Germany’s proposed quota of 482 million tonnes by six percent, down to 453 million tonnes. In combination with a Phase 2 policy that allows each member country to auction up to 10 percent of its carbon permits, this new administrative toughness might keep permits in the system to a minimum and drive up their market price, which is the whole idea.

Phase 3 draft rules are coming on January 23, and there are rumours that power companies and some governments are lobbying for full auctioning of permits. This would make permits truly expensive.

It will also force EU governments to recognize that nuclear power is the best way to provide cheap non-emitting power on a large scale. The ETS’s main limitation is that Germany, the EU’s biggest greenhouse gas (GHG) emitter, is phasing out nuclear generation. Keeping Germany’s anti-nuclear policy in mind, the ETS’s designers hoped that putting a cost on carbon emissions would spur a sort of anti–Manhattan Project—a giant collective effort to find a non-emitting, non-nuclear way to generate massive amounts of power. It has been obvious all along that this won’t happen, no matter how big or how hard they dream. The only ways to reduce Germany’s power-sector GHGs without adding new nuclear plants are to shift from coal to expensive Russian natural gas or to force coal generators to capture and sequester carbon. Either option would jack the price of power up into the stratosphere.

Few politicians are willing to publicly author a policy that results in massive electricity price hikes. So, presented with choice between a rock and a hard place, EU governments, including Germany, chose to go easy on their domestic power generating companies. Hence their generosity with carbon permits in Phase 1 of the ETS. And hence Germany’s attempt to over-allocate in Phase 2.

But with the EC’s semi-clampdown in Phase 2, the rubber is now about to hit the road. Will Germany choose to force its power generators to buy 10 percent of its permits at auction? If so, power consumers in that country will start feeling the sting of high prices. Will they stay anti-nuclear?

In my previous post, I pointed out that the atom is the most likely way the Ontario power sector will meet Canada’s new 18 percent emission reduction targets by 2010. A reduction this size would bring power generation emissions to below the original Kyoto target for that sector in that province. (The Kyoto target for Ontario’s power sector is 24.8 million tonnes; see Environment Canada’s website.)

Luckily, the Ontario and federal governments aren’t hamstrung by anti-nuclear theology. In light of this high likelihood of success, should the federal government bet on the winning pony and help Ontario meet the 18 percent target? If it did, within two years Canada would have a success story, and a best practice, to show off to the world.

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