Three years ago, the European Union implemented an emissions trading scheme that ties in with Kyoto's credit system. Has the scheme provided any emissions reductions for the region? What lessons can the United States learn from the European Union as it tries to create its own domestic climate policy? During today's OnPoint, Neil O'Brien, director of Open Europe, a London-based think tank, explains why he believes the European Union's emissions program has been a total failure. He cautions that the Lieberman-Warner bill could provide similar results and recommends the United States take a different approach to reducing emissions. O'Brien, author of the report, "Europe's Dirty Secret: Why the E.U. Emissions Trading Scheme Isn't Working" also explains why he believes a cap-and-trade program could interfere with technological innovations.
Monica Trauzzi: Welcome to OnPoint. I'm Monica Trauzzi. Joining me today is Neil O'Brien, director of Open Europe, a London-based think tank that focuses on the direction of the European Union. Neil, thanks for coming on the show.
Neil O'Brien: Thanks for having us.
Monica Trauzzi: Neil, for our viewers who may not be familiar with Open Europe, it's essentially calling for the reform of the E.U. based on economic liberalization. And you also call for greater transparency and accountability in order for the E.U. to be successful in the new century. You recently co-authored a report on the E.U. emissions trading scheme and it's titled "Europe's Dirty Secret: Why the EU Emissions Trading Scheme Isn't Working." So what's the core issue with the E.U. emission trading scheme?
Neil O'Brien: Well, I suppose the core issue really is that it hasn't reduced emissions. So, in the first year of it working, for example in the UK, emissions covered by the emissions trading scheme have actually gone up by 3.6 percent. So I mean that's the core of why it's failing and if you look at the reasons behind that, well, there are some reasons which are specific to the European scheme. But also over the last couple of years of experience in Europe it's become apparent that there are actually some pretty fundamental difficulties about running a cap and trade system. And I'm slightly concerned that a lot of the people who are advocates of cap and trade in the U.S. don't really realize how difficult it is to make these things work. So, I mean one thing that we got wrong in Europe is that we allocated a huge number of pollution permits, more in fact than there was pollution overall. So the price of carbon, within the system, has crashed hugely from being about €33 a ton down to just a couple of euro cents a ton. So there's no real incentive to reduce pollution at all at the moment. But certain other things about cap and trade are just fundamentally very difficult to do. Getting the right allocation is fundamentally tricky because really it involves policymakers trying to guess the future of energy prices, the future of the growth of the economy, the future of technology change for the several years ahead. And in the proposal of Lieberman-Warner that's coming up here in the near future, that's actually a very long period they're trying to guess all those kind of variables over a period going right forward to 2050. I mean at least in the European scheme it only goes forward a couple of years, so it's kind of manageable. So cap and trade is a kind of beautiful idea and it's an inspiring idea that looks like it should work in theory. But actually in practice it's much harder to do than you think.
Monica Trauzzi: We'll get back to Lieberman-Warner in just a moment. Hasn't this trading system provided clarity for businesses though? I know in the U.S. businesses are always calling for a price on carbon because they want to have some certainty for the future. Isn't that the case with the E.U.'s?
Neil O'Brien: No. I mean that's one of the criticisms of it. It's exactly that you don't get certainty. If you have just a straight tax, if the government says there's going to be a $20 a ton tax on releasing carbons from your smokestack factory or whatever, then at least you can say, well, look, we can make this investment to reduce pollution because it will pay off, because we know the tax on carbon is €10 or $10 a ton. If you have an emissions trading system there, the fundamental thing about it is you're accepting that the price of carbon is going to move around. It's going to be volatile. And that's bad because it means that business can't have any kind of ability to plan or have any kind of certainty about what the price of making emission reductions is worth. So either you don't do anything and you don't get emissions reductions, which is what's happened in Europe, or even if you are making investments, it's going to cost you more because there will be firms that are investing when they shouldn't be and there will be firms that won't be investing when they should. So you have this huge uncertainty because you have these gyrating prices. I mean, as I said, in Europe the price has been, at one point, €33 a ton. And a lot of people got really badly burned. Little particularly small players in the system like hospital trusts and so on bought emission permits at the top of the market for €33 a ton and they're now worthless paper. So those guys have all lost out.
Monica Trauzzi: Qualify the success of the trading system then. Is it a total failure or are there some redeeming qualities?
Neil O'Brien: This sounds like a hard thing to say, but really it is at the moment a total failure. It's not reducing emissions. It's very costly. I mean just the administrative burden of running it is about a billion euros a year, so in the U.S. it would be something roughly comparable. All kinds of problems that some of its critics predicted before it started have actually come to pass. Not only have you paid a lot of money and you've not got emission reductions, you're also seeing all kinds of windfall profits for, in particular, big oil companies like BP, Exxon, and Shell have all made a lot in the windfall gains. And also big energy generators, they've made a lot of money. In the U.K. for example the electricity generators have made about two billion pounds, similar figures in other comparable member states. And interestingly, in some of the member states there's now a debate about trying to claw back some of that money using windfall taxes. I mean so we're getting into this kind of spiral of ever more complicated policies. So that's a real problem. And furthermore, it didn't really do some of the things that we hoped for from other environmental policies. I mean one of the arguments that even people who were critical of theories of global warming accepted some of these things are good because they enhance your energy security for example. You don't have to import so much foreign oil. But emissions trading doesn't do that. In the case of the European scheme there was a very good study done by McKinsey for the European commission that shows if we ever do manage to get the scheme working, get up to a serious price of carbon like 20 or €30 a ton, that the first effect will be to move from more coal to more gas burning because that's the one swing sector that can really move. So they say that we would be importing about 13 percent more gas from Putin's Russia if the system does work. In the case of the U.S. you could substitute say Hugo Chavez for Vladimir Putin and you would find yourself importing a lot more gas and using a lot less coal. So you need to be careful about these arguments. Some other environmental policies have clear kind of security benefits, but ETS certainly doesn't.
Monica Trauzzi: All right, so some people would say that you're jumping the gun here. The scheme hasn't had enough time to play itself out and the kinks haven't been given enough time to work themselves out. So, is this too preliminary? Do we need a little more time to see whether this scheme is actually going to work?
Neil O'Brien: Well, the first thing I'd say about that is there is a kind of, sometimes I think it's a kind of mismatch between the rhetoric about, you know, we need urgent action on climate change. And then on the other hand, people say, oh yeah, but we've got to give yet more time. Yes, I know it's not going to work at all until 2012, but maybe it will start to work some time in the 2020s. But it doesn't really sit very easily with the idea that we need to do something about all this stuff now. And more generally, I mean I think there are problems which are simply not easy to solve about all these things. Once you've started handing out free permits to the big polluters and they get windfall gains, it's like farm spending or any of these other kind of big federal pork-barrel spending programs. Lobby groups and private interests get very dug in on all these things. And if you can't face down opposition to these things now for example, I mean some people say the good thing about cap and trade is it lets you get around all these opponents of straightforward taxes. It makes it kind of a bit less clear what's going on. There's a kind of veil of ignorance. But actually it doesn't really work because most people are smart enough to figure out there is a cost to all this stuff. Nothing is for free. And, actually, in some ways, cap and trading makes the cost of what your doing much more visible to certain key groups. For example, if you have a tax on say gas, then a lot of people won't particularly like that here, but at least it's not necessarily doing anything to your international competitiveness. Whereas, if you have a cap and trade system and you have some big, I don't know, iron producer in the Midwest or something like that, then they will be facing a very clear cost to that factory through the cap and trade system. And there will be huge pressure for them to relocate to other jurisdictions where they're not going to face that. I mean a classic rule of taxation is you try and tax things that are not mobile and won't move. And one of the problems with cap and trade is you're taxing firms that are very easily able to move. So why not just go to Mexico, make this stuff there, and then import it into the U.S. tax-free? There's no incentive not to do that. And, again, there's a good study from McKinsey, by McKinsey for the European commission, it shows that for a lot of industries in Europe, if we do get to a serious price you'll see a relocation of aluminum, cement, paper, and pulp, all these things to countries that are just one country outside the E.U. and they can ship the products in. Now, that argument is often being used by people who don't want to see these things done. They say it would bounter off competitiveness, but actually I turn the argument around and say, well, if we're serious about reducing emissions we've got to stop firms from avoiding these taxes. Because if they can just go to another country and emit the pollution there, I mean we've only got one atmosphere, it's the same difference really in the end. So what you want to do is tax things that are not going to move into another jurisdiction and cap and trade doesn't do that.
Monica Trauzzi: So, the combination of the European trading scheme with Kyoto has meant what? Is there a greater ability then for companies to manipulate the credit system because they're able to pollute, but still be within the rules?
Neil O'Brien: Well, the linking of the European system to Kyoto has made things even more complicated than they were already. And, of course, the system that you're being proposed here by Lieberman and Warner would also involve importing a lot of credits from the Kyoto system. It would involve importing about 15 percent of credits from abroad and, of course, if you're importing credits from the E.U. system then you are effectively importing business from the Kyoto system as well because the E.U. system is linked to the Kyoto system.
Monica Trauzzi: Right.
Neil O'Brien: Anyway, there's a serious problem with doing all that stuff. There are two real problems with buying any emissions from abroad. First and the most obvious one is that you are basically subsidizing other people to invest in new machinery and you're not getting the emission reductions yourself. So when you come to the next round of say international climate agreements, then you haven't reduced your emissions. You're in a weak position and then you will come under pressure to reduce your emissions next time around and you've helped other people invest in their machinery rather than investing in your own. Secondly, there are some big specific problems with the Kyoto mechanisms as they stand at the moment. The so-called clean development mechanism credits for example. The reality is that it doesn't really live up to the billing of clean development. Only about 2 percent of the money, about €9 billion that have gone through the system have gone to renewable sources of power. Actually most of it is going to large and very polluting industries, particularly in China and India. So you really end up subsidizing pollution rather than paying for emissions reductions abroad. The whole thing is very, very questionable.
Monica Trauzzi: I want to talk a little bit more about the post-2012 strategy because that's being focused on right now in Bali. In the report you say that an international emissions policy should focus on setting tough and enforceable national targets for greenhouse gas reduction, but should leave decisions on how to reach those binding targets up to the individual countries. So does this fall in line with the Bush administration's call for aspirational goals?
Neil O'Brien: Well, I mean one of the interesting things is you have all these different potential policy tools to try and reduce emissions. And the natural inclination of policymakers is to try a bit of everything, but you can't really do that with cap and trade. I mean the whole point of it is that you are supposed to be letting the market operate in a free way with no distortions. The government are not trying to pick winners and you're letting the market decide where the cost effective way to reduce the emissions are. Fair enough in theory. But, of course, what policymakers then do is they couple that with a whole bunch of other policies. But that's just incoherent because if you're subsidizing for example solar power or wind power or so on, and you also have a cap and trade system at the same time, then all you're really doing is paying to reduce the cost of carbon in the system. Really you're kind of pushing and pulling at the same time and you're paying a lot of money, but not actually getting anywhere. So I think the policymakers and people who are sort of superficially attracted to cap and trade should think quite long and hard about what it really means. And you can't coherently run it with all the other environmental policies that are currently in train.
Monica Trauzzi: So, domestically, do you see red flags here with the Lieberman-Warner bill? You were talking about it earlier. Based on what you've seen in Europe are you concerned?
Neil O'Brien: Yeah, I would be concerned for your sake because in some ways what you're trying to do is even more complicated than what we've done and we've not managed to make our system work. I mean that's not because we've been stupid or anything like that, it's just fundamentally a tricky thing to do. Lieberman-Warner is complicated, more complicated in two different ways. Firstly, you have this very overt move to import 15 percent of credits from abroad. And that would cover all of the scarcity in the system until 2021. So until the 2020s you're talking about not making any emission reductions through the scheme yourself. You're going to be paying people in China to make emissions reductions. So, that's one thing. And secondly, in the E.U. scheme, and there was at least a certain simplicity because you have to effectively cash in your chips in 2008, in 2012, so it was quite easy to work out what the scarcities in the periods were. It was kind of simple. Whereas Lieberman-Warner proposes a single schedule, really going forward all the way to 2050. And the uncertainty that that's going to cause in the system means it will be very, very difficult for anybody to rationally work out what the price of carbon is going to be because you can roll over allegations of free allegations between different years. There are all kinds of variables about the credibility of the system and, really, I would anticipate an even more volatile or uncertain price within the American system than the E.U. one, which is going to make it very, very hard for businesses to invest. And so you won't get the kind of technological innovation that is the whole point of this exercise.
Monica Trauzzi: Interesting thoughts. A lot of businesses in the U.S. are calling for a cap and trade to provide more certainty. So it will be interesting to see how things shake down.
Neil O'Brien: You've got to be careful what you wish for sometimes.
Monica Trauzzi: Yeah. Thanks for coming on the show.
Neil O'Brien: Thanks very much. Cheers.
Monica Trauzzi: This is OnPoint. I'm Monica Trauzzi. Thanks for watching.
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