David Merlin-Jones: The EU's flagship environmental policy is producing crime, corruption and profiteering

David Merlin-Jones is a Research Fellow in economics and energy at Civitas.

The EU’s flagship environmental policy is a disaster on a titanic scale. Not only is it adding to energy bills, aggravating fuel poverty and leading to international trade wars, it has also had no real environmental benefit and is unlikely to provide any until 2016, over ten years since its inception. Indeed, the only beneficiaries of the EU’s Emissions Trading System (EU ETS), the jewel in the crown of European climate change legislation, are big banks and businesses making windfall profits.

The EU ETS is a cap-and-trade scheme, meaning there is an upper limit to the emissions allowed in EU countries. This quantity is represented by transferable credits dished out to the ten thousand or so installations covered by the ETS across Europe, a mix of factories and power stations emitting the most CO2. Installations are given a set level for free and must buy extra credits if they emit more CO2 than their allowance permits, or they can sell their spare credits. The theory goes that, as the cap falls, the price of credits rises and companies are forced to invest in reducing their emissions. The scheme was set up in 2005 and is promised to run until at least 2020, with the cap getting increasingly tough from 2013.

The EU promised that the ETS would deliver maximum emission reductions at minimum cost. However, it has failed at both aims. Judging it by environmental standards, the caps for many countries are so large that the 2012 cap for 20 member states, including the UK, are higher than measured emissions in 2005! This means that far too many credits have been given out to installations, leaving many with a surplus worth billions of pounds if sold. Rather ironically, the credits owned by the ten companies with the largest surpluses have a combined worth of €4.1 billion, four times larger than the EU’s environmental budget. Indeed, half of all covered installations are unlikely to have to make any reduction in their CO2 emissions until 2016-18 but can make windfall profits through selling their free credits instead.

Regardless of this uselessness, the economic consequences of the EU ETS are severe. Despite the fact that companies have so far been receiving the majority of their credits for free, some have been passing on their non-existent ‘cost’ to consumers. This is especially prevalent in the energy sector and bill payers have seen their rates soar. It is estimated that, throughout Europe, energy companies will have made €16-50 billion by passing on this cost. Even when the power industry faces having to buy all its credits from next year, it will still just pass this cost to ordinary consumers, so it has little motivation to invest in reducing its emissions to drive down costs. This could lead to a very nasty jump in energy bills, and it will aggravate the fuel poverty that already affects a quarter of UK households.

In business terms, the EU ETS is likely to cause real problems. Given that the covered installations are the most CO2-emitting, they are often energy-intensive. While they receive their credits for free, as this allowance declines, the negligible EU ETS costs on energy-intensive UK companies’ energy bills at present will rise to around £3 million by 2020. As a result, many firms might emigrate to less punishing regimes, taking valuable jobs with them while the UK simply imports their products. This is an environmental as well as economic nightmare and hides the truth that has already begun. While the UK prides itself on having reduced carbon production by 15% from 1990-2005, carbon consumption has actually gone up by 19% because of this. Effectively, the EU is pushing industry abroad to meet its own green targets and is quite happy to risk a rise in global emissions to do this.

This year sees the introduction of aviation to the EU ETS and, with it, a whole host of new problems.

For a start, the System is supposed to cover all airlines that make flights in, out and within the EU, forcing them to buy credits to offset their emissions, regardless of whether they are European or not. Having insisted on this, the EU has created a grand alliance of China, India, Russia and the US against it. All these countries have pledged to oppose their inclusion and effectively told Europe to mind its own business. Worse, they have promised countermeasures if the EU does not back down. Soon, Heathrow could find itself boycotted as extra-EU airlines avoid having to pay the charges and airports such as Geneva could find themselves the new commercial flight hub of choice. This is bad for the UK as whole given the business opportunities it will find itself missing out on.

The ETS has also been a paradise for criminals. Security in the entirely electronic system is so weak that phishing scams, the simple stealing of passwords to access accounts, shut down the ETS for two weeks. The European Law Agency has even estimated that 90% of all ETS market activity in 2009 was fraudulent. In cost terms, €5 billion has been lost so far from just one kind of VAT fraud. To counter crime, a common auction platform is being developed. However, given that countries are able to opt out of this (and the UK already has), the lax security is only likely to continue.

Other beneficiaries of the EU ETS include extra-EU companies deliberately producing emissions to take advantage of the scheme. ETS installations are able to buy up to half their allowance in the form of the cheaper credits available through the Kyoto Protocol’s Clean Development Mechanism and these credits, called Certified Emission Reductions (CERs), are worth the same as EU ETS credits. These are generated by reducing emissions in developing nations and were designed to incentivise green investment there. However, entire companies have developed to manipulate this. In China especially, firms produce the gas HFC-23, which is 11,700 times more potent than CO2 so it generates 11,700 credits for each tonne destroyed. With a profit margin of 7,000%, it is little wonder the World Bank has invested in some of these firms (and lobbied to delay the EU from banning them) and the Chinese Government even taxes the firms’ profits at 65%. The only other winners are the big financial firms that assess the worthiness of these projects on behalf of the UN and are paid on the number of CERs they can generate for their clients: a gross conflict of interest. A study of the top five UN-accredited validatory bodies found that on a scale from ‘A’ (very good) to ‘F’ (very poor), none scored higher than ‘D’.

The EU ETS is not fit for purpose and there is little reason to foresee the scheme getting better. Indeed, as auctioning grows and prices of energy and goods are forced higher, the average consumer will be made worse off and for nigh on no environmental benefit. The EU technocrats have buried their head in the sand about this and all ‘solutions’ have been minor and tokenistic. As far as they are concerned, to admit the scheme is flawed is to admit they are wrong. This is not something they wish to advertise. Overall, the ETS has been hijacked and become a route to extract money out of good intentions, and this goes for the UK Government as well, which will receive £4-8 billion from it per annum from 2013 but refuses to earmark it to spend on energy-related issues or alleviating fuel poverty. As a consequence, it would be hard to defend it against accusations of being a stealth tax.

So what’s the solution? Put simply, if the EU cares about reducing emissions, it should scrap the ETS. It should also do so if it wishes to end the lobbying, crime, corruption and profiteering that consumers are paying for. A carbon tax would be far better and could be much cheaper while still raising large sums to invest in upgrading our energy supply. The UK should make a stand on the issue as well. In environmental terms, the self-proclaimed ‘greenest government ever’ should not be content to worsen global emissions through the ETS, even if this is lucrative. The Government should withdraw Briton from the scheme and replace it with something better for our businesses, our energy bill payers and our environment.