Solidarity and Efficiency

EU Effort Sharing: A door to flexibility and market mechanisms

April 2015 - In October 2014, the European Council set out the basic principles for and quantitative cornerstones of EU climate change policy for the period 2020 to 2030 (see CMR 4/2014). As in the period 2013 to 2020, reductions in sectors not covered by the EU Emissions Trading Scheme (ETS) are largely to be shared among the member states according to a GDP per capita formula. This approach does not necessarily lead to a cost-effective distribution of emission reductions. There exists considerable, low-cost potential in poorer countries, while richer member states like Denmark and Luxembourg, have already introduced a whole range of reduction measures, especially in the efficiency sector. This means that the remaining potential can only be tapped at higher costs than those involved in reduction activities in, for example, Romania and Bulgaria. This is also evident in the potential analysis contained in the EU Commission’s Impact Assessment, where a cost-effective distribution of reductions was calculated which would lead to greater reductions in poorer countries than would a GDP-based distribution.

Sign of solidarity

Burdening the less-wealthy EU member states with especially high reduction obligations would be politically unthinkable. In many cases, the reductions they are already required to achieve involve some considerable effort. Expecting more from the richer states (in addition to other solidarity mechanisms in the overall climate package) would thus rightly indicate that there is no alternative.

Matching funds with potential

Nonetheless, it would be a less than satisfactory move to invest a lot of money in improving the efficiency of what are already comparatively efficient systems in richer member states like Denmark and Germany, while at the same time investing less in poorer countries such as Romania. This would widen the efficiency gap even further and leave it up to the Structural Fund to close it again. Ingeniously designed flexibility may help here.

Up to now, meaning in the period 2013 to 2020, flexibility has been allowed as follows:

Banking and borrowing between specific years in a certain scope
Limited use of international certificates (CERs/ERUs)
Bilateral transfer of AEAs, the emission allowances under the Effort Sharing Decision (ESD).

Project-based mechanisms were missing from this list. Pan-EU project-based mechanisms will only be possible at purely national level in the period 2013 to 2020. Project-based mechanisms within the EU are set out under the ETS Directive (Article 24a) in principle and are usable in theory under the ESD for the ESD sectors, but this option was never operationalised and so was never truly available. Up to now, the available options for AEA exchange have not been used even though in the early years of that period, all member states were AEA-rich. By way of contrast, in the period 2021 to 2030, real effort will be needed in all countries if the targets are to be achieved. Flexibility will then become economically attractive.

The big opportunity here is to make climate change mitigation cheaper and use climate change investment to write the next chapter of the EU success story - sharing out prosperity. Money, knowledge and technology must be used to tap the lower-cost potential. This brings investment and innovation to economically weaker regions, while opening up opportunities for investment and markets for companies in more efficient member states. In this way, climate change mitigation can again be seen as more of a business opportunity - and as a tool for concrete support, with a direct, positive impact for local populations. Warmer homes, secure jobs and stronger regional economies make solidarity in the EU accessible. And as a result, perhaps, the image of climate change policy can be improved in places where this is still urgently needed.

Action needed

The flexible mechanisms must be designed in such a way that this promise can be fulfilled. In the lead-up to the October Council, Germany and others called for improved flexibility, for example by creating a trading platform for project mechanisms. In the meantime, there are calls from the member states for a certain quantity of AEAs to be auctioned annually to promote market liquidity - some are even talking about the need for a functioning ESD market. Although concrete rules have not yet been discussed, there is broad consensus when it comes to integrating flexibility and market elements/market mechanisms into the ESD.

Proposals for a fitting design of the flexibility mechanisms will take time to draw up. It is important that they meet the following criteria:

Transparency and Integrity: Flexibility must not mean a hollowing out of ambition. All provisions must ensure that double counting is avoided. And there must be no attempt to use flexibility as a smokescreen for feeding hot air into the system
Manageability, broad access, private sector involvement: Flexibility which relies solely on bilateral agreements between member states would appear too cumbersome. Experience gained with the CDM has shown private sector potential in climate change mitigation to be a business opportunity. This can be repeated within the EU, but project-based mechanisms are needed to do so. Policymakers must thus create the conditions and the framework to allow the private sector to unleash its full potential.
State controls, no cherry-picking by private industry at the cost of the member states: As important as the private sector role may be, that of state controls is equally so. Because all member states must make considerable effort, if project-based mechanisms are used it must be ensured that each member state is in a position to prevent cherry picking. Each member state must be able to decide which areas they leave to the private sector, meaning which projects they make eligible for the project-based mechanisms. The states must be able to prevent private companies from selling cheap potential abroad while state funding programmes are used to leverage higher-cost potential.
Visibility: To reap the intangible dividends as well, the climate change mitigation-related benefits to be had from flexibility must be made visible for businesses, private individuals and countries.

Many technical issues must still be addressed. For example, how much centralised supervision is needed beyond the registration process? The situation is somewhat clearer regarding the framework to be staked out and covered by the necessary regulations.

The debate on implementation starts now. At some point in the foreseeable future, the EU Commission will issue calls for tender for the impact assessment on the rules for the non-ETS sectors.

Concrete proposals can be expected at the start of 2016. The time has thus come to develop concrete ideas and feed them into the debate. The Climate Mechanisms Review will continue to report on related developments.

by Silke Karcher

This article was published first in Carbon Mechanisms Review 1-2015