WPAC – Trading in Europe

The European Union Emissions Trading System is the largest multi-country, multi-sector greenhouse gas emissions trading system in the world. So how is this relevant to wood pellets? The short answer is that it is meant to make coal too expensive for power generators. Well then, how well is it working?

The European Union has mandated a 20 per cent greenhouse gas reduction from 1990 levels by 2020 and is working toward legislating a 40 per cent reduction by 2030, thus driving demand for Canadian wood pellets.

We export most of our pellets to thermal power generators in the UK, Belgium and the Netherlands. Since they cost more than coal, wood pellets are supported by a combination of “carrots” (incentives) and “sticks” (taxes and penalties). One such “stick” is the EU emissions trading system (ETS), which is meant to make using fossil fuels unaffordable. However, many believe the ETS has failed. The European Commission and the European Parliament have each recognized the ETS’s shortcomings and are working to remedy them.

Established by an EU directive (similar to a Canadian legislative act), the ETS was launched in 2005. As of 2013, the ETS covers more than 11,000 factories, power stations, and other installations in 31 countries – all 28 EU member states plus Iceland, Norway, and Liechtenstein. Aviation operators flying into or from a European airport are also covered by the ETS.

The ETS works on a “cap and trade” basis, so there is a “cap” or limit set on the total greenhouse gas emissions allowed by all participants covered by the ETS and this cap is converted into tradable emissions allowances. Participants covered by the ETS must monitor and report their emissions each year and surrender enough emission allowances to cover their annual emissions.

Participants who are likely to emit more than their allocation have a choice between taking measures to reduce their emissions or buying additional allowances; either from companies with a surplus or from EU member-state-held auctions. Emissions trading enable reductions to occur where the cost of the reduction is cheapest, lessening the overall cost of tackling climate change.

The ETS has been divided into a number of trading periods: the first period (2005 to 2007), the second period (2008 to 2012), and the third (2013 to 2020). Problems began during the first trading period and have persisted; more emissions allowances were allocated than necessary and a massive overcapacity has continued to build in the carbon market. At the start of phase three, the surplus stood at almost two billion allowances, which has kept the price of emissions allowances to a lowly 5 per tonne.

The current phase has been revised in an attempt to increase the price of carbon; the number of available allowances is to be reduced by 1.74 per cent each year. It remains to be seen whether these changes will raise the cost of emissions allowances.

In the UK, the consensus is that an allowance price of at least 30 a tonne is required to drive investment in low carbon projects so in April 2013, the government implemented a carbon price floor (a level below which the carbon price would not be allowed to fall). Under this mechanism, the government charges a tax on CO2 emissions meant to equal the difference between the carbon price floor and the market value of ETS allowances. It is the combined cost of ETS emissions allowances and the rising UK carbon price support that will eventually make using coal unaffordable for UK generators.

Although regulators have tinkered with ways to increase the demand and price of ETS emissions allowances, a nine-year record of poor performance would indicate that little is likely to change. On the other hand, as the UK carbon price support continues to increase, it will soon become uneconomic for generators to use coal. And since the UK’s treasury pockets all revenue generated from the carbon price support while the carbon price floor mechanism simultaneously helps the UK in reaching its climate targets, it would also seem that the UK government will be happy for the price of ETS emissions allowances to remain low for the long term.

Gordon Murray is executive director of the Wood Pellet Association of Canada. He encourages all those who want to support and benefit from the growth of the Canadian wood pellet industry to join. Gordon welcomes all comments and can be contacted by telephone at 250-837-8821 or by e-mail at gord@pellet.org.